House of Commons - Treasury

Select Committee on Treasury Tenth Report

5 Transparency

Transparency to the public and to employees

67. Relatively little information has hitherto been publicly available about the private equity industry, and the question of transparency has become more important as the industry has grown. Sir David Walker has referred to "the understandable tendency of many in the industry … to say that 'private means private' and to be attentive to confidentiality to the point of secretiveness."[140] He told us that the industry's "significance and influence in our economy has grown hugely in the last two years" but that "its attentiveness to the stakeholder interests … has not matched that growth in its significance".[141] And Peter Linthwaite, then Chief Executive of the BVCA, accepted that "as the size of transactions has increased there is a wider stakeholder base, who may have legitimate interests in the businesses that are being acquired."[142] In February 2007, the BVCA asked Sir David Walker to undertake a review of the adequacy of disclosure and transparency in private equity with a view to recommending a set of voluntary guidelines. Sir David told us he was focusing "almost exclusively on the buy-out end of private equity".[143]

68. In March 2007, the then Economic Secretary to the Treasury, Ed Balls MP, said of the difference in reporting requirements between private equity-owned companies and listed companies that:

This difference is logical - it is rooted in the distinction between keeping a small group of private shareholders informed, and reporting to markets as a whole. Nevertheless, large businesses, and particularly those in the public eye, have a wider responsibility to engage with the community in which they operate and to meet the legitimate interests of stakeholders, both employees and the wider public, in how their operations affect them. As the private equity sector has grown and as some major companies have moved from transparent public to opaque private markets, this need has become more acute.[144]

69. The call for greater transparency was widely supported. For example, Jack Dromey of Unite (T&G) told us that "if one has very powerful companies operating in secret and they are totally unaccountable for the consequences of their actions for workers and the public that is wrong; it offends against what has been a generation of progress on openness and transparency of public companies".[145] The London Investment Banking Association (LIBA) described the Walker Review as "a very positive development which will likely maximise the over-all benefit [to] the [private equity] market in general".[146]

70. Trade unions were particularly concerned about the lack of transparency between private equity firms and their workforces. Paul Kenny of Unite (Amicus) told us of the difficulty, in the case of the AA, of finding out even who was involved in the takeover,[147] and the union has called for "European wide regulation on transparency and regulatory compulsion for private equity companies"[148] so that workers have the same rights regardless of the country and the company they work in. The TUC referred to the apparent contradiction between the Information and Consultation Regulations 2004, which require employers to consult employee representatives in situations such as forthcoming takeovers, and the requirements for secrecy in the Takeover Code, although the TUC recognised that this issue was not specific to private equity.[149]

71. Although ownership models are traditionally used to define the reporting requirements of companies, the TUC made the point that "economic and social impact" should be the determinant of reporting requirements,[150] rather than ownership structure, and we note that Sir David Walker proposes more extensive reporting by the larger portfolio companies. Notwithstanding the different types of equity invested in the companies, the wider issues of economic and social responsibility, especially in the cases of the larger buy-outs, are the same in terms of the role these companies play in the wider economy, as employers and as providers of goods and services to the community.

72. On 17 July, Sir David Walker proposed the following changes in reporting:[151]

Portfolio companies that were formerly FTSE 250 companies, or where the equity consideration on acquisition exceeded £300 million, or where the company has more than 1,000 employees and an enterprise value greater than £500 million, should report to the following enhanced standard:
- File annual report and financial statements on a company website within four rather than nine months of year-end;
- Publish details of the board composition
- Refer in Board statements to the company's values and its role in the wider community;
- Cover in financial reporting the company's balance sheet management, with descriptions of the level, structure and conditionality of debt;
- Publish a short interim statement no more than two months after mid-year.
General partners (i.e. private equity firms) should publish an annual review, accessible on their website, containing:
- An indication of the leadership team of the management company;
- A commitment to confirm to the proposed guidelines on "a comply and explain basis";
- Details of "the philosophy of their approach to employees and the working environment in their portfolio companies", the handling of conflicts of interests, and corporate social responsibility;
- A broad indication of the performance of their funds, providing information about how value has been created;
- A categorisation of the limited partners in their funds.

73. We welcome Sir David Walker's proposals to increase transparency in the private equity industry. We would like the guidelines published in the autumn to be clear and specific in order to facilitate compliance by the industry. In particular, we would like to see more detailed guidance on the content of:

Board statements by relevant portfolio companies setting out their approach to their stakeholders, together with information on their strategy for the company;
Annual reviews by general partners, including the information on how value has been created;
Reports on the level, structure and conditionality of debt.

We suggest that there be arrangements for additional independent monitoring of the industry's conformity with this code over and above the expected scrutiny by unions, politicians and the media, to provide greater assurance that compliance will not fall short of the desired level. We look forward to seeing the final details of Sir David Walker's guidelines for the private equity industry when they are published in the autumn.

Independent data

74. Another concern with regard to private equity is the general lack of independent data. Much of the data available are provided by the industry itself and some of the research is sponsored by it. Sir David Walker referred to the "partiality and unsatisfactory nature" of the data,[152] and Paul Myners described the data available as "inconsistent and/or lacking in completeness or independence".[153] Statistics which lump together all the diverse companies making up the private equity industry were particularly criticised.[154]

75. Sir David Walker's consultation document emphasises the importance of "investing resource in developing an authoritative and respected capability that avoids misleading aggregation of apples and pears and commands confidence within the industry as well as externally", and sets out the aspects on which he believes information should be provided.[155] Given the absence of comprehensive industry-wide data on the private equity industry, we look forward to seeing Sir David Walker's more detailed proposals for developing a respected capability for providing such data that commands confidence within the industry and externally when he publishes his final guidelines for the private equity industry in the autumn.

A legislative response?

76. Sir David Walker has said that he "does not see the need for and does not recommend any change in existing regulatory or legislative provisions on disclosure in the UK". He considers his guidelines as "particularly apt for an industry whose evolution has involved, and seems likely to continue to involve, relatively rapid change"and describes conformity with guidelines as being on a "comply or explain basis".[156] He expects that "buyout firms and portfolio companies will generally conform, with the added discipline … of external scrutiny by unions, politicians and the media". He told us that if transparency in the private equity industry was regulated from the outset, "it is an entirely predictable consequence that you will end up in a mess".[157] Paul Myners agreed with the view that this was not an area "which requires legislative intervention"[158]. However, Jack Dromey of Unite (T&G) described self-regulation by private equity as "worse than useless", and believed that "the rogues will undercut the reputable".[159] John Cridland of the CBI said that if companies did not implement a voluntary code, "it is down to you and regulatory bodies to decide whether more is necessary.[160] We will certainly be willing to use our influence to help to ensure that any guidance drawn up by Sir David Walker is implemented.

Transparency to investors

THE PURPOSE OF TRANSPARENCY

77. Peter Linthwaite, then of the BVCA, told us that the main purpose of transparency was "to make sure that there is information to investors, or potential investors, from which they can make an informed decision."[161] Paul Myners observed that "Public companies work with a more complex set of requirements around disclosure in order to address the fact that they have multiple owners and their securities are freely traded. These forces for disclosure do not apply to businesses owned by private equity".[162] The CBI told us that "Private equity fund investors are far better informed about the performance of their businesses than are their counterparts in the publicly listed sector."[163]

78. The FSA has a regulatory responsibility for ensuring that there is an appropriate level of transparency to private equity investors, to enable informed decision-making and promote efficient, orderly and fair markets. The FSA told us that it had conducted a review in 2006 which had found that transparency for existing and potential investors in private equity was "extensive".[164] The FSA noted that "methodologies for disclosure, valuation and performance reporting used in the private equity market are not always applied consistently", but indicated that, because the private equity market is predominantly a wholesale market, "Investors should … have the appropriate level of sophistication to assess information given to them by funds in which they plan to invest or have invested."[165] Sir David Walker is conducting a review of around 100 private equity investors, and told us that the findings so far suggested that those limited partners were "generally very well satisfied with the flow of information, the disclosure and transparency to them". He believed that the only question remaining was "whether the methods of valuation between different funds are precisely comparable".[166] Paul Myners, on the other hand, told us that, although, theoretically, investors "should be in a position to insist on necessary disclosure standards", in his experience "investors can be quite lethargic in this respect".[167]

COMPETITION AND THE FEE STRUCTURE

79. The fee structure for private equity is often referred to as "2 and 20", reflecting the 2% annual management fee commonly charged and the 20% rate of carried interest. Concern has centred on the fact that, despite the great increase in the size of the larger deals, the percentage charged as a management fee has fallen only moderately, apparently to 1.5 or 1.75%.[168] As Jon Moulton of Alchemy put it, "The institutions give us the same terms essentially for a £100 million fund as for a £10 billion, 100 times the fees and income. The costs of running the funds do not go up by a factor of 100. … Nobody forces the institutions to do it." Robert Easton of Carlyle Group told us that "The reason why these levels are as they are … is because the people whose money we are managing are getting good value overall and they are happy with it."[169] Dominic Murphy of KKR emphasised that the fee structure was fiercely competitive.[170]

80. On the other hand, Professor Williams linked the willingness of investors to pay high fees to the general lack of information about the private equity industry.[171] Paul Myners argued that "a more candid and complete explanation of the returns to limited partners and general partners and the construction and allocation of the general partner return might facilitate a more informed challenge to fund fees (and the level of charges to funds by general partners for other services provided to the partnership)."[172] Sir David Walker's consultation document indicates a reluctance to disturb "the confidentiality which generally governs the relationship and information flow between general partner and limited partner".[173] We note that the percentage fee paid by funds to general partners in the larger private equity firms has declined only to a small extent (apparently from 2% to 1.5% or 1.75%) despite the massive rise in the size of some funds. We invite Sir David Walker to consider whether more information could be made available on fees in order to make the private equity market more competitive in this respect.

The TUPE Regulations

81. The Transfer of Undertakings (Protection of Employment) Regulations (or TUPE Regulations) are intended to protect employees if the business in which they are employed changes hands. Its effect is to move employees and any liabilities associated with them from the old employer to the new employer. When TUPE applies, employees have the legal right to transfer to the new employer on their existing terms and conditions of employment and with all their existing employment rights and liabilities intact (although there are special provisions dealing with pensions under occupational pension schemes). In order to comply with TUPE, an outgoing employer must inform and consult staff, and if there are any changes or proposals for changes following the transfer, these must be discussed with the employees' representatives. Several witnesses pointed out that TUPE applied if assets were bought from a company, but not if shares were bought, and therefore that TUPE did not apply to takeovers.[174] On the other hand, witnesses from BVCA told us that TUPE did apply to takeovers.[175] We ask the Government to clarify the application of TUPE to takeovers in time for the resumption of our inquiry.

140 Disclosure and Transparency in Private Equity: Consultation Document July 2007, Sir David Walker, July 2007, p 3 Back

141 Q 482 Back

142 Q 106 Back

143 Q 482 Back

144 Speech by the then Economic Secretary to the Treasury, Ed Balls MP, to the London Business School, March 2007 Back

145 Q 204 Back

146 Ev 140 Back

147 Q 165 Back

148 Ev 105 Back

149 Ev 176 Back