Letter from... the UK

Private equity bosses have been stunned by their sudden exposure to the glare of publicity. Until recently the average newspaper reader knew next to nothing about private equity (PE) – which is strange, given that PE-backed companies employ 8% of the UK workforce. That inattention has been more than corrected in past weeks.

Leading figures in the PE sector have been aggressively and very publicly challenged by the House of Commons Treasury Select Committee. And trade union leaders have accused them of job and wage cutting, tax avoidance and creating artificial profits through financial engineering.

Under the weight of public examination, the PE sector decided it must change its approach. Accordingly, it commissioned Sir David Walker, a senior investment banker and former director of the Bank of England, to review the sector’s disclosure and transparency regime. In his consultative report, Walker says that ‘private equity needs to become more open’. He concludes that it is the perceived secrecy of the sector that has aided its enemies to make what he regards as excessive accusations against it.

Walker believes that some PE-owned companies adopt reporting best practice, while others do not. The concern is particularly about the former FTSE250 companies that have been taken private using leveraged buy-outs – usually based on huge debt. One of the strengths of PE, says Walker, is that the business and its managers have only, on average, 150 partners to report to, compared to 150,000 or so shareholders in a typical Plc. The narrower spread of ownership can concentrate managers’ minds and improve their performance.

But the cost of this stronger focus can be weaker reporting to a wider range of stakeholders, including staff, customers, suppliers and the media. Measures to rectify this, Walker suggests, might include: filing annual reports and financial statements four months from year-end, instead of the current nine months, and interim financial statements within two months of mid-year; extending financial reporting to cover balance sheet management; disclosing the composition of boards; and specifying companies’ values and approach to risk management.

Walker’s report – which is open to consultation until 9 October – has sparked a mixed reaction. Within the PE sector, there has been broad support and acceptance of the need for this type of reform.

But by considering exclusively improved transparency, Walker and the sector are open to criticisms that they worry more about presentation than how the sector operates. Trade unions remain unhappy about the non-disclosure of bosses’ pay and perks. Nor is the review intended to consider the tax arrangements of those who own and run leveraged buy-outs, who benefit substantially from interest on loans being tax deductible.

Ultimately, the Treasury Select Committee’s review of the PE sector is more significant. Its interim report gives us a flavour of what is to come when its delayed full report is published in the autumn.

Initial recommendations include that the Treasury and HM Revenue & Customs should consider the tax treatment of ‘carried interest’ (the share of profits taken by the PE partners) and that they make faster progress on their review of residence and domicile rules, which affect the tax paid by foreign PE investors with UK domicile. More generally, the Treasury is asked to review whether the current tax system favours PE over equity. And major corporate investors are being asked to explain why they have different requirements of PE-owned companies and Plcs.

Meanwhile, events are moving fast for the PE sector for a very different reason. PE investors are finding loans have become more expensive as the impact of the US sub-prime home loans defaults ripples out, forcing PE firms themselves to put in a higher proportion of the capital for bids. Many projected leveraged buy-outs now seem to be on the shelf. With PE capital drying up, it is economics, not politics, that is driving change – as is often the way.

Paul Gosling is contributing news editor of accounting & business and a freelance journalist.