It has been a landmark week for private equity in the UK. Tuesday's publication of the Myners Review on Institutional Investment in the UK, very strongly endorsed by the Government in the Budget speech on Wednesday, could turn out to be the single most important step in increasing the flow of capital from UK investors to European private equity funds; and other measures in the Budget might also help the growing businesses targeted by the sector.
The publication of Paul Myners' review, commissioned by the Chancellor in the 2000 Budget, was seen by many as the pre-cursor to the largest shake-up in the pensions industry for many years, not least because it proposed radical changes in the charging structure adopted by fund managers. But the report actually focuses much of its attention on the decision making process adopted by pension fund trustees – and the fund managers they appoint – and raises some vital objections to it. It is these objections, and the proposals accepted by the Government to deal with them, which will have the greatest impact on the supply of funds to European private equity.
As well as calling for more sophistication among the pension trustees who make the crucial asset allocation decisions on behalf of funds, the review identified several tax and regulatory provisions which might distort those decisions. Most importantly, the Government has confirmed that the “Minimum Funding Requirement” – the widely criticised solvency test for pension funds – will be abolished, as Mr Myners recommended in November. Further, Myners wants to sweep away the regulatory distortion which requires pension trustees to be authorised in order to invest in limited partnership funds – or to appoint an authorised person to do so on their behalf. He also wants greater understanding of private equity among regulators, and endorses calls by the industry to reform limited partnership law to improve the market-standard fund structure. He then addresses an important barrier to investment in limited partnerships by life insurance companies, and proposes a change to the taxation of such companies so that capital gains are taxed as they are distributed by the fund, rather than as they arise. Again, it is clear that the UK Chancellor has taken these proposals very seriously, and it seems likely that he will act on them.
As important as the proposals themselves is the comprehensive review of the private equity sector which is included in the Myners review – and the implied criticism of pension funds which have failed to take advantage of returns consistently better than for quoted equity. That will raise the profile of the asset class among the trustees, and should cause them to review their own decision making processes.
But the review also lays down important challenges to the private equity industry and charges the British Venture Capital Association (BVCA) – which has warmly welcomed the review – with important responsibilities. The review calls for better research into, and publicity for, the economic impact of private equity, for a dialogue with institutional investors on valuation issues and for more audited valuations and performance data. The BVCA has already announced that, in order to assist in this process, it will admit institutional investors as members.
The Chancellor made other important announcements too. As widely predicted, he extended the already popular Enterprise Management Incentive scheme, so that small companies will be able to grant tax advantaged options worth up to £3 million to their employees, and his proposals to simplify VAT and tax computations for small businesses might also be important, although the detail of these changes is awaited.
Overall, the news is very positive. But the Government's responsibility for stimulating enterprise and facilitating growing business – highlighted by Myners as a key driver for returns to the private equity sector, and a responsibility often publicly accepted by the present UK Government – requires it to avoid complexity in its approach to tax and regulation: it is disappointing that this week's Budget has done little to simplify the myriad complex rules with which businesses and entrepreneurs increasingly have to cope.
SJ Berwin & Co is a European law firm with a particular focus on private equity. The above comment is taken from the firm's weekly e-bulletin, Private Equity Comment, which provides commentary on legal and tax developments which affect the European private equity community. For comment or to subscribe to these bulletins, please email firstname.lastname@example.org.