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Nigerian rules on private equity funds

Banji Adenusi
With private equity (PE) transactions in Africa now grossing an excess of $1 billion each year and growing, it is no surprise that the regulators are turning their spotlight on the sector to prevent abuse. Most recently, Nigeria's Securities and Exchange Commission brought out specific rules to govern the operations of private equity funds in Nigeria. This demonstrates the Commission's recognition of the growing importance of PE funds in driving investments in the country, especially considering the buoyancy of sectors such as telecoms, healthcare and real estate. It is furthermore a recognition of the management of the operational and investment risks associated with these funds – underscoring the need for a robust risk assessment and management framework for investment advisers.

The rules apply to PE funds established in Nigeria with a minimum commitment of N1 billion ($6.3 million) of investors' funds; the funds are restricted to sourcing investments from qualified investors alone (Rule 249(d)(4)). The revised rules impose a minimum capital requirement of N20 million on PE fund managers, which is justified on the basis of the risk exposure of the fund. This capital requirement is a fair cap, especially when juxtaposed with the EU directive on the regulation of private equity (the Alternative Investment Fund Managers or AIFM Directive), which imposes a capital requirement of €125,000 ($164,000) for external managers of funds and €300,000 for a fund manager that is an internally managed fund. The AIFM Directive also requires, however, that the manager provide additional funds equal to 0.02% of the amount by which the value of the portfolios exceed €250 million.

The rules equally contain a host of transparency and disclosure requirements, which among other things require that the fund manager describes the investment policy and objective of the fund, the industry or geographical focus of the fund, the fund manager's experience in private equity, investment criteria for target portfolio companies, total capital commitment, repayment of capital, and valuation methodology (Rule 249(d)(5)). These vital pieces of information are meant to be disclosed to investors before they invest in a fund.

There are also reporting requirements, both to the Commission and the investors, regarding the details of total commitments, valuation of each investment, current and new investments, total number of investors, and the current value of the assets of the fund (Rule 249(d)(6)). One shortcoming of the reporting requirement, however, is that there is no requirement for the risk management system put in place by the fund managers. While Rule 249(d)(4) imposes a restriction on the percentage of assets that a fund can invest in a single investment – a maximum limit of 30% – there is no disclosure requirement on fund managers in instances where the proportion of voting rights in a non-listed company held by one of its funds exceeds, reaches or falls below the threshold.

While the introduction of these rules is commendable, a few key considerations will be had to certain scenarios not contemplated by the rules. There are few, if any, continuing compliance requirements on the fund managers for PE funds. However, one argument that has been posited is that the existing SEC compliance guidelines will serve to fill this gap. It may be pertinent to borrow a leaf from the AIFM Directive, which requires fund managers to ensure the appointment of a single depositary for each fund under management (article 21(1)), and equally procure the independent valuation of all funds at least once a year (article 19). These requirements, however, have the attendant effect of increasing investment cost.

Another likely oversight on the part of the regulator is in relation to asset stripping – a grave possibility in an investment environment such as Nigeria – of the investee companies through buyouts that may form part of a short term investment strategy of PE investors. Although investors are free to exit their investments, it would seem that the nature of PE investments require a great deal of regulatory supervision in view of the enormity of the investments. In comparison, the AIFM Directive includes a provision that prohibits a fund or the fund manager from facilitating, supporting or instructing and distributing, capital reduction, shareholder redemption and acquisition of its shares by the investee company until a period of 24 months following its investment in the investee company (article 30).

According to the Securities and Exchange Commission, the two goals of the amended rules are to provide a framework for the operation of PE Funds and pre-empt their illegal operations as the market develops. These rules are a step in the right direction in anticipating the future developments of PE investments. In the long run they will be a benefit both to investors and the entire PE chain.

Banji Adenusi

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