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Newsroom & speeches
11 September 2009
This directive is important for the future of the EU financial services industry. I take a close personal interest in its development. I made a long speech on the subject in July where I set out my views in some detail, and have been campaigning across Europe over the summer on this issue. I am pleased to have the opportunity today to discuss the subject further.
The alternative investment industry is important to Europe. European investors – pension funds, institutions and others – need tailored investment solutions which focus on the balance between return and volatility, and access to a wide range of assets to facilitate effective diversification. Regulation must allow market-driven innovation in that area.
This industry is also important to the broader economy. Last year, the UK private equity industry invested £8 billion into companies in continental Europe, and about the same again in companies based in the UK. This investment has helped start-ups to grow and established firms to restructure and invest for the future.
Investment is needed now more than ever as overstretched firms look for capital to rebuild and de-risk their balance sheets. The private equity industry has capital to invest. The industry worldwide has over $1 trillion in uninvested capital.* EU firms need that sort of investment and we must not deprive our companies, our industries and our workers of it by closing Europe’s doors to foreign managers.
The asset stripping, job cutting, quick flipping private equity industry which some rail against is, in my view, largely an invention of the industry’s opponents. The private equity industry does not operate in this way for a simple reason; it would not make any money if it did so.
The model relies on selling the portfolio company for a profit at the end of an investment term. No buyer would pay a premium for a firm robbed of its long-term viability through asset stripping, indiscriminate job cuts and franchise erosion. We must not allow prejudice to obscure the fact that private equity has generally been a force for good: for its clients and the companies in which it invests and their employees.
There can be no question that we need better regulation, internationally, at European level and nationally. The UK is not in the business of blocking more stringent regulation and effective supervision.
But let me repeat something I have said previously - imposing ill-considered rules in haste is counterproductive, whether at European or national level. We must not be beguiled by protectionism hiding as though it were protection. Hedge funds and private equity have not been central to the financial crisis - as acknowledged by Jacques de Larosiere, Paul Volker, Charlie McCreevy and Lord Turner. Paul said when speaking in Brussels in June that 70% of companies in difficulty “have been involved at some point or another with Private Equity”. It’s not clear exactly what this might mean. However, I would think it likely that more than 70 per cent have been involved with accountants or lawyers, and 100 per cent with men. Perhaps we should legislate against all these groups too.
Unlike some European countries, the UK has regulated alternative fund managers for many years. This regime is stringent and robust.
It cannot be a coincidence that in the US, where there has historically been no requirement for hedge fund managers to be registered, there have been instances of hedge fund fraud, while in the UK we have had no such problem.
Our regulatory regime has also contributed to the growth of the UK industry. Institutional clients demanded that their fund managers be well regulated and decided that the UK system delivered that outcome. Indeed, in the early and middle part of this decade, the UK hedge funds industry gained market share from the US even though UK regulation was significantly more stringent. So it is clear to me that it is not only the UK Government which supports appropriate and rigorous regulation of the alternative investment management industry, but also the industry, its clients and their advisers.
While I maintain that UK regulation of hedge funds has done a good job of mitigating the risks they could pose, we are not complacent. This is why we announced in our recent white paper that the FSA would extend its surveillance of the sector to include monitoring the impact of significant hedge funds’ investment positions on markets and we will give the FSA effective powers to intervene where this surveillance identifies significant or systemic risks.
We have made clear to the Commission our views on their failure to consult on the AIFM directive. However, we are where we are. The UK will work hard to achieve a directive that allows efficient, well run and well regulated fund managers to compete for business without restriction across the EU and to make the EU a base from which to compete in global markets. But current proposals need remedying before this can be delivered.
This directive imposes a wide range of obligations on the manager – which just to name a few include the need to be authorised, to have risk management systems, to have initial and ongoing capital requirements, leverage limits, and an independent valuator. It also requires disclosure to investors and supervisors of key information about the fund and its strategy.
This is a long list of obligations, and in the main we agree with the Commission that these are the right areas to be addressed. However, what we cannot agree with is the Commission’s one-size fits all approach.
Regulation must acknowledge where there are differences. This is particularly notable when you compare private equity and hedge funds. Those who know the industry know that these are quite simply two different beasts and the directive does not seek to cater for this fact – a proper consultation ahead of the publication of the draft directive would have provided evidence about the risks of such simplistic conflation.
Some say that this directive does not go far enough as it only covers EU managers and does not regulate hedge funds themselves. The manager controls the fund through delegated authorities. If we regulate the manager we have an oversight of all the funds under the direction of a manager – even if they are outside the EU. This will give the EU greater information on the impact that they may have on European markets. The hedge fund itself is simply the product; the vehicle in which the assets are held. While we need to regulate retail investment funds to ensure their strategies are appropriate for retail investors, professional investors can decide for themselves. If we believe they are not competent to make these decisions without the support of this directive we are drawing conclusions about the competence of professional investors which would have very profound consequences. I see no justification for such a conclusion.
A final issue on scope is that of naked short selling. Some argue that the Commission’s proposal does not cover this issue and that it should. I find them wrong on both counts. The directive does cover this issue in the articles on liquidity and in its provision for the Commission to adopt implementing measures specifically governing the issue of naked short selling. I find these provisions inappropriate – short selling is in no way unique to hedge fund managers and should be governed consistently for all market participants. I therefore welcome the Commission’s upcoming review of EU market abuse rules. This directive is not the right place to address short selling or tax avoidance. The G20 is taking forward effective work in addressing tax avoidance.
Finally, I want to touch on portfolio company disclosure. This is an important issue not only for private equity managers but for all stakeholders of private equity portfolio companies - their employees and trade unions, their suppliers and their customers. These groups have a shared interest in ensuring that firms whose long-term success they rely on are not put at a competitive disadvantage through ill-considered regulation.
There are two key disclosure requirements set out in this directive. The first is to provide information to employees, shareholders and the target company regarding the private equity manager's intentions for a possible takeover and future running of the target company once the fund has taken a significant stake.
These obligations are similar to those placed on any bidder for a quoted company under the Takeover Directive but there are important differences. For instance, the Commission's draft would leave the target company and its shareholders holding different information about a possible takeover from an EU private equity firm compared to one from any other bidder outside the EU. Why would we want to do that? Particularly in a competitive bid situation, this would have serious consequences.
Unless this obligation is removed, it is likely to lead to less investment by private equity firms into European businesses. At a time when so many EU companies are in real need of new equity investment, this would be a bad outcome.
The second obligation is to provide information to employees on an annual basis. Through the Walker guidelines, the UK private equity industry agreed voluntarily to provide substantial annual disclosure for larger portfolio companies. This disclosure must be timely and must include effective communication to employees. This is setting a world standard. These obligations – in the main – are similar to the AIFM obligations. However a key difference is that the Walker guidelines limit this requirement to larger portfolio companies on the argument that they are likely to be competing with larger public companies with a similar level of disclosure. Therefore concern about putting the portfolio company at a competitive disadvantage is much less.
However, the directive proposes a very low threshold for these disclosure obligations. Poul is suggesting an even lower threshold. This would impose administrative costs on smaller companies and put them at a competitive disadvantage. This would benefit neither private equity investors nor the portfolio company employees who may see their company being unable to compete with its peers, with potential adverse consequences for corporate success and workplace security.
Let me be clear: I see no reason, other than enlightened self-interest, why private equity should be required to go beyond Walker guidelines and no reason why we should penalise private equity ownership by placing upon it burdens that do not apply to, for instance, family controlled businesses or subsidiaries of large multi-national corporations. The evidence simply does not support discriminating against private equity. Poul, you speak about level playing fields and needing to avoid arbitrage, but you are opening the door for arbitrage by penalising Private Equity. This means that you are penalising our pension funds and charities which have invested in Private Equity.
This directive is now being discussed in Council Working Groups, under Sweden’s chairmanship. We are of course fully engaged in that process. I am meeting again next week with Mats Odell, the Swedish Minister leading the negotiations.
The directive is also subject to co-decision by the European Parliament, so it is important that we also engage with them and with the recently-appointed rapporteur, M. Jean Paul Gauzes who I am sure will do an excellent job. I know that the Parliament's ECON Committee held its first discussion earlier in September and that Jean Paul hopes to produce his draft report later this month. Given the lamentable absence of public consultation, this is the first opportunity that MEPs will have formally to engage in this debate on the draft directive and I know that they will make a valuable contribution. It is only disappointing that Britain no longer has a voice in the EPP and therefore does not have the positions of responsibility in negotiations that this would bring.
And as the Parliament joins the debate, opportunities for other stakeholders to engage should also increase. I want to see not only investment managers but also institutional investors – pension funds, endowments and sovereign wealth funds – getting involved in a constructive way. If institutional investors can make clear which regulatory safeguards they want to see applied to their fund managers and which they find to be costly and unnecessary, this will send a powerful message to policymakers. Those who lobby constructively, offering solutions as well as pointing out problems, seeking to understand as well as to be understood, will - I believe - get a fair hearing anywhere in the EU. The Hedge Fund industry has been effective in lobbying. I think that UK Private Equity needs to up its game to do the same, engaging with European officials and MEPs etc.
In conclusion, it is clear to us all that the draft directive as it currently stands is flawed. It tilts at mythical windmills, at times pandering to prejudice. This was perhaps inevitable given the inadequate process by which it was developed, driven by political concerns. However, in the long term an open single market in fund management must be a major opportunity for Europe, and we must all do our bit to ensure the best possible result for EU investors and for the future of the EU funds industry.
*Source: Prequin Global Review 2009, p13
