EU Private Fund Regulation: The Anglo-Continental Divide on Private Equity
Today, the British government revived its review of the European Union’s proposal to regulate private equity firms and hedge funds. The controversial draft of the European Commission’s alternative investment fund managers (AIFM) directive would prescribe leverage restrictions and disclosure requirements for all advisers managing funds over €100 million. The Financial Times quoted British Member of European Parliament, Sharon Bowles, now head of the European Parliament’s economic and monetary affairs committee, as predicting that implementation of the AIFM directive would result in the “excommunication” of European pension funds and institutional investors from global capital markets. For the time being, it appears that the chorus of objections from members of the British government, ministers of the City of London, industry groups, and U.S. authorities, has found a sympathetic ear. Earlier this week, the Guardian reported that Sweden, which holds the EU’s six-month rotating presidency, announced its intention to “remove unnecessary burdens on alternative investment funds” in the current draft.
As the debate over how to regulate AIFM in Europe has progressed, a striking ideological standoff has begun to take place. Generally speaking, British government officials have acknowledged a need for more comprehensive regulation of AIFMs, but are wary of straitjacketing the U.K. hedge fund or private equity industry. For good reasons too. UK-based private equity firms raised more than half of the €76 billion in funds raised in Europe in 2007. The government’s coffers have benefited generously from associated tax revenues.
London’s Conservative mayor, Boris Johnson, aired his frustration over the directive on BBC Radio 4’s Today program: “I mean it’s a weird thing that under the fog of confusion and war the [European] Commission seems to be proceeding to attack something in which London simply excels and was not responsible for the recent catastrophes.” Johnson denied that he was speaking “in any spirit of – you know - narrow nationalism” but warned that London risked an exodus of private equity and hedge funds should the EC’s AIFM directive become law. (Boris Johnson’s arguments sound similar to those expressed by the Private Equity Council in hearings held on Capitol Hill last week: private equity does not pose a systemic risk to the world’s financial markets. In fact, the European Commission agreed, finding that private equity funds “did not contribute to increase macro-prudential risk.”)
But some socialist politicians on the Continent see private equity regulation through a different lens. For them, the question is not whether private equity creates macroeconomic risks, but whether private equity takeovers benefit all stakeholders (including employees) in the acquired companies and not just shareholders. Over the past several years, certain socialist politicians and labor unions have cast private equity in the role of foreign interlopers in national economies.
The Chairman of Germany’s Social Democrat Party, Franz Müntefering, famously denigrated private equity firms as “locusts” who stripped bare their portfolio companies’ assets in order to gorge on large profits. Back in 2005, The Independent reported that the Social Democrats accused private equity firms of being a threat to German democracy because leveraged takeovers often resulted in significant personnel reductions. As an example, the Social Democrats cited KKR’s buyout of German telecommunications company Telenovis, in which half of the company’s 8,000 employees were made redundant, even though a 12.5% wage reduction had been agreed to by workers. But no one is viewed as a greater threat to private equity in Europe than Poul Nyrup Rasmussen, President of the Party of European Socialists and former Danish Prime Minister. In a scathing 2008 article, “Taming the Private Equity Locusts,” Rasmussen described a leveraged buyout as a transaction in which a “once profitable and healthy company is milked for short-term profits, benefiting neither workers nor the real economy.”
The influence of the socialists on the European Commission’s AIFM directive appears in a section addressing the acquisition of “controlling stakes” by buyout firms. Article 26 of the directive provides that if a private equity fund acquires, whether alone or in concert with others, 30% or more of the voting rights of a public or private company domiciled in the European Community, then the acquiring funds would have to comply with regulations and reporting requirements related to:
- disclosing information to other shareholders and to representatives of employees or to the employees themselves, at the time of acquisition;
- the annual disclosure of investment strategies and decisions; and
- general disclosure about the performance of the portfolio companies.
In explaining the purposes behind these provisions, the European Commission expressed a need to disclose information about companies that have a “wider public interest.” But it also emphasized a concern that in private equity buyouts “employees do not enjoy the same protection and rights as is the case when a transfer of undertaking occurs.” (Under the EC Transfer of Undertaking Directive, employees are protected by a set of rights when their employers are merged with or purchased by another business entity.)
The European Commission’s “Impact Assessment” of the proposed AIFM directive cites several recent studies of private equity buyouts in Europe for evidence that leveraged buyouts harm employees. In the EC’s opinion, one study suggested that private equity buyouts resulted in, among other things, little change in union recognition, union member density or management attitudes to unions, little change in issues over which managers negotiate with and consult unions, and a shift from pension to defined contribution schemes based on investment performance. For these and other reasons, the Commission argued “greater transparency and public accountability of private equity activities would help to ensure that the interests of all relevant stakeholders are taken into account in the governance of the portfolio companies.”
We’ll learn more about the outcome of these and other negotiations once the AIFM conference is held in Luxembourg this September. But what is evident at this point, at least, is that some members of the European Parliament hold radically divergent views on what form regulation of private equity should take. Whereas in the United States, discussions have generally centered around systemic risk and greater transparency for investors, in Europe an influential minority has focused on labor protections. With such divergent points of departure, it’s difficult to see how the Anglo-American and Continental European visions for reform will be easily reconciled.
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