The UK Treasury Select Committee has published an inconclusive set of findings following its five month enquiry into private equity, stressing that more work was needed and calling upon the Treasury to look more closely at the industry’s current tax treatment.
The Committee’s report highlighted a number of key issues, particularly around accountability, tax and the risk posed by leverage, but largely shied away from offering solutions. Instead, it called upon the industry to redouble its efforts to improve transparency, and asked the government’s financial watchdogs to step up their investigation of specific areas.
Committee chairman John McFall stressed that the report was an interim one, admitting that the issues involved were “highly complex,” and that “a short inquiry cannot do full justice to them”. As a result, he said, the conclusions drawn by the committee had been “correspondingly cautious”.
McFall highlighted the “absolutely crucial” importance of greater transparency, although the report made few new suggestions on this score. Instead, it largely echoed those put forward by Sir David Walker following his recent review – including the need for more independent data on the industry. However, the committee did take a less sympathetic approach to private equity investors than Walker, suggesting it was their responsibility to reduce management fees through “greater activism”.
Excessive leverage was another key focus of the report. The committee’s recommendations in this area were largely aimed at the Financial Services Authority, suggesting that the watchdog should take a closer look at incentive structures related to debt financing, step up their monitoring of investment banks’ exposure to leveraged buyouts and ensure that all lenders have suitable monitoring structures in place to manage risk.
The Treasury itself was also asked to intervene in a number of areas. The committee suggested it take a closer look at two of the main pillars of the buyout industry – first, by broadening the scope of its tax enquiry to encompass the treatment of carried interest, and also that by looking more broadly at whether the current tax system distorts the economy by “unduly” favouring debt over equity. It also requested clarification about the Memorandum of Understanding, an agreement between the industry and the government over tax arrangements, and about the current rules on the tax treatment of non-domiciled individuals.
The Bank of England also had a role to play, according to the committee. The central bank should investigate the potential impact of an economic downturn, both on the private equity industry and the economy more generally, the report said.
In general terms, the report was surprisingly even-handed on the advantages and disadvantages of the private equity model, concluding “that there are benefits and potential problems associated with [public and private ownership], and that different forms of ownership may be appropriate for a company at different times in its history.” However, it questioned how much profit was due to financial engineering rather than value creation in large leveraged buyouts, and called upon institutional investors to re-examine why their expectations of public and private companies are currently so different.
McFall insisted that the enquiry had been a worthwhile exercise, saying that it had “shed significant light on an important aspect of the UK economy and… made possible a more informed public debate”.