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PE's Emerging Markets Push Presents Opportunity for Attys

12 June 2018

As private equity players continue to form funds focused on emerging markets, attorneys will be charged with drawing up fund documents that will enable fund managers to flourish while taking into account the risks and geopolitical issues that can arise with foreign investment.

Private equity funds that invest in emerging markets have enjoyed strong returns in recent years, with a recent report from research firm Preqin saying that such investment vehicles from 2014 and 2015 have average net returns of 14.7 percent and 16.6 percent, respectively. That's up from the average returns of roughly 12 percent for the three years prior. It also compares favorably with the numbers for PE funds focused on North America and Western Europe from 2014 and 2015, which have average net returns of 11.9 percent and 13.1 percent, respectively, according to Preqin.

Christopher Elvin, head of private equity products at Preqin, said that the improved performance from these funds is a sure sign that the PE industry's push into emerging markets will only continue to accelerate.

"Despite talk of an overcrowded market and high valuations, emerging markets-focused private equity is on the rise," Elvin said. "With more established regions like North America and Europe becoming ever-more crowded and expensive deal markets, emerging regions may shine through as a strong contender for private equity to find new space to grow," he added.

Private equity players are always on the lookout for new and innovative ways they can earn money while also satisfying their investors by way of high returns, and based on the above-mentioned figures, funds focused on making investments in unconventional regions have clearly shown promise.

"Investors tend to chase returns," noted David Fann, president and CEO of alternative assets consulting group TorreyCove Capital Partners. "If [emerging markets] are doing well, capital flow should follow.”

However, blindly launching an investment fund focused on a region that is considered an emerging market without having done the necessary due diligence to ensure that the move will be a successful one can wind up damaging a PE firm's reputation. Thus, legal advisers who can help their private equity clients determine where in the world might be a good place to invest will be highly coveted.

Emerging markets, as defined by Preqin, include all countries in Africa, Central and Eastern Europe, Central America and South America. They also include all of Asia, except for Hong Kong, Japan and Singapore, and the Middle East, minus Israel.

While the Preqin figures show that the average net returns for funds focused on emerging markets have gone up overall, attorneys looking to prove they are essential advisers should show up to meetings with PE clients armed with deeper knowledge.

For instance, among emerging markets the majority of activity is focused on greater China, according to Preqin.

There are a number of reasons that the private equity industry is increasingly setting its sights on China, including a rapidly growing economy, a rising middle class, increased social mobility and purchasing power among Chinese consumers, according to Nadia Murad, a partner in the Investment Funds Group at Kirkland & Ellis.

"In recent years, as China's economy has developed, local markets there have become more receptive to private equity investments," Murad told Law360. "However, like other emerging markets, investing in China involves certain challenges and risks that need to be considered."

That includes issues like the risk of greater volatility in currency exchange rates, social economic and political uncertainty, controls over foreign investment and less developed legal systems and compliance infrastructure, Murad explained.

While China offers much promise for private equity fund managers, it also presents a litany of difficulties that will necessitate the assistance of trusted legal counsel, according to Gavin Anderson, a partner at Debevoise & Plimpton LLP who is based in Hong Kong and is a member of the firm's Investment Funds and Investment Management practice group.

"Although the overall political system in China has been stable, at a more granular level the specific regulations or rules applicable to a particular situation may be unclear in interpretation or effect, or may change unpredictably, which can create some uncertainty," Anderson said. "Advisers must be able to understand that framework and navigate potential ambiguities; judgment, experience and market knowledge are critical."

The above-mentioned risks and challenges are not unique to private equity funds focused on China, either, and they don't represent all of the potential obstacles that fund managers might come across when attempting to capitalize on the growing popularity of emerging markets. Lawyers and their private equity clients should pay very close attention to the moves being made by President Donald Trump, for example.

"Most notably, the current U.S. administration has indicated that the U.S. may withdraw from certain existing international trade agreements and strategic alliances, and has announced its support of certain tariffs and greater restrictions on trade generally, all of which could significantly and adversely affect private equity investments and operations in emerging markets," Murad said.

The reality, according to Jonathan Adler, a corporate partner with Debevoise, is that each emerging market must be looked at separately; whether it's Southeast Asia, India, China, Latin America, Sub-Saharan Africa or the Middle East, each region will have its own distinct economic, demographic, political, regulatory and other characteristics, Adler explained.

"And each is at a different place in its development as well as the current economic and investment cycle," he said.

Legal advisers should push to be included early on in the process when a client is considering a fund that will focus on emerging markets, according to Yousuf Dhamee, a partner in the private investment funds practice of Paul Hastings LLP, because then they are able come up with the right structure that will allow the fund to be prosperous for the fund manager as well as the limited partners contributing capital.

"A lot of the work is really in the structuring, and planning at an early stage," he said.

Meanwhile, Dhamee said that any law firm hoping to land consistent work on emerging markets funds should consider having local offices in the region in which they are seeking work, because the lawyers that work out of a local office will have better and more opportunity to learn about the rules, risks and challenges specific to a given jurisdiction.

"That way, you can adequately describe risks to investors and protect clients in case some of those risks materialize,” he said.

Meanwhile, in addition to having regional offices, law firms should be sure to connect with local legal counsel, Dhamee said, who can often provide additional expertise that is even more precise.

"At Paul Hastings we're fortunate in that we have locally licensed attorneys in many regions, but there will still be cases where we’ll work with truly local firms if there's expertise we feel we can get," he said.

Nadia Murad

Practices