Private Equity: Economic and Social Risks — House of Lords, 2022-07-21
Topic: Domestic Commerce
Prem Sikka (Labour, Centre-left): I am grateful for an opportunity to exchange some thoughts about private equity, a subject that should really concern us all. In my view, it is likely to be the location of the next major financial crash, and there will not be enough money to bail out the affected entities. Private equity is enmeshed with numerous other parts of the economy. It gets its cash from insurance companies, pension funds, banks, local authorities, trusts and wealthy individuals. The Government’s quantitative easing of £895 billion has also provided vast amounts of resources to these firms Private equity consortiums function as banks but are not actually regulated as banks. There is no minimum capital requirement, no control on leverage and no stress tests, even though the collapse of a private equity firm can destabilise all other sectors. The recent collapse of the US-based Archegos Capital Management shows how quickly the domino effects spread. It very quickly depleted the capital buffers of Goldman Sachs, Morgan Stanley, UBS and Credit Suisse. My first question is: can the Minister publish the Government’s assessment of the possible domino effects which may arise from the collapse of a UK-based private equity firm In a light-touch environment, private equity has been cooking its books. Recently, the Financial Times reported that parts of the private equity market resemble Ponzi and pyramid schemes. Private equity firms are transferring assets between each other at knowingly inflated prices to bump up profits, balance sheets and returns. My second question is: can the Minister explain what estimate has been made of balance sheet and profit inflation by the UK-based private equity firms, and what are the Government going to do about it In 2021, 803 private equity buy-out deals, worth some £46.8 billion, were completed. This investment is welcome, but private equity also poses threats to jobs, pensions, the country’s tax base and the wider economy. On average, private equity retains its interest in a company for 5.9 years, sometimes a lot less. There is no long-term commitment to any place, product, workers or customers. We all know that short-termism has been holding this country back for years. Financial engineering, tax avoidance and opacity are key parts of the private equity business model. Short-term returns are extracted through related party transactions in the form of rental payments, management fees, royalties and much more Private equity eliminates the downside risk of bankruptcy by injecting finance not as equity but as secured debt. This means that, in the event of bankruptcy, private equity needs to be paid first. Inevitably, unsecured creditors recover little, if anything, of the amount due to them. I give some examples. Bernard Matthews, Bon Marché, Cath Kidston, Comet, Debenhams, Flybe, Maplin, Monarch Airlines, Payless Shoes, TM Lewin and Toys "R" Us are just some of the monuments to the predatory practices of private equity are just some of the monuments to the predatory practices of private equity. All too often, wages are pushed down, jobs lost and pension schemes looted to generate short-term returns for private equity In September 2013, private equity firm Rutland Partners acquired a £25 million stake in Bernard Matthews. The company was then loaded with bank borrowing and a secured loan from Rutland, which carried an interest rate of 20% per annum. Asset stripping began straightaway. In 2016, the assets of Bernard Matthews, but not the whole business, were sold off for £87.5 million to Boparan Private Office. Rutland made a quick profit of £13.9 million. The key was dumping the amount owed to unsecured creditors and the £75 million deficit on the employee pension scheme, which eventually resulted in 700 employees losing some of their pension rights. At the time, I was advising the House of Commons Work and Pensions Committee on the case and, on 3 March 2017, the committee wrote to Boparan to ask why it bought only the assets, not the entire business, including liabilities to unsecured creditors and the pension scheme. Boparan replied that it had offered to buy the whole company, including its liabilities, but the offer was rejected by Rutland because, by dumping liabilities and the pension scheme deficit, it stood to make a bigger profit. The business model of private equity is all about asset stripping and dumping pension obligations. This pattern is visible across many private equity businesses. Silentnight appointed KPMG as administrator to enable its rescue but the firm did not actually do that. KPMG and its insolvency partner deliberately pushed Silentnight into insolvency, so that private equity firm HIG, a client coveted by KPMG, could buy the company out of administration at a lower price by dumping pension obligations to employees. About 1,200 workers lost some of their pension rights. That is a criminal act. The partner of KPMG lied—he has been found to have lied by the regulators—but the Insolvency Service has not mounted any criminal prosecution. Indeed, the Government have rewarded KPMG by giving it lots of public contracts Water companies have long been exploited by private equity. From 2006 to 2017, Thames Water was owned by a private equity consortium fronted by Macquarie Bank. During this period, Thames Water’s debt ballooned from £2.4 billion to £10 billion, mostly from tax haven affiliates, and interest payments paid to the group itself swelled the charges for customers. For the period of its ownership, private equity extracted £1.2 billion in dividends, plus £3.186 billion in interest payments. The company’s tax liability for the years from 2007 to 2016 totalled only £100,000, but we know that billions of litres of water leaked away and the company dumped raw sewage into the rivers. Meanwhile, the private equity investors got a return of between 15.5% and 19% a year In 2007, Alliance Boots was bought by a private equity firm, Kohlberg Kravis Roberts. The company’s control immediately shifted from Nottingham to Zug in Switzerland. The buyout was financed by the borrowing of £9 billion and loaded on to the company. This enabled the extraction of profits and profit shifting; and Alliance Boots engaged in a series of transactions through entities in Luxembourg, the Cayman Islands and Gibraltar to transfer profits. The net result was that Alliance Boots, which relied heavily on revenue from NHS prescriptions, dodged taxes in this country of £1.28 billion Asda has been bought by private equity firm TDR Capital, in conjunction with the billionaire Issa brothers. What was the company’s first step? To set up a parent company in Jersey. We know what will follow: a lot of financial engineering and tax avoidance Morrisons has been bought by Clayton, Dubilier and Rice’s offshore vehicle, Market21 GP Holdings, which is registered in the Caribbean. The supermarket is now controlled by a newly created entity in the Cayman Islands. We know the next step: asset stripping, profit shifting and tax avoidance The involvement of private equity in social care is a source of crisis. Private equity firms own one in eight care home beds in England. They typically load debts of around £35,072 for each care bed with an interest charge of £102 per bed per week. This roughly amounts to an average of 16% of the weekly cost of a bed, leaving little for staff and front-line services. Staff are poorly paid, which is one reason there is high turnover. They cannot provide the promised levels of service. Too many private equity-owned care homes, especially those owned by HC-One, are regularly sanctioned by the regulator for failing to meet the minimum standards. At the time of its collapse in 2011, Southern Cross was owned by a private equity firm called Blackstone. Many of its care homes were sold to Four Seasons Health Care, another private equity-owned firm—this time, owned by a company based in Guernsey. In 2017, with 220 care homes and 17,000 residents, it became bankrupt because it had extracted high returns and did not provide the required level of service. Again, it made billions in profit In the time available, I have provided a glimpse into some of the predatory practices of private equity. The Bank for International Settlements has now warned that excessive leverage is a danger as private equity firms will struggle to meet the higher borrowing costs imposed by rising interest rates. The Government can of course stop the dangers of high leverage by abolishing the tax relief on interest payments. It is not a business cost. Why on earth is tax relief being given? Whether an investment is funded by equity or debt has absolutely no impact on the systemic or business risk of the project concerned. Therefore, there is no case whatever for allowing tax relief on interest payments by corporations. Tax relief on mortgage interest payments made by individuals was abolished long ago on the grounds that it encouraged excessive borrowing, distorted markets and created new risks. That is even more applicable to private equity entities, which can drag the whole economy down I remind noble Lords that the previous financial crash was caused not by people rushing to banks to withdraw their funds but by excessive leverage. Lehman Brothers and Bear Stearns had leverage ratios of 30:1 and 33:1. Private equity has even higher ratios yet we seem to be oblivious to that. There is nothing in the 330-page Financial Services and Markets Bill, published yesterday, to address any of the concerns I have raised. I hope we do not live to regret that. I beg to move.