The Financial Conduct Authority (FCA) confirmed on Wednesday that it’s reviewing how higher interest rates may have impacted the private market and whether the risks will spill to other sectors such as banking.
FCA Chief Executive Nikhil Rathi warned the rates may impact the real estate sector, just like “what’s happening in China,” referring to that country’s ongoing property crisis.
Private equity (PE) includes investment in companies that are not listed on the stock market. Relying heavily on borrowing to fund the investments, PE firms have benefited hugely over the past decades from low interest rates across the globe.
Activities have slowed globally since 2021 when central banks began raising rates, but the UK’s PE investments have remained relatively resilient.
According to the University of Nottingham’s Centre for Private Equity and MBO Research, in the first half of this year, the UK market was “the busiest by volume and came in second in terms of value,” with 59 buyouts totaling €5 billion.
Private asset prices, which are calculated using models, remained relatively high despite rising borrowing costs, raising concerns over the valuation process and the potential risks of blow-ups.
Since December 2021, the Bank of England has raised rates for 14 consecutive times, from 0.1 percent to 5.25 percent, the highest level since 2008.
The markets are now expecting “higher interest rates for longer,” Mr. Rathi told reporters.
“At some point you might expect that risk will crystallize in valuations of assets. Those valuations of assets could be assets like commercial real estate, and we know what’s happening in China,” he said.
A series of debt defaults in China’s sprawling property sector since 2021 have left behind half-finished apartment buildings and disgruntled homebuyers.
Evergrande, a property developing in China’s southern city of Shenzhen, is the world’s most heavily indebted real estate developer, at the center of the property market crisis that is dragging on the country’s economic growth.
Observers fear the real estate crisis may further slow the world’s second-largest economy and spill over globally.
Speaking of the FCA’s review of PE risks on Wednesday, Mr. Rathi highlighted the growth of PE over the years and the use of leverage, or debt in those markets.
He said the regulator is probing where the risks maybe, how the assets are evaluated, and whether the risks may spill elsewhere.
“We’re looking at it from a risk management perspective to understand where that build-up of risk might have taken place, how the valuations are governed, and how that might feed back into other parts of the financial system be that banking, insurance or elsewhere,” he said.
Mr. Rathi also said a review that’s being carried out by the Financial Stability Board (FSB)—the G20 financial watchdog—will fill the gaps in the understanding of the market, according to the Financial Times.
“Private markets in particular are challenging because different jurisdictions have different powers of information collection around those markets,” he said. “Some can reach into them, others can’t.”
The FSB has launched a work program to look at how leverage have created and amplified vulnerabilities in the global financial system. Mr. Rishi said Sarah Pritchard, the FCA’s market director, will co-chair the program, which will “identify those areas where there are data gaps and which the international community needs to address.”
Last week, FSB Chair Klaas Knot told the Financial Times some risks can be mitigated by improved transparency, while other may require a cap on how much hedge funds are allowed to borrow.
