The World Federation of Exchanges (WFE) released a paper showing a need for enhanced oversight and policy coordination as private investment markets balloon.
Traditionally a complement to public capital markets, private markets have expanded rapidly, aided by policy incentives, raising critical questions about how this unchecked growth could pose significant risks to market integrity, retail investors and potentially even financial stability. In a new paper, Strengthening Private Markets, the WFE calls for improved data and supervisory scrutiny, more global policy focus, and a fairer balance of incentives between public and private markets.
The key risks of unsupervised growth of private markets are identified in the paper:
- Systemic risk: Increased leverage, opaque valuations, and the bundling of private credit with equity introduce complex risks. These need closer scrutiny to avoid destabilizing impacts on the wider financial system.
- Risk to retail investors: Disclosures must be strengthened, and risks clearly communicated. High fees and illiquidity pose additional concerns for non-professional investors.
- Unmonitored secondary trading: The emergence of new trading platforms for private assets could affect public market pricing and integrity. There must be supervisory reporting of such trades and potential disclosure to the public.
Risk and secondary trading
Secondary trading, in its various forms, needs to be quantified and assessed, in its own right and in terms of any interaction with public markets, with market integrity as the regulatory nexus, as do systemic risks associated with the combination of leverage and illiquid secondary trading, according to WFE.
- As secondary-market activity increases, it is important to understand potential spillovers into public markets. It is also necessary to recognize that private investment may in practice benefit from and even rely on hedges available for public stock indices.
- Secondary-market deals should be reported to supervisors, who should have powers to put the information into the public domain, where there is any potential relevance to price formation in lit public markets.
- The role of leverage in private investments needs to be followed more closely. As with OTC derivatives, it is hard to get a clear picture of aggregate exposures, which can trigger disturbances in banks and in funding markets more generally.
While publicly listed assets are designed to be tradable, secondary private markets are not yet well developed, which raises questions about the extent to which they lend themselves to active secondary trading. Also, private companies are typically leveraged more than listed ones, which may increasingly lead to challenges for the financial system.
A second issue that bears closer scrutiny is the emergence of secondary trading, if the market continues to grow in size and range of investors targeted. In such circumstances, while private equity can be seen as both a diversifier and a performance enhancer for portfolios, the leverage that is typically deployed to run may make it susceptible to market downturns, as reflected in the share prices of listed private equity firms.
More generally, private assets will tend to be inherently less liquid. This can make the pressure on their market price more intense in a downturn and can also force people to sell other more liquid assets to raise cash. The uncertainty engendered by stale valuations only makes this more challenging and, in this context, the phenomenon of investors using private assets to collateralize loans may merit particular vigilance.
The incidence of exits and distributions is clearly subject to fluctuation from one year to the next, and the emergence of the ‘continuation fund’ technique (shuffling an investment from one fund to another) in reality demonstrates that it is easy to in effect get locked in to a private asset.
All of this, combined with the importance from a public policy perspective of encouraging lit, public markets, means that special care needs to be deployed when it comes to organized platforms for secondary trading. These are a step in the right direction, unless it results in fewer companies coming to public listing than otherwise; and in price formation that interacts with lit, public markets in ways that harm the latter.
It is also worth bearing in mind that private equity may in practice rely on lit markets for two things: proxy valuations and hedging via derivatives. And large transactions in private assets may influence the protagonists’ views on similar, listed assets, ultimately affecting the price movements of the latter and raising interesting questions from a market abuse perspective.
Secondary-market activity used to typically mean an exit via listing. Now it includes various other options, including sale to another private equity firm, trade sale or the use of more formalized trading platforms that aim to support intermittent trading activity. They also include a variation on securitization, known as collateralized fund obligations – in other words, complex financial engineering. The overall picture is one of greater activity and more ways in which it could affect tried and tested public markets.
Nandini Sukumar, CEO of the WFE, said in a statement: “Public markets remain the critical infrastructure that underpin capital markets – they are the gold standard, providing liquidity, authoritative pricing, equal access, regulatory oversight and system-wide confidence. Private markets have their place in the ecosystem. However, they need public markets. Ensuring private markets develop without undermining these benefits is the vital policy objective here. As private assets proliferate and begin to target retail investors, policymakers must ensure that transparency, risk management, and investor protection standards keep pace. Private must evolve within a framework that supports stability, fairness, and long-term economic growth.”
Richard Metcalfe, head of Regulatory Affairs at the WFE, said in a statement: “Transparency, effective oversight, and informed regulation are not constraints – they are prerequisites for sustainable growth. Some national regulators, such as the UK’s FCA, France’s AMF, Singapore’s MAS, and Australia’s ASIC, are starting to look more closely at how to bring more accountability to private markets, and valuable work has been done by the international standard setters at IOSCO, but the rapid growth of private markets means that efforts must be redoubled.”