Background  

SEC Rules on Private Equity Funds 2013, as amended (the Existing SEC Rules) is one of the primary regulations applicable to capital market operators including (but not limited to) Private Equity Funds (PE funds) in Nigeria. It inter alia makes provision for a PE fund definition, delineates the rules’ scope of applicability, and outlines eligibility of a fund and operational constraints. 

In a bid to improve the regulatory oversight for the capital markets, the Securities and Exchange Commission in Nigeria (SEC) on December 22, 2023, introduced new set of proposed rules and amendments (the Proposed Amendment) applicable to different capital market products and operators including, Green, Social, and Sustainability-Linked and Transition Bonds, Collective Investment Schemes, Commodity brokerage, portfolio management operations, private equity funds, amongst others. 

This Newsletter highlights the key changes proposed by the SEC (in the Proposed Amendment) to the Existing SEC Rules on PE Funds.  

New Exemption Regime: increased registration requirement threshold (i.e. N5 billion) 

• The Proposed Amendment introduces a higher threshold for determining PE Funds that are subject to the registration requirements under the Existing SEC Rules. Under the Proposed Amendment this threshold has been increased to N5 billion (from N1 billion); therefore, PE Funds with a target fund size above N5 billion are subject to registration and approval of the SEC, while funds with less than N5 billion are required to obtain a no objection from the SEC prior to commencement of operations.  
• This is a significant amendment as hitherto; the Existing Rules maintained a strict registration and approval regime with limited exemptions. However, this nuanced approach implies that s PE funds (with fund size less than N5 billion) can get into the PE market without going through the extensive registration requirements under the Existing SEC Rules by obtaining a letter of no objection from the SEC. This is a positive step towards opening the market for increased participation and investments and removing the regulatory barrier to entry.  

Disclosure of Investment Restrictions, Revised Pension Funds Investment Strategy, and Fee Structure 

• The Proposed Amendment now requires PE Funds to disclose investment restrictions applicable to the PE Funds in its governing documents.  
• Furthermore, the Proposed Amendment sets a floor on the allowable investment threshold of PE Funds that target pension fund assets. Specifically, such fund must always allocate a minimum of 3% of its total fund size/capital to pension fund assets. The justification of this new proposal may be to ensure a certain level of commitment (by firms that target pension fund assets) to pension fund investments. It is however unclear the exposure this would portend to the pension funds industry (in Nigeria) in that potentially, a PE Fund may be permitted (under the Proposed Amendment) to allocate more than 3% of its fund size to pension fund assets. 
• Further to the above, the Proposed Amendment provides a standard fee structure for PE Funds’ transactions in Nigeria by making provision for management and performance fees. The total management fees and expenses as stated in the Proposed Amendment must not exceed 2% of the total sum raised in Nigeria, and the total performance fee (otherwise known as ‘carry’) should not exceed 20% of the total sum raised.  
• According to the SEC, the revised fee structure (for expenses/management and performance) is aimed at standardizing the fee structure in the PE industry. Also, the fees proposed under the Proposed Amendment are consistent with global best practices; however, it is questionable whether the SEC should set these fees (in its regulations) or subject it to private arrangement. The policy argument in this regard is that investors in PE Funds are usually sophisticated and information asymmetry is limited, thus, parties can freely negotiate and protect their respective interests. More so, the reference to ‘of the total sum raised in Nigeria’ also creates additional uncertainty as to whether the proposed fee structure/formula or cap is inapplicable to sums raised outside Nigeria. 

Inclusion of Policy on Conflict of Interest 

• The Proposed Amendment also introduces additional documentary requirement bordering on conflict of interest on PE Funds registering with the SEC. Accordingly, a PE Fund is now required to submit a policy on conflict of interest in addition to the other existing documents required for registering with the SEC. The rationale according to SEC, is to “accommodate conflict of interest;” in other words, conflict of interest might be permissible under strict policy guidelines of the PE Fund.  

Change in Valuation Method 

• The Proposed Amendment changes the valuation method for assets under the management of PE Funds from ‘fair value’ to ‘good faith’ valuation. Therefore, instead of the existing requirement to determine such value at fair value (where value is the amount for which an asset could be exchanged between knowledgeable willing parties in an arm’s length transaction), the Proposed Amendment now provides that such assets are to be valued ‘in good faith’ by the Fund Manager on the basis of appropriate valuation methods based on principles approved by the fund’s advisory board.  
• Additionally, the Proposed Amendment requires documentation of valuations, preservation of supporting data, annual review by the fund’s statutory auditor, and disclosure of the valuation policy in the fund’s information document. The foregoing requirements ensure that there is increased transparency, documentation, and disclosure of valuation policy for best valuation practices.  
• It is however unclear whether this new valuation methodology creates additional agency costs between Fund Managers and limited partners, especially those with limited bargaining power and without representation on the fund’s advisory board. 

Conclusion  

The Proposed Amendment signifies a step towards more sophisticated regulation of the private equity sector in Nigeria. By introducing clearer definitions, reducing regulatory hurdles for smaller funds, and imposing stricter requirements on larger ones, the SEC is ensuring a transparent, and investor-friendly private equity landscape. 

It also remains to be seen whether the SEC would make additional updates to some of the sections on the Proposed Amendment based on the feedback from industry participants.  

For more information, contact us at partners@credence-law.com.