Editorial: Private Equity and the European Commission: the Big Bluff

UK private equity funds and their lobbyists, according to press reports, are frantically pressuring the government to “protect its members from imminent EU regulation” (“Private Equity sector lobbies ministers to protect it from EU”, The Independent, April 20, 2009). According to the Financial Times report of the same day, Simon Walker of the British Venture Capital Association (BVCA) is “horrified” at “the extent of the burdens imposed.” “Under the draft European Union law”, writes the FT, “any private equity group managing funds equal to more than €250 million in total would be forced to disclose more information about its structure, strategy, and investors.” More information compared with what? The ludicrous “Code of Conduct” established by the (Sir David) Walker Commission in 2007 applies to a mere 56 of some 1,300 UK private equity-owned portfolio companies – and allows them to disclose nothing of what is really happening on their balance sheets.

The IUF pointed this out in February (The Commissioner, ‘Transparency’, and Codes of Conduct: the Last Refuge of a Scoundrel?), when the British and European VCAs and EU Internal Market Commissioner McCreevy tried promoting Walker-style “self-regulation in response to the European Parliament’s September 2008 vote demanding comprehensive regulation of both private equity and hedge funds. Walker, quoted in the FT, now accuses Poul Nyrup Rasmussen, who heads the Party of European Socialists, of leading an “economic crusade” against private equity. We leave it to Mr. Walker to explain the meaning of “economic crusade”. The fact is that the “crusade” seems to have caught on: the European Parliament voted by a cross-party majority of 526 to 82 to request the Commission to prepare comprehensive regulation.

To subvert the vote, McCreevy and the various Venture Capital Associations first tried to flog a recycled Code of Conduct. Now that it’s clear the European Commission will have to do something more substantial, they’ve shifted to Plan B. Plan B itself is no secret: – it’s set out in McCreevy’s 2006 “Alternative Investment Expert Group’s Report on Developing European Private Equity”, authored by…members of the European Venture Capital Association (the Experts). That report called for expanding the operations of both private equity and hedge funds through a generalized EU regime patterned after the UK/Ireland “light touch” model. Far from reigning in private equity, it would establish a uniform basis for EU-wide operations. The EVCA adapted to the 2008 Europarliament vote by setting up a “Brussels Task Force” to identify areas where regulation would be acceptable, specify the precise conditions for implementation and fight all regulations which would interfere with the funds’ key profit-generating mechanisms.

“There is a very real danger that private equity may get swept up in the general hardening of sentiment towards oversight of the financial services sector”, declared the EVCA in its call to arms. The reports adopted by Parliament “call for measures including capital requirements; binding disclosure and transparency; controls on asset stripping and capital depletion and limits on directors’ remuneration… The window of opportunity is closing fast.”

Has it closed? Only the actual text of the draft Directive can tell us that. When the financial press reported in late March that the funds were preparing a response to the draft, the IUF asked McCreevy’s office for a copy. We were informed that “It is our strict practice to refuse to provide privileged access to internal Commission documents because it is unethical and would leave us open to accusations of bias. Given the political sensitivities around the hedge fund/private equity file, we have been even more vigilant and attentive to this in the present instance.”

So private equity has seen the (top secret, highly confidential) draft and is “horrified” that the disclosure requirements (and how much do they really disclose?) might apply to 500-600 private equity-owned portfolio companies, who just might have to provide some minimal information of relevance to government, their employees and public finance at a potential cost (according to Walker) of L25-30,000. It strains the imagination to think that private equity is aggressively lobbying for “protection” from accounting fees in London and Brussels.

What else is in the directive? Could all this be the prelude to a scenario in which the “soft-touch” 2006 McCreevy program is newly clothed in the language of regulation and a “horrified” private equity lobby screams that innovation and growth are being murdered by “crusaders”? If the Directive fails to meet the minimal objectives set out in the Report adopted by parliament, Eurosocialist and other MPs would presumably be obliged to denounce a piece of legislation which does little or nothing to protect the public from unregulated pools of speculative capital as requested in last year’s vote. Commission President Barrosso would declare that if industry and the Socialists are equally up in arms the Directive must be doing something right. And Simon Walker would than announce, as he did in his February 1 Financial Times article, that private equity would reluctantly have to “bite the bullet” and comply.

Despite a massive number of amendments, the Rasmussen Report adopted by the European Parliament last year set out some basic policy objectives to be achieved through comprehensive regulation. The IUF cooperated on the elaboration of the Report at every stage, and the Report reflects many of the labour movement’s fundamental concerns about private equity. To determine whether the proposed Directive meets those goals, and whether the fuss in the UK press isn’t really a shadow play designed to once again frustrate serious regulation, the following questions should be put to Simon Walker:

Does the scope of the Directive apply to private equity funds, which are generally offshore, or only to fund managers domiciled in the EU? If the latter is the case, it is a non-starter, as it leaves intact the offshoring which is at the core of the regulatory and fiscal vacuum.

What is the threshold of applicability? In addition to the mega-buyout funds, the sector abounds in medium-sized to smallish investment funds owning companies with many thousands of employees. Are they exempt? Are small to medium portfolio companies covered?

What are the leverage requirements – will the Directive limit or halt the practice of buying out companies with limited equity and massive debt? Through what mechanisms?

What are the proposed rules on “asset stripping and capital depletion” – will the Directive stop the funds from paying off the initial buyout debt by selling off assets and pumping out dividends through piling new debt onto the portfolio companies?

What exactly is covered under disclosure requirements – the kind of nonsense which meets the UK Code of Conduct or detailed, comprehensive audited quarterly information on the situation of the funds and their portfolio companies? Is the Directive’s touch sufficiently “light” that it would permit a private equity fund to say, as Blackstone recently told the US Securities and Exchange Commission, that “rates of return have no direct impact on our financials and therefore we question the relevance to our investors”? Or are the funds simply being exhorted to behave “honestly”?

What specific protections are applied to workers and trade unions under private equity ownership? What does the Directive require of private equity funds as employers?

A crumbling wall of leveraged debt is at the center of the current economic global meltdown. Private equity and hedge funds are part of the problem, not part of the solution, as Walker and McCreevy want us to believe.

“A half year has passed since the European Parliament voted for strong regulation of both private equity and hedge funds”, says IUF general secretary Ron Oswald. “It’s time to get the Directive out in the open, evaluate it in relation to what the Parliament thought they were voting for, and stop an orchestrated farce which would have us believe that the Commission tail is wagging the private equity dog.”