Wednesday, March 10, 2010

EU frowns on private equity vampire night dinners

Private equity, whatever it does in the real world, generally sticks to a core business model: to increase leverage (borrowing ratios). This not only multiplies profits (and losses, and risk levels), but also, typically through deft use of offshore jurisdictions, involves offsetting debt service costs against tax. The result of this abusive manoeuvring is a simple one-way transfer from taxpayers to (usually wealthy) investors in private equity (sorry about the photo; we were feeling a little mischievous). Unsurprisingly, there is concern in Europe about this business model, and moves are afoot to tackle it. From the Financial Times:

"Investors based in the EU could be barred from investing in private equity funds based outside the 27-country bloc. . . . the proposed regulation could “severely disturb” many of the world’s biggest private equity groups by depriving them of access to EU investors, while in turn reducing foreign investment into EU companies."

That, if you don't like taxpayer abuse, seems like a solid idea. But that's not the way the FT spins it. This same article begins, instead, with a piece of private equity lobbying puff:

"Europe risks building a protectionist wall between itself and the global private equity industry if plans for a sweeping overhaul of regulation in the sector go ahead, some of the world’s biggest institutional investors have warned."

We prefer this alternative view, from a reader on the usually well-informed insider site called Naked Capitalism, which picks apart the same FT story:

"In parallel with the Greece/Goldman/default swaps/hedge fund vampire night dinners, etc., the EU is slowly advancing on the proposal to regulate hedge funds and private equity firms (and their managers).

The industry has spent vast recources over the past year in trying to water down the draft legislation, which was not entirely brilliant to start with. What seems to elude the industry is that all the bad press feeds back into the legislative process. Most of the 736 Members of the European Parliament had a vague understanding of this aspect of the financial industry to start with and, probably, believe that it has significantly contributed to the financial crisis. The very bad PR for hedge funds and over-leveraged and job slashing PE firms over the past weeks are hardly helping the industry.

What I find silly is that the Industry, in its efforts to convince the Parlamentarians, and the other relevant EU Institutions, are using the same bad old arguments like if you regulate in Europe, it will scare off investment and the pensions of ordinary people are jeopardized. Well yes, the EU does not welcome trashy short-term cancerogenus (sic) cash spreading from Cayman funds run by math nerds that design real nukes one day and their financial equivalent the next."

Well said. And as NC adds:

"If local/regional players, who presumably have an information advantage by knowing the local market, won’t stump up for a particularly business, why should an offshore investor do better? Yes, there are always exceptions, but one needs to be plenty wary.)
. . .
Europe functioned before there ever was a PE industry, and from what I can tell, its hotbed of innovation, the German Mittelstand, does not have much traffic with PE investors. The idea that what is good for the private equity industry may not be good for the average citizen appears not to have occurred to these operators."

Exactly. The IMF has now belatedly accepted even that capital controls may be a good idea. Let's hope European legislators find the courage to confront the lobbyists. Read the rest of the post: it's worth it.


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