Due diligence tops LP checklist in Asia

Institutional investors overwhelmingly cite deep due diligence as a prelude to new investments, according to an E&Y survey.

More than 70 percent of institutional investors believe a fund’s due diligence processes will be the most important issue to consider when making new allocations to Asia in 2013, compared to just 25 percent in 2012, according to a recent Ernst & Young survey.

The report credits this sharp increase to “a heightened awareness of fraud and corruption” in the region, which makes LPs expect GPs to conduct “thorough due diligence” on their investments, the report said.

A Kroll Advisory Services study last year also found that although more than 70 percent of all companies in Asia believe they are vulnerable to corruption and bribery, less than half “have made a thorough assessment of risks”, especially in regard to the US Foreign Corrupt Practices Act and the UK Bribery Act.

“While Asia companies are increasingly aware of what the FCPA and UK Bribery Act [are], they are still not fully aware of how and when these pieces of legislation apply to them and, thus, do not know how to protect against a violation,” Penelope Lepeudry, Kroll managing director for Southeast Asia, said in a statement.

Private equity-backed companies can be equally unaware, according to Violet Ho, Kroll senior managing director for Greater China.

“There has long been a misconception among private equity funds that they are in a jurisdictional void,” Ho told Private Equity International. Very few local firms consider corruption a problem if they don’t deal with US and Western companies.

In some of the worst cases, Ho said she has seen private equity firms actually helping to cover up a portfolio company’s corruption, because a potential public scandal could impact exit options. The risk of being stuck with an unprofitable company may prompt some private equity funds to take a “see no evil, hear no evil” approach, Ho added.

A mistake that some private equity firms make, Ho said, is doing inadequate due diligence up front.

According to the Ernst & Young report, institutional investors find that due diligence in Asia, particularly in Greater China, “takes an unusually long time”, and traditional methods do not usually suffice.

“In Asian markets… due diligence has to be done by gathering unbiased information from the field by interviewing customers, suppliers and competitors,” according to an Indian institutional investor.