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The Commissioner at the Banquet

02-Nov-2006



If, as is said, the appetite grows while eating, the growth of European private equity demonstrates that a healthy financial appetite greatly stimulates political ambition. In 2004, European private equity firms invested close to 37 billion euros, of which two-thirds went to buyout deals. In 2005, 32 billion euros were invested in buyouts. Over 19 percent of this went to buyouts of over 300 million euros; 37.4 percent was in the 150 to 300 million euros range. Private equity is feasting on big companies with substantial assets and large payrolls. Private equity-financed buyout companies in Europe now employ an estimated 5 million workers. In the UK, one out of every 5 private sector workers has a buyout fund for a boss.

European private equity raised 72 billion in new funds last year, of which 57 billion is earmarked for buyouts. Far from inducing indigestion, the buyout binge has only whetted investors' political and financial appetites. Private equity has embarked on a lobbying offensive in Brussels and in national capitals, aimed at eliminating all obstacles perceived to limit the number of courses served at the banquet.

Enter EU Commissioner for Internal Market and Services Charlie McCreevy, who last year called on the private equity industry to prepare a blueprint for getting richer quicker through yet more buyouts. The results, drafted by 10 "experts" from private equity funds (with a handful of "observers" from other funds and investment banks), are now available in the Alternative Investment Expert Group's Report on Developing European Private Equity, and will form the basis of a Commission White Paper. McCreevy praised the experts' "sterling" work, declaring it "a compelling case for cultivating Europe's growing private equity business." "My services", he said, "have been drawing attention to industry needs as expressed in the present report. If Finance Ministers are serious about doing something to improve the regulatory and tax environment for private equity, here is a ready-made agenda."

The European Private Equity and Venture Capital Association naturally "welcomed" the report's release and favorable reception in Brussels their members wrote it. Financial investors and their lobbyists have always known what their opponents have often been slow to realize: the transfer of wealth from one group of investors to another is a supremely political operation which requires carefully targeted political pressure to frame the regulatory and fiscal environment in which businesses operate. The rapid expansion of European private equity required critical changes to EU legislation on banking, financial services and pension funds (e.g. the Capital Requirements Directive, the Pension Fund Directive, and the forthcoming Solvency 2), generally following comparable moves in North America. Such changes are often referred to as deregulation, suggesting that simple erasure is the heart of the process. It is actually reregulation, requiring thousands of pages of new laws and regulations at all levels.

Financial investors are satisfied for the moment with the work accomplished at EU level to facilitate their expansion. The essence of the Report is a call for action by the Commission to harmonize the implementation of existing regulations by aligning national practices to create an unimpeded single market for cross-border private equity. While pension funds may, for example, be invested in private equity under EU law, the experts and Commissioner McCreevy - find it intolerable that some member states still limit or even prohibit the practice.

The grievances and remedies cataloged in the Report distil private equity's fundamental requirements and concerns: opposition to all forms of regulatory "intrusion", a craving for secrecy, implacable hostility to disclosure requirements and "conduct of business" rules, opposition to capital gains taxes and a fundamental loathing of asset to liability requirements. Commissioner McCreevy agrees with the experts' prescription for maintaining and expanding "the current mix of self-regulation and light-touch supervisory oversight." The Report, he said, makes a "compelling case" for encouraging a regime "without handholding by the local supervisors."

The stakes are considerable for workers and their unions. Can investors deploying hundreds of billions of euros, owning companies employing 5 million workers, be left to "regulate" themselves? Private equity funds rigorously deny that they are employers, preferring to define themselves as an "asset class". In EU law the funds inhabit a parallel universe in which key aspects of labour legislation seemingly do not apply. For millions of workers in companies controlled by private equity, however, the employment relationship is clear: the boss is a buyout fund. In fact, the funds are among the world's largest employers, and the big ones would number among the world's top ten transnational employers if they were only recognized as such. They are the new conglomerates, in an age when investors chant the mantra of "concentrating on the core."

Private equity funds are not just hidden employers. What distinguishes private equity buyouts from traditional acquisitions and mergers is their exclusive reliance on heavily leveraged debt, which imposes specific requirements on generating and managing the acquired companies' cash flow. Private equity does the deals but supplies little capital of its own the buyout operators raise the cash from institutional investors, of which pension funds have become the largest component. A percentage of the final sale price known as "carried interest", typically around 20 percent, goes to the private equity firm when the restructured company either goes public or is sold to other financial investors. Investment banks rake in fees and interest from advising on the deals and trading the debt, but the real bonanza falls to the private equity firms, who in addition to the "carried interest" from a successful "exit" earn management fees, acquisition fees and "financial advisory" fees whenever they borrow money. The Wall Street Journal, in its edition of October 26 observed; "Some investors say they believe that the fees mean the private equity firms can prosper even if the deals they invest in are no longer lucrative, separating the interests of investors from those of the firm themselves."

Under this system of financing, investors can only meet their targets by squeezing and permanently raiding acquired companies' free cash flow, effectively imposing a levy on current and future employees. The result is permanent pressure to reduce wages, benefits, and payroll while minimizing investment in fixed capital. The turnaround time for the whole operation, encompassing buyout, restructuring, and "exit", is set at 3-5 years. Private equity describes the process as "unlocking value" through "long term" investment. In reality, it is concentrated financial plunder, taken on the run.

As private equity increasingly stimulates investors' appetites for short-term profit, listed companies come under growing pressure to "deliver shareholder value" through similar measures. The Australian retailer Coles Myer, for example, only fought off a recent private equity bid by laying off 2,500 workers the only way to demonstrate to shareholders that it was serious about "delivering value".

The current size of the buyout funds means that no company is immune from a potential takeover. The shadow of private equity now looms over all publicly traded companies, creating a permanent "pre-bid" environment. Any corporation which fails to satisfy investors by regularly delivering double-digit profits, boosting dividends, buying back shares and taking on new debt to demonstrate that it is serious about acquisitions but respectful of cash flow is now a target. The buyout funds are hungrier than ever, and flush with cash.

Increasing levels of debt and leveraged debt in particular - bring heightened potential for financial instability, crisis and collapse. Private equity's continued advance depends on favorable interest rates, rising share prices and liquidity in stock markets. A shift in any of these variables would inhibit successful "exits" and shake the entire edifice. In 1998, the Federal Bank of New York brokered a USD 3.65 billion bailout of Long Term Capital Management, the hedge fund founded by Nobel Prize-winning economists. This sum would not even cover the collapse of a single one of today's large private equity funds and there are many.

Private equity funds and their lobbyists assert that taking companies private through leveraged buyouts shields them from short-term financial market pressures. In fact, it is private equity's insatiable appetite that is helping feed the market's widening hunger for short-term maximum gain, accelerating the general tendency for corporations to downsize and divest rather than retain and reinvest the profits now being paid out to investors at unprecedented levels. This financialization of the global economy has imposed a levy on services and manufacturing, rewarding finance at the expense of investment in long-term job creation.

Unions must act to reverse the hollowing out of productive investment which is destroying jobs and intensifying pressures at the workplace. If, as McCreevy and the experts contend, it is "regulatory uncertainty" which is blocking the further expansion of private equity in Europe, maintaining that uncertainty should be our first line of defense. We should mobilize to ensure that the maximum degree of current national regulation, including limitations on funding private equity, is rigorously applied at a broader level. There is broad scope for union political intervention at national level as well as a coordinated response directed at the EU.

However, current regulation is clearly not sufficient - as the spectacular advance of the buyout business illustrates. The ease with which private equity firms have succeeded in furnishing the Commission with a "ready-made agenda" raises serious questions about the "social partnership" said to underlie the European social model. Their Report should be the occasion for European labour to publicly question the nature of the enterprise in which we are purportedly partners.

All systems for regulating markets must adapt and evolve, for markets are constantly mutating. The rise of a new class of investors, and the siphoning off of social wealth to reward financial markets, are not the inevitable result of a natural process, but one which has been carefully constructed at every stage through conscious political intervention.

The forward march of private equity buyouts and the financialization of the global economy can and must be reversed. To do so, we will have to move beyond "corporate governance" issues to develop - and fight for - a comprehensive program for regulating finance that will encourage productive, long-term investment in jobs and skills as an alternative to feeding unrestrained financial appetites.