The private market investments sector has grown rapidly in recent years. For example, in the Euro area, compound annual growth rates between 2010 and 2023 stand at 10% for private equity funds, 14% for private credit funds and 12% for real asset funds,¹ while in the UK assets under management in private markets funds has almost trebled in the decade to 2023.²

Governments and regulators are seeking to improve access to private markets in order to promote investment in long-term, productive assets. For example, in the EU, European Long-Term Investment Fund (ELTIF) fund launches have accelerated since the introduction of ELTIF II, the Alternative Investment Fund Managers Directive II (AIFMDII) harmonised loan origination fund regime aims to boost cross-border lending within the EU,³ and the Letta report calls for a clear strategy to bolster private equity and venture capital.⁴ In the UK, the National Wealth Fund aims to crowd private investment into clean energy and growth industries primarily through private assets, The Pensions Regulator (TPR) has issued guidance encouraging pension schemes to consider investing in private markets following the Mansion House Compact,⁵ and upcoming reforms to the AIFMD and the retail disclosure regime are intended to make them more proportionate for alternative managers and investment trusts.^6,7

As the market grows, it is attracting greater scrutiny from supervisors. Key concerns include potential systemic risk, especially in light of interconnectedness between private markets and the banking sector, and consumer protection as the sector expands into retail markets. The sector is seeing an increase in both direct supervisory engagement and indirect scrutiny (e.g. via banking supervisors probing banks’ interactions with the sector). To respond effectively, firms need to ensure that investment in their risk management frameworks and operational capability keeps pace with the growth of their investment teams. This includes more formalised processes and controls, better use of technology and data, and strong governance.

Valuation
 

Valuation is a key supervisory focus area. In the UK, the Financial Conduct Authority (FCA) is conducting a multi-firm review of valuation governance of private assets, while in the EU, there is increased attention since the European Securities and Markets Authority’s (ESMA) valuation review highlighted particular risks for private equity and real estate assets.⁸

Of particular concern is that subjectivity and conflicts of interest in the valuation process could result in inaccurate valuations. While values are ultimately crystallised on exit, before then inflated values can support borrowing, avoid covenant breaches, support fund performance (and potentially annual performance fees), and result in unfair prices for any investors entering or exiting the fund during its lifecycle.

We think that key elements to a strong valuation process include having the right level of resources and expertise, using high-quality data as inputs, robust challenge at key stages of the process especially around any key assumptions and judgements made (for example, if a set of comparable companies is used, how these have been chosen), and clear documentation of why decisions have been made. As recently highlighted by the Luxembourg’s Commission de Surveillance du Secteur Financier,⁹ firms also need robust controls to identify and prevent errors in the process.

Where firms do not have the right level of resources and expertise in-house, they may use a third-party valuer. When doing so, they need to ensure that the information they provide to the valuer is complete and accurate, that they are satisfied with the robustness of the methodology, and that they review the outputs carefully before approving the valuations.

Where firms with a minority stake in a company have limited information about it, they may be able to find out how a co-investor has valued it. However, they are still responsible for their own valuation. When making new investments, we think firms should consider whether they have sufficient information rights to enable a robust valuation. If firms cannot negotiate better information rights, they should consider whether there is sufficient public information available, and how any valuation uncertainty feeds into their investment risk assessment and overall risk appetite.

In our view, firms should review their valuation committee to ensure that responsibilities are clearly defined and there is sufficient independence and senior-level expertise. We think that governance committees should ensure that the assumptions behind valuation models are robust and periodically back-tested. They should also understand how valuation models may interact with other models used across the business (e.g. models used for credit risk underwriting may provide inputs into valuation models) and the limitations of these models. The Prudential Regulation Authority's (PRA) expectations on model risk management – while not directly applicable – contain some useful principles for firms looking to improve their valuation model governance.¹⁰

Systemic risk

Supervisors are increasingly focusing on whether and how private market investments could cause systemic risk, especially where there are high levels of leverage, concentration and interconnectedness. The current high interest rate environment is leading to difficulty exiting investments, which has resulted in some firms taking on further leverage to refinance their investments or fund dividend payments. Regulatory and supervisory interest in the sector fits into a broader focus on the risks posed by non-bank financial institutions (NBFI).

In the EU, the new AIFMD II regime imposes leverage limits on loan origination funds, the European Supervisory Authorities have been assessing how private credit could contribute to systemic risk,¹² and the Commission is consulting on the adequacy of macro-prudential policies for NBFI.¹³ In the UK, the Bank of England (BoE) has been assessing how vulnerabilities in private equity may affect the wider financial system, while the PRA has been focusing on the adequacy of banks’ risk management frameworks governing their private-equity-linked finance businesses –^14,15 which may result in banks asking private equity firms to provide more information to help them understand interlinkages and risk correlations between different transactions. The Financial Stability Board has also been focusing on liquidity preparedness for margin and collateral calls,¹⁶ which is particularly relevant to firms with highly leveraged positions.

We think that private markets firms are likely to see increased supervisory scrutiny on their risk management frameworks and tools, including stress testing, risk limits, early warning signals as a stress event approaches, and increased governance in times of stress. We think that private credit managers should also examine the robustness of their credit risk management and underwriting standards, which the BoE notes have weakened over the past few years.¹⁷ In our view, some firms would also benefit from more automated and streamlined processes to monitor their portfolios, so that they can identify financing issues and work with borrowers before these become more significant.

Private markets firms will also need robust data governance to ensure good data quality to enable them to manage risks effectively. In addition, we expect private markets firms to receive more data requests from supervisors, including exercises such as the BoE’s system-wide exploratory scenario.

Private markets firms may also face tighter credit conditions from banks once the final Basel III reforms are implemented, effective from 2025 in the EU and expected from 2026 in the UK as some types of lending may incur higher capital charges – they could engage with banks to understand whether there are any actions that they can take to mitigate this (e.g. having the debt rated).

Retail investment
 

There is increasing retail participation in private markets. For example, a survey of 800 European fund selectors found that respondents (including wealth managers) significantly increased their allocation to private equity and debt between H1 2023 and H1 2024 (see Figure 1), and also planned to increase their adoption of private equity over the next year.

Figure 1: intermediaries allocating to private markets rises (%)

Source: Broadridge¹⁸

Policymakers are seeking to encourage retail investment, for example through reforms to European Long-Term Investment Funds (ELTIFs), Long-Term Asset Funds (LTAFs) and the pensions market. In 2025, the European Commission is expected to make proposals to channel more EU savings and pension investments into the EU economy,¹⁹ which could include incentives to invest in ELTIFs.²⁰ Where firms expand into retail markets, they will need to consider carefully how they meet retail investor protection rules, including Markets in Financial Instruments Directive (MiFID II) and, in the UK, the Consumer Duty.

Expanding into retail markets will have significant implications for product design. For example, retail investors may prefer an open-ended fund – firms will need to think carefully about redemption terms to ensure they can manage liquidity effectively, and make clear to retail investors how liquidity management tools could delay the return of their monies. Offering liquidity during the fund’s lifecycle will also increase the importance of accurate asset valuations. In addition, UK managers will need to demonstrate that their fund provides value to retail investors in line with the FCA’s focus on long-term value.

Investment managers will also need to consider their distribution strategy and build new relationships with distributors. We think firms should pay particular attention to defining an appropriate target market, working with distributors to ensure that the product is reaching the intended target market, and ensuring that their product information is clear and understandable to retail investors (especially regarding the risks and charges).

Conclusion
 

While Governments and regulators are keen to facilitate investment in long-term, productive assets, they also want to ensure that firms have robust controls in place to mitigate risks to the market and to consumers. We think firms should invest in their risk management and operational capabilities, including their use of technology and data.

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