Increasingly complex regulation lays new burden on private capital CFOs in Germany

Germany’s private equity boom and increasing ESG focus lie behind extra reporting demands for private capital CFOs. How can they best respond?

Chief Financial Officers (CFOs) are increasingly investing in technology, growing their workforce and – most commonly – outsourcing more functions in response to increased reporting demands.

That was the finding of our recent report, The Future Private Capital CFO: Evolving in a Digital Age, which surveyed 300 general partners (GPs) from around the world.

For German GPs, the best blend of strategies will become clear as additional reporting requirements emerge. But outsourcing is likely to be central – the key way to access expertise and minimise costs.

CFOs generally agree that technology, operations and accounting are the main skill-sets likely to be outsourced. Meanwhile our own German private equity clients believe the main advantage of outsourcing is that it allows firms to concentrate on core competencies and improve their business operations.

ESG in Germany is no longer a side show

The increase in regulatory and legal requirements means that environmental, social and governance (ESG) factors can no longer be an after-thought or something that can be put off.

Many ESG reporting requirements are still being drawn up, but it is a matter of when, not if, they must be addressed. Companies lagging in compliance on ESG in Germany may be surprised how quickly this happens.

Europe is at the forefront of ESG legislation and Germany has taken a lead since it abandoned nuclear energy in 2011.

Many of its companies are already attractive targets for private equity firms. The country’s export-oriented manufacturing businesses have established strong market positions thanks to their global reputation for quality.

Mittelstand firms – family-owned small and medium enterprises (SMEs) – represent the archetypal target for private capital firms hunting for acquisitions.

German private capital fund acquisitions demonstrate demand

A series of high-profile investments by private capital funds have helped push Germany into second place behind the UK for private equity deal-making. They include:

• The March 2021 acquisition of premium ophthalmic lenses manufacturer Rodenstoc by Apax Partners, in a deal thought to be worth about €1.5bn
• Global private equity firm L Catterton, known for its focus on companies with strong consumer brands, acquired footwear company Birkenstock for a sum reported to be about €4bn, the following month
• The leveraged buyout of ThyssenKrupp elevator unit in a debt-for-equity deal valued at $23bn, organised by a consortium of private equity firms, including Advent International and Cinven.

The impact of the Covid-19 pandemic and cuts to the state aid helping companies weather that storm have fuelled many of these raids. At the same time, succession issues in family-owned SMEs are precipitating change.

Regulatory complexity drives demand for private capital reporting

But while private equity activity is generating greater reporting requirements, the increase is also driven by new legislation.

A raft of new laws is expected. One is the Corporate Due Diligence in Supply Chains Act, which Germany is likely to introduce in January 2022. Focusing on human rights and environmental protection due diligence, it will apply to all businesses employing more than 3,000 people.

It is by no means certain that the European Union will ever fully harmonise the developing patchwork of national-level regulations. And that is before we consider ESG and diversity and inclusion (D&I). These will accelerate German private equity firms’ shift towards outsourcing.

CFOs expect Limited Partners (LPs) increasingly to require daily and live reporting, although this will probably vary according to sector liquidity. Companies that are ahead on ESG due diligence will have an advantage. We expect some strategic arbitrage as German private equity firms look for value in the mispricing of assets because of oversights in the cost of ESG due diligence and compliance.

The public nature of ESG demands in an age of rapid information flow may also explain why LPs require more frequent reporting, outside typical portfolio management data on holding weighting, exposure and returns.

German private capital CFOs expect growing emphasis on cybersecurity

CFOs also expect LPs to pay greater attention to cybersecurity. These concerns are growing as more companies migrate back-office operations to the cloud, while the drumbeat of high-profile attacks quickens.

The complexities of designing, implementing and maintaining secure systems call for expertise beyond the resources of most companies and private equity firms. This is another factor in the drive towards outsourcing services to partners such as Intertrust Group.

A growing number of private equity firms will need to outsource more regulatory compliance work to service providers. A CFO whose firm is doing business in Germany can mitigate risks and liabilities by choosing the right local partner – one who knows the language, labour laws, authorities and fast-developing ESG and D&I compliance requirements.

Why Intertrust Group?

• From portfolio management to ESG, legal and regulatory compliance and monitoring, we partner with private capital funds to provide efficient, cost-effective outsourcing solutions.
• Our teams provide global and localised focus for all regions. Nationally tailored services include our fully resourced German subsidiary.
• With our comprehensive, well-established language and jurisdiction-specific legal and regulatory compliance and monitoring service, we offer expert solutions to private equity domicile issues in Eurozone cross-border finance.
• Our technological solutions are stress-tested in the real world to deliver bespoke solutions.
• We specialise in turn-key and bespoke solutions for back, middle and front office, from technology and operations to accounts – all localised for relevant regulatory and legal frameworks.

Read the full report