Private equity buyouts 'no current risk'

These takeovers debt for a large portion of the purchase price of a company.

The Council of Financial Regulators is examining the impact private equity transactions have on the marketplace and is preparing a report on the issue, Mr Costello told a conference.

"Let me say we see no immediate risk to the financial system in any respect. Our financial system is well capitalised and enjoying very strong profits," Mr Costello said.

"But we will be having a look at what may emerge if private equity grows substantially over three, five or 10 years."

The council consists of the Reserve Bank of Australia (RBA), the Australian Prudential Regulation Authority (APRA), the Australian Securities and Investments Commission (ASIC) and Treasury.

Mr Costello's comments come just days before the Foreign Investment Review Board (FIRB) is due to report back to the treasurer on the $11.1 billion private equity consortium bid for Qantas.

Mr Costello said private equity appears to be gaining popularity globally because of compliance costs, accessibility to the highest quality management and strategic partners, reduced agency problems, and lower transaction costs.

While private equity is relatively small in Australia by international standards - at $22 billion at the end of 2006 - Mr Costello said it is an increasing component of the country's capital markets.

"While the Australian private equity market is still relatively undeveloped - as a proportion of both GDP and mergers and acquisitions activity - we can expect that Australia will continue to receive more attention from large international private equity firms," he said.

"We can also expect private equity investment in this country to continue to grow."

He said this industry does have positives for the Australian economy as private equity fund managers prudently invest and substantially grow the size and profitability of their businesses.

But it does present regulatory challenges.

"Finding the optimal regulatory approach will require a careful balancing act. Too much regulation could be detrimental to capital market efficiency, or cause the private equity industry to move to more lightly regulated jurisdictions."

"And too little regulation could damage market confidence."

One important issue is that in many private equity arrangements, investors will be borrowing from overseas, making Australian companies sensitive to international economic shocks or market downturns.

"Many Australian investors were burned in this type of situation during the recession of the early 1990s," Mr Costello said.

"The Reserve Bank has also expressed concern that if the economic environment becomes less favourable, there could be large and potentially disruptive company balance-sheet adjustments."