Bank of England warns that mounting pressure on the £6.5 trillion (£6.5 billion) private equity sector could lead to a crunch, which would cause banks to suffer large losses and trigger a crisis in the real economy.
Regulators are increasing their scrutiny of the private-equity market, amid concerns that the sharp rise in interest rates over the last two years is creating problems for a heavily debt-dependent industry.
Nathanael Benjamin’s, Bank executive director of financial stability strategy, and risk, Nathanael Benjamin warned on Monday that it was difficult to gauge the magnitude of the threat due to the “opacity and complexity of the sector”.
He warned recent developments could not only “disrupt funding supply to real economy businesses in a stressful situation”, increasing the risk that private equity-backed companies would cut jobs, but inflict significant and correlated losses on systemic institutions such as banks that are vulnerable to the industry.
Benjamin said that it is “not difficult to understand” why the dynamics of this area “causes us concern related to financial system as a entire”.
He has made the most detailed comments yet about the dangers posed by private equity. The comments come after the central banks financial policy committee announced last month it would be conducting a more thorough review of private equity risk and publishing its findings in June.
Private equity firms, also known as “buyout” firms, use debt to purchase companies. The market grew quickly during the ultra-low-interest rate period that followed the financial crisis of 2007-2009, from $2 trillion to $8 trillion last year.
According to estimates, British companies that are backed by venture capital and buyout firms, such as Alton Towers’ owner Merlin Entertainments, and Wagamama employ 2.2 millions people worldwide. Suppliers to these businesses also have another 1.3 million employees, the industry says.
Benjamin stated that private equity is a significant sector within the financial system, and also for the real economy. He added that recent increases in borrowing costs have increased the challenges faced by the industry.
Benjamin warned that while many companies with high leverage and buyout houses are seeking to refinance their debt, they risk delaying the effect of the higher interest rates and increasing future credit losses.
He added that the crash in the listing market has also made it difficult for private equity firms who own companies to sell them through the stock market. The sector has seen a rise in borrowing as firms look for alternative ways to release liquidity. This includes loans backed by their net assets, dubbed “leverage on lever”.
Benjamin said that this not only raises “natural questions about risks associated with these financing arrangements”, but also threatens to increase risk profiles for the banks and credit funds who provide the leverage. Benjamin warned that the situation was further complicated by the lack of transparency regarding private market valuations, leverage levels and the increasingly complex and interconnected links between private equity and wider financial system.
Michael Moore, Chief Executive of the British Private Equity and Venture Capital Association said: “The Private Capital Industry stands ready to explain how it has played an important role in the UK’s economy for more than 40 years and shown its resilience throughout different economic cycles.”