Friday Letter: State of siege

Doug Lowenstein has now officially been head of the new Private Equity Council for two weeks. We’re certain he’s been busy getting his schedule in order and his list of priorities sorted.  

We’re also certain that this former videogame-industry defender is well aware of the many challenges that face private equity today from many different groups all over the world. It might be said that, to use a war metaphor, private equity is under siege. The new, Washington DC-based lobbying group that Lowenstein now heads has its work cut out, as does the thin volunteer corps of private equity apologists around the world. Consider the list of aggressors below, all of which are capable of new surprise attacks in the coming months:

 

The lawmakers

As the new face of capitalism, general partners should be on notice that lawmakers everywhere have a long history of legislating to “help” capitalism avoid excess. This includes lawmakers in the United States. This coming Tuesday, the House Financial Services Committee will hold a hearing called “Hedge Funds and Systemic Risk in the Financial Markets”. A Reuters report notes that private equity will also be discussed. Committee leader Barney Frank has been quoted as saying that hedge fund hearings will likely result in controls being placed on hedge fund-pension fund interaction. Will a law to “help” private equity funds come next?

 

The tax authorities

More troubling are recent indications from the US Congress that certain lawmakers are studying whether carried interest might be better characterised as ordinary income, which comes with a drastically higher tax rate.

In the UK, Her Majesty’s Treasury recently decided to take another look at whether it’s fair for private equity firms to deduct interest paid on shareholder loan notes in buyouts.

 

The public

Lawmakers wouldn’t consider legislating private equity unless they felt they’d be scoring points with the voting public. And thanks to a preference for opacity on the parts of GPs, the voting public barely knows a thing about private equity. All they know is some private equity guy in a 1980s movie gave a speech about how greed is good. The industry is not rushing to help. For example the proposed owners of TXU – KKR, TPG – have websites that don’t list anyone’s names in the “Who We Are” sections.

 

The regulators

Regulators around the world see private equity as unclaimed territory. Regulatory juggernaut, the European Commission, has drafted a version of its Markets in Financial Instruments Directive, which might, among other restrictions, force small private equity firms to set aside vast sums in capital reserves, as well as require firms to “deal with” potential conflicts of interest, instead of just disclose them. In China, the government has moved to impose greater scrutiny over foreign investors.

 

The labour unions

As frequent buyers of troubled companies, private equity firms have earned a reputation, deservedly or otherwise, as groups that drive hard bargains with union members. As such they have been the targets of labour-organised scorched-earth campaigns involving giant inflatable rats and live camels, among other embarrassments. With only a few exceptions, GPs have failed to stand up for themselves after being accused of destroying jobs and stealing healthcare from babies.

 

The press

When the mainstream financial press routinely accuses you of greed, dirty tricks and recklessness, you know you’re in trouble. Private equity has failed to come up with a good story for why it is routinely buying companies away from public market investors. Not to worry – reporters will come up with their own theories to fill the information void, as will every other group that doesn’t understand the business of private equity.

As stated at the outset, all this amounts to a heavy workload for private equity lobbyists around the world. The state of siege continues. An end is not in sight. One strategy the industry should not pursue is to pull up the draw bridge.