Commentary: Lighting up private markets — what the SEC needs to do to achieve true transparency

The phrase "knowledge is power" rings true in many aspects of modern life. For allocators in charge of trillions of dollars of assets — many of which are linked to our pensions — this principle is particularly relevant.

Over the past decade, allocators have been increasingly looking to private assets for lucrative returns that have soared to new highs during the pandemic. Despite institutional demand driving the private markets to grow to an estimated $13 trillion by 2025, according to Morgan Stanley, data on illiquid assets has historically been scarce. This, however, could be about to change. In the U.S., the Securities and Exchange Commission recently announced proposals to address the lack of transparency in private markets by forcing private market participants to disclose fees and returns in greater detail. The SEC proposals would, for example, require audits of private funds, bans on excess fees, and prohibitions on preferential terms for certain investors in private markets, among other things.

While a welcome step for improved transparency and better oversight of the industry by the U.S. regulator, we believe it doesn't do enough to benefit asset owners who invest our savings and pensions in private markets.

To understand this seemingly counterintuitive argument requires an understanding of the availability of private markets data, the issues around data access, and the growing desire on the part of asset owners to have a holistic view of their exposures, and risk across public and private markets.

A key reason for the historic lack of transparency has been the challenge of gathering and quantifying private asset data. For publicly traded liquid assets such as equities, regulation, high trading volumes and digitization have long established the widespread availability of market data. However, shares of private markets are not traded on exchanges, which would allow for real-time measurement.

Instead, value and returns are only measured when transactions occur, which happen seldom for illiquid assets such as private equity, venture capital, real estate, or even more esoteric investments such as valuable art and wine.

Addressing the issue of data accuracy and accessibility is not only important to level the playing field for investors but for managing risk. Events such as the COVID-19 pandemic have highlighted issues with the black holes in private asset data, as market dislocations shocked portfolios. Being able to visualize exposure and accurately analyze liquidity across public and private markets is vital in stress-testing portfolios. With recent seismic market events in the rear-view mirror, we need to learn from history and prepare for inevitable disruption.

While the SEC's proposals remedy some of these issues, they fall short by overlooking the fact that private markets returns are somewhat subjective. Stated returns can hypothetically be manipulated, as absent a transaction, value can be estimated as a multiple of financial metrics. Yet under the SEC's current proposals, financial metrics are not part of the disclosure, defeating the purpose.

New regulation should ideally drive a cultural shift toward more transparency in private markets. However, without financial metrics being at the center of regulatory reporting requirements, there is a risk that companies could disclose returns without knowing what drives them, and could even create space for bad actors to engineer their numbers free of oversight.

To be truly effective, new regulation ought to build on the huge leaps forward in data and technology driven by managers, allocators and service providers. Significant progress has been made in harvesting, enriching and analyzing these enormous data sets in a format consistent with more established data from publicly traded asset classes than was previously possible.

Firms like ours are collecting data directly from managers, enabling consistent data sets and data quality to provide deep analytics and detailed portfolio intelligence. Improving the accuracy, availability and integrity of this data — if necessary, through a regulatory mandate — is where the SEC could really make a difference and speed up the process already used by asset owners as part of their fiduciary duty to end investors.

With the growing importance of private investments and the increasingly blurred lines between public and private, the SEC is correct to reduce the transparency gap between the two. However, it must go further to tackle the accuracy of disclosures to avoid market distortion that would negate a well-intentioned effort to fix a critical issue in modern markets. At the same time, efforts must be made to protect the intellectual property of a manager's portfolio. Reporting on a lag, for example, is an acceptable compromise that ultimately provides greater transparency while protecting managers from immediately showing their hand.

Implemented in the right way with a robust methodology, new regulation can build on the impressive work already established in private asset transparency by managers and allocators and help propel the industry to new highs. Regulators, allocators and managers alike should embrace and support the principles of true transparency. Far from damaging the industry, such measures will improve its competitiveness and could even attract a new cohort of investors to private markets, after the mystery of private investing has been illuminated.

Andrea Gentilini is head of SEI Novus for SEI's Institutional Group and is based in Zurich. This content represents the views of the author. It was submitted and edited under Pensions & Investments guidelines but is not a product of P&I's editorial team.