Private Equity Insights Q4 2023

Q4 2023

The big picture: As 2024 begins, the economy and markets are showing some encouraging signs, with inflation stabilising and interest rates poised to remain where they are or even start to come down in the coming year. Private equity leaders are hopeful this leads to a more active IPO and M&A cycle this year.

But challenges remain: Cyber threats loom large. Geopolitical conflicts around the world threaten near- and long-term stability. Sustainability reporting requirements are emerging in different countries and regions. And the economic outlook is such that the slightest negative news could swing markets into a more pronounced downturn.

In our latest issue of Private Equity Insights, we provide a rundown of the results from our annual Top Risks Survey, looking specifically at responses from and concerns expressed by board members and C-suite leaders with PE firms and PE-owned entities. We also dive into the latest developments on the AI regulatory front and explore the role of internal audit in sustainability reporting.

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Risks reflect hard-to-predict market: The volatility that roiled the PE market in 2023 is evident in how leaders in the industry have shifted their risk priorities for the coming year as well as over the long term.

Notable results: Among the top 10 risk issues PE respondents identified in 2023, only three concerns — the economy (including inflationary pressures), attracting and retaining top talent and addressing succession challenges, and changes in sustaining workplace culture — remain top 10 risk issues for 2024. Their decade-out risk view — into 2034 — contains only three holdovers from last year’s 10-year risk view: talent retention and succession challenges, adoption of digital technologies requiring new skills in short supply, and the rapid speed of disruptive innovations.

Key takeaways: These shifts in short- and long-term risk perspectives shed light on how PE and portfolio company leadership teams are likely to prioritise their time, expertise and investments. The risk-rating variability also reflects the fundamental changes the PE market has undergone in the past 12 months.

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What you should know: In his first executive order on AI, President Biden is directing various federal agencies to identify the risks of the technology as well as harness the benefits.

Why it matters to private equity: Regulatory and legislative changes are coming, so it's important to watch the details.

Our insights: In this Flash Report, we summarise the key directives contained in the executive order, address key takeaways and concerns for organisations to consider, and outline steps businesses can take to prepare for changes in the AI regulatory landscape.

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What you need to know: On December 8, after two and a half years of negotiation, the Council of the EU and the EU Parliament finally reached a provisional agreement on the EU AI Act, which was first proposed by the European Commission in 2021. The agreement creates legislation that introduces harmonised rules and definitions for those using AI systems and putting those systems into service, and it bans certain types of AI practices.

Why it matters to private equity: The AI Act is the first comprehensive law in the world that also impacts general-purpose AI systems and includes safeguards and prohibitions that will reduce the risk presented by AI for government agencies, businesses and individuals.

The bottom line: The AI Act represents a game changer for organisations operating in the EU and could have a broader impact than many realise due to its extraterritoriality implications. What’s more, the AI Act may be the first salvo in a lengthy political and regulatory campaign to rein in the power of AI and protect consumers and data.

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Driving the news: The SEC has charged SolarWinds and its CISO for fraud and internal-control failures relating to cybersecurity risks.

Why it matters to private equity: These charges highlight the importance of implementing strong controls and disclosing known concerns to investors. In its complaint, the SEC alleges that SolarWinds misled investors by understating cybersecurity risks and ignoring red flags about cyber risks.

Important takeaway: The SEC's enforcement action signals a potential expansion of executive accountability in public reporting.

The bottom line: Executives should advocate for effective risk governance, ensure clarity on roles and responsibilities, and enhance the disclosure process to avoid personal liability.

Go deeper: In this Flash Report, we summarise the SEC’s allegations against SolarWinds and offer nine points for executives and functional leaders with SEC registrants to consider regarding their own accountability and responsibility for public reporting.

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The manner in which failure is embraced instead of feared in a business can improve the way the company evolves and responds to new market opportunities.

At a recent National Association of Corporate Directors Master Class event, Protiviti moderated a discussion among the participating directors about making innovation work in today’s rapidly evolving and disruptive markets.

The premise underpinning the conversation was that the risk-reward balance of years past with respect to innovation may not be suitable in the years to come.

The big picture is one of constant change fostered by disruptive technologies — generative AI, the metaverse, digital twin solutions, quantum computing, the ever-expanding Internet of Things, and increasing broadband speed and access.

The effect of technical debt and the likelihood of waves of regulation to protect consumers from harm and avoid unwanted consequences are also relevant considerations.

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What’s new: ESG guidance, stakeholder demands and regulatory mandates are evolving and becoming more specific, and the time of taking a “soft approach” to sustainability reporting has passed. As the need grows to provide, or prepare to provide, limited and/or reasonable assurance in sustainability reporting, internal audit’s role in the reporting process becomes obvious and essential.

Why it matters to private equity: Sustainability disclosures must be backed by high-quality, “regulator-grade” data. The internal audit function, with its understanding of the entire organisation and intimate knowledge of internal controls, is well-suited to validate the accuracy and reliability of the data that is used in ESG reporting.

The bottom line: Internal audit has a substantial opportunity in helping businesses meet their sustainability reporting obligations and assess ESG risks by imparting operational, technology and financial reporting assurance expertise and bringing together senior leadership, boards and other key parties that have a role to play in providing auditable sustainability reporting.

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