Private Equity: Economic and Social Risks

Lord Tunnicliffe Excerpts

Thursday 21st July 2022 Lords Chamber

[Lord Tunnicliffe (Lab)]

My Lords, I congratulate my noble friend Lord Sikka on securing this debate; I am also grateful to the other speaker in this discussion. Given the imminent arrival of the Recess, the group is small, but several interesting points have been made and important questions posed.

Like it or not, private equity is part of our economy. It is an umbrella term, but each fund is different and each transaction unique; we should bear that in mind. Nevertheless, as the Lords Library briefing on this debate highlights, opinion on the role of private equity is split. Some work, mainly in the field of academia, has been done to assess its impact, but the evidence base is not extensive. There are competing views about the sustainability of the increased company debt, the extent to which these funds create jobs or improve pay, and so on. It seems to me therefore that one of the tasks we face is to better understand and quantify some of the practices discussed this afternoon. I hope the Treasury and others are working to expand the evidence base and come to more concrete views. Perhaps the Minister can touch on that in her reply.

One of the areas covered by my noble friend in his remarks was the role of the Financial Conduct Authority, the FCA, in regulating the activity of relevant funds. Over the years we have had many debates on the FCA, its powers and performance. It fulfils some of its functions very effectively, but some have a nagging feeling that it lacks certain tools and fails to properly utilise others.

My noble friend will know that in recent weeks I have tried—somewhat unsuccessfully, I concede—to tease out details of the forthcoming Financial Services and Markets Bill. I believe that the Bill has now been published and that consideration will begin in another place following the Summer Recess. In fact, I know it has been published since I have a copy, and I realise that first you have to weigh it to get a sense of its depth. I appreciate that the Minister may not be able to go into detail about the Bill at this stage. However, she can expect my noble friend to be able to pursue some of these issues further through amendments to that Bill.

That legislation will of course be considered immediately after the Conservative leadership race, which has highlighted something of an obsession with deregulation. While that may be expected, given the personalities involved, surely the answer to questions about the role or potential risks of private equity is to regulate this area in a smarter way? Part of that better regulation could be to close some of the tax loopholes exploited by private equity firms. As has been mentioned, the carried interest loophole is particularly controversial. Many also perceive an incentive for funds to take on debt rather than making equity investments. Labour has committed to closing some of these loopholes, using the process to fund an expansion in mental health care. It took some time, but the Treasury did eventually come round to Labour’s proposals for a windfall tax on energy profits. Can I perhaps tempt the Minister to take on this plan, too?

Another oft-cited concern with private equity has been its interest in established British businesses. We have recently seen the acquisition of Morrisons by a US firm, for example. In recent months, the high-street chemist Boots has been seeking a buyer, with several private equity firms expressing an interest. Ultimately, potential buyers struggled to raise funds and that sale has been abandoned—for now. However, we can be sure that funds will continue to show an interest in large British firms.

With that in mind, what consideration have the Government given to introducing enhanced takeover tests when UK firms of a certain size find themselves the target of a takeover? Ministers often cite the ability to scrutinise or block deals under the National Security and Investment Act, but those provisions do not seem to be sufficient. “National security” is not properly defined in that Act. It is for the Secretary of State to decide what it means, and it is also their decision whether to issue a call-in notice. The Minister may not think there are any issues here, but the Government should at least be willing to outline their position.

It is not just so-called traditional businesses that are targeted by private equity; overseas investment funds also have an increasing interest in British sports clubs. Several private equity firms have been involved in takeovers of football clubs, particularly—but not exclusively—in the Premier League. Just a month ago, the multi-billion-pound sale of Chelsea Football Club was completed, enabling the exit of Roman Abramovich. That consortium was fronted by California-based firm Clearlake Capital. We hope that such deals will ultimately prove to be good for the clubs involved, and for British football, but recent history creates some doubt. There are numerous examples of clubs which have been taken over by private equity or venture capital funds, who load the club with debt and leave others to pick up the pieces. This is one of the reasons why the Government commissioned Tracey Crouch’s Fan-Led Review of Football Governance, and why we will soon have an independent regulator with powers to investigate takeover bids.

However, it is not just sport. As others have noted, we see increasing private equity involvement in our social care sector. While the Department of Health and Social Care insists that this is not impacting on care quality, those who work in the sector speak of pressure on wages and resources, with owners of some facilities seeking to maximise their profit margin. There are genuine fears about what this will mean in the future, given the growth in demand for care services and the issues around staffing. The Government have repeatedly promised social care reform but, as in so many other areas, we have not seen meaningful progress. Private equity ownership of care homes need not be a bad thing if core regulatory requirements protect the quality of service, but it is not clear that current rules are up to scratch.

Elsewhere last year, Parliament passed the Advanced Research and Invention Agency Act, formally setting up a body of that name to invest in high-risk but potentially high-reward projects. During the passage of that Bill, Labour suggested that ARIA should be able to take an equity stake in the ventures that it funds or have a share of the intellectual property developed by those businesses. Those amendments were pursued by my noble friend Lord Browne of Ladyton out of a fear that venture capital firms, probably based in America, would swoop in and buy out any British start-ups that showed promise, moving IP and jobs across the Atlantic. The Government were not able to answer why they felt it right that these start-ups would be taxpayer-funded while their eventual success would be enjoyed by private investors. Does the Minister believe that is a sustainable position?

Despite the concerns that I have raised today, the involvement of private equity in the British economy is not inherently bad. It is a way for some firms to raise much-needed funds, enabling expansion or any number of other desirable outcomes. However, as the debate title suggests, there are risks. Too often we see firms that are operating entirely successfully taken over by private equity, overleveraged and ultimately left in a less stable position. That is not good news for our economy, nor for those who have given years of loyal service to a business. We should not discount the role that investment funds can play but we must ensure that this activity is adequately regulated. I hope the Minister can demonstrate a commitment to that in her response.

[Baroness Penn (Con)]

My Lords, I congratulate the noble Lord, Lord Sikka, on securing this debate. Private equity is a salient issue for the UK economy, and it is important for us to recognise both the benefits that private equity investment can bring and the risks that can occur alongside it. I thank the other two noble Lords for their constructive contributions to the debate.

I will politely disagree with the noble Viscount, Lord Chandos, on his remarks about the Conservative Benches. I look to the Cross Benches and the Liberal Democrat Benches; even our Green representative is not here. I agree with the noble Lord, Lord Tunnicliffe, that attendance tonight probably has more to do with the timing of the debate than other events going on at this moment. However, I welcome the noble Viscount’s glass-half-full attitude to private equity investment.

The UK is proud to be home to businesses of all shapes and sizes, in every region of the country, and across a variety of sectors. Each of those companies will require different growth strategies for their business that reflect their individual strengths. Private equity plays a valuable role in providing companies with the capital to achieve that. It can also help to ensure that innovative companies are able to weather disruption and continue their long-term growth trajectory to reach their full potential.

Private equity can unlock funding for firms that would not be able to easily access public markets, a vital source of support for both early-stage businesses and businesses that are struggling temporarily, and can enable them to grow into thriving firms. In 2021, businesses backed by private equity and venture capital directly contributed £102 billion to the UK economy, representing 5% of UK GDP. As firms thrive, that benefits the British people both as consumers and as employees of these firms. On jobs, private equity-backed businesses employed 1.9 million workers last year, meaning that 6% of the total jobs in the UK are supported by private equity-backed businesses.

The Government recognise the risks that can come with this form of financing. Private equity has a responsibility to represent the long-term interests of the businesses in which they invest. When mismanagement of a business occurs, it is important that those in the business’s senior management can be held accountable. In order to ensure that this can happen, directors of UK companies owned by private equity firms are subject to the same duties and obligations as other directors. They must comply with the duty to promote the success of their company in Section 172 of the Companies Act. They must exercise reasonable care, skill, diligence and independent judgment, and they must comply with insolvency law. To ensure that any payments to shareholders are legal and sustainable, any dividends and other distributions to shareholders of these companies can be made only out of realised profits.

[Lord Tunnicliffe (Lab)]

The argument is that there are all these laws to protect everybody. Has any action been taken against any private equity firms for disobeying any of these laws?

[Baroness Penn (Con)]

I will have to check that point for the noble Lord and get back to him in writing. From memory, action has been taken but I would want to check whether it was specifically against private equity companies or private equity-backed companies, rather than more broadly. I will also acknowledge, later in my speech, that there are instances where the laws and regulations have not always worked well, and where there is more progress to be made, such as in our audit reforms.

In addition, many private equity firms have voluntarily taken action to improve their disclosures by signing up to Sir David Walker’s Guidelines for Disclosure and Transparency in Private Equity. Private equity-backed companies above a certain size that volunteer to sign up to these guidelines agree to disclose information comparable to that published by listed companies in the FTSE 250. These regulations and guidance aim to ensure that private equity firms’ involvement in UK companies is in the best interests of the company and its employees in the long term. To further support this, the Government have reviewed the legislation on limited partnerships and intend to introduce measures in this parliamentary Session that will increase the transparency of the ownership and activities of these structures.

Transparency is important, and it is vital that investors and all those who depend on the largest companies can rely on the information they publish. That is why the Government are taking further action in this area, which aims to protect the UK economy against risks to jobs, pensions and suppliers from unexpected company collapses. Under the Government’s recently announced audit and corporate governance reform plans, the definition of a public interest entity will be expanded to cover virtually all types of company with a turnover of more than £750 million and more than 750 employees. This means that large private equity-owned companies will be subject to enhanced disclosure obligations relating to resilience and other matters. They will also be subject to stronger audit rules and the new, strengthened regulator will have powers to sanction directors for breaches of duties relating to reporting and audit.

As a result of these audit and corporate governance reforms, private equity-backed firms will have to publish information about the risks they face and the steps they have taken to prevent fraud, and disclose their realised profits and losses which are the basis for dividend payments. The Government recognise that instances of asset stripping do occur, to the detriment of creditors, employees and wider stakeholders. That is why, in 2018, the Government committed to delivering new powers to better enable insolvency practitioners to reverse transactions that have unfairly extracted value from companies prior to formal insolvency proceedings. The Government’s reforms will enhance the transparency requirements for our largest companies as well as the tools our insolvency practitioners can access. This is designed to ensure that large UK firms will not be able to dish out dividends when they are on the brink of collapse.

To address the point made by the noble Viscount, Lord Chandos, about the creditor hierarchy for small traders, the hierarchy that currently exist in insolvency law—