Private Capital Markets for All
The recent amendments by the U.S. Securities and Exchange Commission (SEC) to modernize the Accredited Investor definition is positive to expand access to private capital markets.
During the sleepy time period of late summer, the U.S. SEC implemented a change that could have significant ramifications on global private capital markets[1]. The amendments to modernize the Accredited Investor definition adds knowledge and expertise as criteria to participate in private capital markets. Previously, sophisticated investors were excluded if they did not meet income or net worth tests. In the words of the SEC Chairman, Jay Clayton, “For the first time, individuals will be permitted to participate in our private capital markets not only based on their income or net worth, but also based on established, clear measures of financial sophistication.”
At Atlas One Digital Securities, we have a vision to increase access to the private capital markets, and hence support this expanded definition and hope that this sets the path to Private Capital Markets for All.
Why is access to Private Capital Markets important?
Private capital markets have grown dramatically in the past two decades as regulatory changes following accounting scandals in the early 2000s prompted companies to stay private longer, and institutional investors gradually increased their appetite for private market opportunities.
In fact, between 2017–19, the $2.4 Trillion (T) raised in private markets exceed that raised in public equity markets[2],, and there is even more potential in the vast asset pool of real estate. In 2017, the value of residential real estate globally was $221T and commercial real estate was $33T[3].
However, access to private capital markets is mostly limited to institutions and high net worth investors. Ticket sizes for investment need to be sizable to cover the fixed costs of deals. But Accredited Investor rules have also played a role, limiting access to only high net worth or high income investors who meet prescribed thresholds. Most jurisdictions globally use net worth/net income tests to determine who is accredited.
The limited access to private markets has a material impact on individual investors as opportunities and returns are lost. Returns by private equity funds have been higher than public markets since 2009 with investors earning over 2 times more than the S&P 500 between 2009–16[4].
Diminishing public market opportunities and higher private returns therefore only exasperates income and wealth gaps — the opposite of what we need to narrow societal divisions.
How has the Accredited Investor definition expanded?
Net income and net worth are crude but objective tests to affirm accredited investor status. A broker statement or pay slip is all that is needed. Adding knowledge and expertise tests risk being far more subjective. The SEC has prescribed, among other amendments, “certain professional certifications, designations or credentials or other credentials issued by an accredited educational institution….”. The SEC has also logically added private companies, family offices, and employees of funds with more than $5million of assets to the accredited investor definition.
These expanded definitions have the potential to substantially increase the universe of potential Accredited Investors. Many younger, university educated investors who have not yet reached net income or net worth thresholds will now be eligible to participate in private capital market deals.
Issuers and broker-dealers will need to develop simple verification processes to access this new accredited pool without creating burdensome administrative work for investors.
Where do we go from here?
While increasing access for investors with professional certifications and credentials from accredited educational institutions is a significant broadening, it still risks entrenching inequality for those investors without these qualifications. The budding millennial and generation-Z group of Robin Hood investors may not have the required qualifications but are developing their experience through easy access to online and mobile investing technology. Overtime, this technology could affirm that investors generate sufficient investing experience to accredit them access to private capital markets. This could be a logical additional expansion to the Accredited Investor definition.
The SEC amendments will also have big implications for global issuers and investors. The U.S. still has the world’s largest private capital markets, therefore, the increased pool of Accredited Investors will benefit non-U.S. issuers in raising capital in the U.S. More interestingly, the SEC changes also set a benchmark for other jurisdictions to potentially follow. Jurisdictions all over the world, and particularly in financial hubs, will need to keep their private capital markets competitive and will likely follow the U.S. moves. This would benefit individual investors globally.
Private capital markets have grown substantially over the past two decades and the recent developments of more efficient execution technology and, now, increased investor access thanks to regulatory changes will further charge this growth.
George Nast
Co-Founder & C.E.O.
Atlas One Digital Securities Inc.
[1] See Link https://www.sec.gov/news/press-release/2020-191
[2] Source: McKinsey, Dealogic, SIFMA. Total Private fundraising was $2.75T including private debt
3 Source: Savills
4 Source: Burgiss Private IQ
