THE WALKER REPORT

Sir David Walker cuts an imposing and orthodox figure in City of London circles. Just the person, it might be argued, for a British review of the buyout industry. And just the person, many will hope, to help save the industry with a little light-touch selfregulation.

His immaculate tailoring, shock of white hair and authoritative tone are among the first things you notice about Walker, all adding to the sense of a man who discovered his natural surroundings within the higher echelons of Europe's financial services industry. His role as senior adviser at Morgan Stanley, where he was European chairman until 2005, and his formative years spent as a public servant at the UK Treasury in the 60s make it hard to think of many more suitable candidates for an independent review of transparency and disclosure in the UK buyout industry. He understands the business but has no vested interest, providing you discount his involvement with Reuters corporate venture fund. He was non-executive chairman of the news agency.

And if any anecdotal evidence were required to support his independence of spirit, then look no further than London's City airport, where the sexagenarian banker occasionally swaps his pinstripe for leathers before roaring off on his motorbike to meetings in London's West End.

ONLY THE BEGINNING
Commissioned by UK trade association the British Private Equity and Venture Capital Association (BVCA), Walker's independent report was an attempt by the industry to defuse the furore that had erupted around a number of large buyouts, notably the AA deal, a UK breakdown service taken private by Permira and CVC Capital Partners. The deal became a battleground which unions and politicians used to attack an allegedly secretive and opaque group of powerful financiers.

Walker published his report in mid-July. As expected, large buyout firms are set to bear the brunt of his proposed voluntary disclosure code, which is now undergoing a threemonth consultation period.

The work has effectively now begun in earnest. He tells Private Equity International: “There is more to come from this process. The concern was to set out principles in the first document. The final proposals will not be radically different, but there are one or two areas where we need to move from principles to greater specificity.”

Without that detail he does not believe the wider constituency of the media, politicians and unions will be able to play watchdog to his principled guidelines. He is loath to create a bureaucracy to enforce compliance, but he is clear on the risks the industry faces if it fails to engage with his code of conduct.

He observes without menace: “If they conform, they will be left to get on with their business without intrusion. So embracing the guidelines in a positive spirit is a matter of enlightened self-interest for private equity because they offer a much better way forward than black-letter regulation or fresh legislation.”

His pragmatic approach suggests new disclosure requirements for large portfolio companies – defined as companies formerly in the FTSE 250, an index of the UK's biggest listed companies; companies with more than 1,000 employees and a value of more than £500 million (€742 million; $1.02 billion); or companies where the deal value involves an equity consideration of more than £300 million.

Walker wants these large companies to publish an annual report within four months of their financial yearend, rather than the nine months required by UK corporate accounts repository Companies House, which outlines the composition of their entire board, details the level and structure of their debt, and talks about the company's values and “role in the wider community”.

He says he understands buyout firms' critics, and hints that GPs are to a degree culpable for the mess they find themselves in. “The industry has acquired very significant rights of ownership and implicit in that are significant responsibilities. The obligations are not merely contractual. The way you treat employees is not just a question of TUPE (Transfer of Under takings Protection of Employment regulations). This excitement partly arose as a consequence of clumsiness in communications by the industry.”

Embracing the guidelines in a positive spirit is a matter of enlightened self-interest for private equity because they offer a much better way forward than blackletter regulation or fresh legislation

Sir David Walker

He believes that in most cases the cost of publishing would be marginal. In the case of a delisting of a public company such as Alliance Boots, much of the information would be already available and the disclosure less onerous than for a public company.

Walker stops short of recommending the appointment of independent non-executive directors to the board of portfolio companies, suggesting this was not required by the private equity model – although he concedes that firms may look to appoint outside directors, albeit dependent, for the sake of “constructive tension” on the board, particularly when it came to the company's audit committee.

A LITTLE COMMUNICATION COULD GO A LONG WAY
“When I was at the Bank of England there was debate about whether official economic forecasts should be published,” Walker says. “My view has always been in favour of openness as a basis for informed discussion.” Or put more crudely: pile the information up on the street corners for those that are interested. The private equity industry has fallen into a habit of non-disclosure and a culture of secretiveness for its own sake, he believes.

He is proposing changes – across the industry – to the way that private equity firms interact with their broader stakeholder base. He wants all GPs to publish an annual report on their website that includes details of senior management, an explicit commitment to transparency principles, and a description of their philosophy regarding employee relations and CSR (corporate and social responsibility).

In time, these requirements could be extended to other large private companies, he believes, and could become a selling point for the buyout firms themselves. He is almost evangelical, but never proscriptive, on this point: “In the annual review GPs have to say what their policy is towards employees.

We want to make a virtue of it, showing a place where people will want to work. But I am not telling you what your policies should be.”

However, he argues strongly against moves towards public company-style reporting for portfolio companies, which he described memorably in the report as “an incubus that need not and should not be imposed on private equity”.

Let's assume over some period that what's caused the superior return is actually better management. It should prompt the CEO of any company to address the question ‘What is private equity doing that we are not?’

Sir David Walker

“But more widely, regulatory arbitrage [between public and private markets] is taking place and it is no bad thing. It keeps a regulator honest. Are all the detail and complexity, the appurtenances of the Combined Code, not found by some to be going too far?”

Independent he may be, but he is in no doubt that private equity is an appropriate model of ownership and a necessary alternative to the quoted markets. He says: “The requirement for quarterly earnings reporting in public companies has created barriers between owner and manager that constipate the process. In a flexible economy there is a role for both public and private equity. There may be times in a company's life when the sharper, shorter lines of management of private equity are appropriate. You have to be careful not to generalise and extremely careful not to use public company benchmarks for private equity.”

A typical generalisation promulgated by the industry's opponents is the mantra that buyouts by definition tend to be over-leveraged. Walker concedes this is undoubtedly true of some transactions but questions whether the opposite scenario might be worth interrogating more closely: “Listed companies make up 90 percent of the economy. If some of them are under-leveraged, is that not a potentially bigger cost for the economy?”

MORE INFORMATION PLEASE
His admiration is not unconditional and he knows the industry's failings. His frustration lies in part in the industry not being able to make its case more compelling with robust data. He wants firms to publish performance data that details the extent to which valuation increases can be attributed to financial engineering, industry-wide valuation shifts or operational management.

“I think we need to be more specific on a template for the annual review of the GP. They need to provide an attribution analysis. It is important for everybody to know how the big buyout firms make their superior returns.”

As far as Walker is concerned, this is more important than just the industry's future ability to conduct its business. It goes right to the heart of the nation's competitiveness.

He says: “Let's assume over some period that what's caused the superior return is actually better management. It should prompt the CEO of any company to address the question ‘What is private equity doing that we are not?’”

It should be a political issue, he says. If he were the Prime Minister or Chancellor, the question as to the impact of private equity on UK productivity would be a major preoccupation. “Much more and better evidence-based analysis is required here and then needs to be communicated effectively by private equity as an industry.”

He believes London could become a “centre of excellence” for buyout research if properly funded by the big buyout firms.

So far, the response to Walker has been positive from the industry's critics and one of muted support from its participants. In private most seem happy to sign up for the less onerous impositions such as an annual review listing the firm's executives and values. They are less keen on anything they perceive will distort a level playing field. One asks: “Why should we publish our plans and leverage structures for our companies when entrepreneurs like Richard Branson and Philip Green don't?”

Walker appears keen to produce a workable solution, one that in time Branson and Green could sign up to and to which even other jurisdictions could adhere. But he does not think the proposals on the table are very wide of the mark.

“My driving concern is the public interest, which requires something like the guidelines that we are now discussing – appropriate, sufficient and capable of going with the grain of the way private equity does business. It doesn't cut across the magic of what buyouts are capable of. It doesn't risk undermining the industry's significant contribution to the overall performance of the economy.”

“What is it that irritates the oyster to create the pearl? Private equity is a constructive irritant,” Walker concludes. Perhaps Walker himself will provide the grit the industry needs to continue its production of pearls.