Investment Markets » Banking and Finance
The Dangers Of The Private-Equity Boom
The FSA warns that the collapse of a large private-equity buyout could destabilise the economy. Is tighter regulation needed?
The Financial Services Authority's report on the multi-billion-pound private equity industry makes alarming reading. It warns that the collapse of a large buyout deal could – in extreme circumstances – put the economy's stability at risk. But as to what might be done to avert this disaster, silence reigns.
In fact, this inquiry into private equity's "smash and grab" merchants is the same sort of blind grope around that the watchdog achieved when it looked at hedge funds.
Meanwhile the risks are mounting: private equity is borrowing record sums to target some of Britain's largest companies and selling the bulk of the debt to unknown third parties. The FSA says its planning fact-finding exercises and regular reviews. Nothing to worry about then.
The report, which coincided with news that the US private equity firm KKR came within a whisker of launching a massive €40bn buyout for French media giant Vivendi, was certainly timely. No company it seems is too large a prey for private equity to swallow.
The obvious fear is that the industry, which is predicated of the fact that the cost of borrowing is a lot lower than the potential profits, is little more than a giant Ponzi scheme waiting to collapse when these happy circumstances change.
But FSA chief Hector Sants is right to conclude that this view is probably overdone: it's fair to assume that the risk is spread widely enough to avert a major collapse even from a large individual default. The authority was also right not to opt for regulatory overkill.
But, that doesn't mean we can sleep easy. These large public-to-private deals create tempting opportunities for insider dealing and other market abuses. So far, there are no concrete examples of that, but suspicion is widespread – if only because private equity firms make such fat returns from apparently staid investments. They should counter accusations of sharp practice by becoming more open – they should be private, not secret.
Private-equity investors see themselves as the new kings of the jungle, but they would be better to submit now to the light regulation the FSA proposes than to endure the knee-jerk reaction of a Parliament in full cry, when the first big redundancies hit some high-profile constituency.
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