Masterson of his own destiny

What led to your group's decision to spin out of HSBC?
The turning point of the decision was a financial review of the way HSBC deploys its capital into private equity. That was sparked by a $750m commitment the group made to an independent US private equity firm called AEA Partners. The key to that investment strategy was avoiding conflicts of interest. We realised that being a wholly owned private equity player in the buyout business, where you're buying controlling stakes, can be quite complicated if you're a bank like HSBC, which operates a major investment banking business that sometimes advises people who are seeking to acquire businesses the private equity arm is trying to buy. These conflicts are all manageable, but not wholly satisfactory.

Can you provide an example of this type of conflict?
We were bidding for a company in the UK called Auto Windscreens [a provider of automotive glass replacements and repairs] HSBC acquired in a £98m management buyout from Heywood Williams Group Plc in August 1998 and sold to Lex Service Plc for £112m in March 2001. One of the major clients of the bank was being advised by the investment arm in making a rival bid. Although it was done properly, it's still extremely irritating for a client of the bank to see the bank itself bidding against it, even if it's a different division. Getting round that sort of nonsense is achieved by having an independent company manage the capital.

But HSBC will remain a major financial backer of Montagu?
Yes ? 50 per cent of our capital. What we've bought is the management company, which has negligible net assets. It is not a decommitment from investing in the asset class; HSBC remains very keen on the asset class, it's made a lot of money from private equity over the years. We ended up with a structure where the bank retains a significant minority, with 19.9 per cent, but the managers, the guys who are actually making the investment decisions, control the rest of the equity. That way, we can genuinely say HSBC's capital is managed by someone who is not at the beck and call of HSBC.

HSBC is actually increasing its commitment to private equity. When we closed the spin out, we launched a new fund, the Montagu Capital Fund, which is targeted at what we call the micromid cap market, the below-£50m enterprise value businesses that are off the radar for our main fund. Montagu Capital has held a first close after receiving a £25m commitment from HSBC. The fund is targeted at £125m.

What accounts for the accelerated trend of European in-house private equity units spinning out? The trend is not as pronounced in the us.
I think we're just catching up, really. The US has a long history of independent fund managers in private equity. Most limited partners in the US prefer to have an independent manager, not a manager who is a wholly owned subsidiary of a major bank. The prospective limited partner looks at the subsidiary of the bank and asks, ?How do I know your real motivation is the fundamental performance of the fund? Maybe you just want me to participate in generating lots of fees for the investment banking side.? Now, clearly, with the capital sums of the size we're talking about, for HSBC it's a non-starter as an argument, but there's still that little doubt in the back of people's minds.

What will happen to HSBC's regional private equity divisions?
No change there. If you look at HSBC's global private equity business, there's Asia, which is the second largest regional group after Europe. HSBC Asia remains a wholly owned subsidiary. They're fundraising right now. There really isn't a conflict of interest issue to manage out there. Then there's HSBC Private Equity Latin America, which is actually doing okay, because we raised the fund just at the threshold of the crisis but didn't invest any of it. We've redirected it with a debt-to-equity swap focus as opposed to a buyout focus. And that also remains a wholly owned subsidiary of the bank. And in the Middle East we have a $110m private equity fund that was raised only about six months ago, again wholly owned by the bank with external investors.