SIR DAVID WALKER

11 DECEMBER 2007

  Q1 Chairman: Sir David, good morning and welcome to our inquiry into private equity. Can I ask you to remind us why you undertook this role and what you hope to achieve for the private equity industry as a result of your chairmanship of this group?

Sir David Walker: Thank you, Chairman. I was asked to take on this review at the end of February by the private equity industry, though I would want to say that, although I confirmed that I would indeed undertake the review, it was not for the private equity industry; I made clear from the beginning my interest was in trying to create a structure, if that were possible, that was in the United Kingdom public interest. As I have said to you and to this Committee before, I have approached it as an independent. My object was to see whether this imbalance between the very substantial rights of ownership that were being acquired by private equity, the rate of accumulation of which had accelerated in the 18 months, two years before the spring of this year, might not be better matched with a sense of obligation on the part of the industry to be more transparent and more open about their activities. I am very happy to take this further in detail, Chairman, but perhaps I can say now that in the process the strongest sense that has emerged in my mind is of the inadequacy of our understanding, including, I have to say, my own, but I think that goes for us all, of the economic impact of private equity.

  Q2  Chairman: So, your objective was to make private equity more transparent?

  Sir David Walker: Yes.

  Q3  Chairman: How would you respond to the allegations, quite a lot of allegations, in the newspapers that you have watered down your final guidelines? For example, attribution analysis, now an industry-wide issue, giving private equity companies longer to publish accounts—from four to six months—giving them the option of an annual report or updating their website and, in terms of the private equity firms which come into this scheme, increasing the £300 million figure for private equity companies, £500 million for unlisted companies, having a figure of 1,000 staff, at least, employed and having at least half their revenues in the United Kingdom. Those are quite a number of changes from your interim document and both The Financial Times and The Daily Telegraph, I think, feel that you have been got at. The Daily Telegraph, for example, when they talk about the arbitrary cut-off, says it shows that the real point of all this is public relations and keeping the unions at bay. That is The Telegraph talking. What is your response to that?

  Sir David Walker: I would focus on the substance, Chairman, and say most of it is insubstantial. I will begin by saying that there is nothing in the green document, the final report, published just three, four weeks ago, in the light of the comment that has been made, that I would want to change in any direction, but the allegations are just false largely. There are one or two areas, and I will identify those up front, where we did dilute what was proposed. The most significant in my mind was extending the period of reporting by portfolio companies, their annual reports and accounts, from four months, which is a quoted company regime, to six months and for their mid-term reviews from two months to three months, and I had in mind there that, although some of the companies that go into private equity come from the public markets, were quoted and would have little difficulty in moving to four months from the nine months that is allowed for private companies, for companies that were previously private companies the reporting burden and pressure on the accounting and finance function in a firm when they are going through, very frequently, a radical process of change at the beginning of the private equity process was unreasonable, so I thought that it was sensible to allow them a bit more time. That is, in my view, the only material, let us call it, dilution.

  Q4  Chairman: But attribution analysis, for example, you suggested of individual firms so that we could decide whether the moneys were coming from financial engineering, multiple expansion or operational improvements, and now it is on an industry-wide basis. That seems a big opportunity loss there, Sir David.

  Sir David Walker: Absolutely not. I comprehensively disagree. What you are asking for, it became increasingly clear—

  Q5  Chairman: But you made it very clear in your original document that you wanted attribution analysis for each company.

  Sir David Walker: Yes.

  Q6  Chairman: And you have changed your mind.

  Sir David Walker: But I had a four-month consultation process. I am surprised that you should appear to be suggesting that I was not attentive to the consultation process. We consulted 70 people. There were 70 points of contact.

  Q7  Chairman: I am not suggesting that at all, Sir David. What I am suggesting is that somebody like yourself, who is so well versed in the private equity industry, and you have spent a lifetime in banking, came out with such very firm comments in your original report and then went backwards at one hundred miles per hour. That is my suggestion.

  Sir David Walker: Chairman, I did not go backwards. If I would be allowed to respond to your question, I am absolutely clear that the importance of attribution analysis is as great, no, greater than I described in the July document; so I am completely with that proposition. If I were pressed by this Committee or elsewhere, what is the most important element in the whole report, high quality attribution analysis would be very high on my list. Why did I move away from the requirement that this be done by individual firms? It was to avoid, Chairman, perverse incentives. I did not realise in July the power of the perverse incentive that would be put in place, and that I will not put my name to. What I have in mind is if we required individual firms now to produce their own attribution analysis, the invitation to them to put the most favourable possible spin on their performance would be irresistible. What they would seek to do, I have to say, and I refer to my experience in financial services—I know what would happen—they would seek to display very little significance from financial engineering, very little significance from the rise in market multiples and a superior performance as a result of their announcement of operational improvement. So, the conclusion to which I came, which is a step on the way, which I think is true for quite a lot that is in my report, is what we need to do first is to establish a clear template to take as much of the subjectivity out of the attribution analysis as is possible. In the three or four months we made very great process with all the firms in discussion of a methodology for attribution analysis. My pretty confident expectation is that about a year from now there will be a template which they can all be held to, and that will be the point to review the question: should they be asked or required to produce these analyses individually? But at the moment I am extremely concerned that if we were to require what I had in mind in July, we would just give a perverse incentive and what would be produced would be non-comparable and, I think, frankly, misleading. They would all want to show how well they had done.

  Q8  Chairman: Do you believe your proposed guidelines go far enough to quell public disquiet over the activities of private equity firms, especially given that these guidelines include nothing on remuneration and are silent on the taxation of private equity?

  Sir David Walker: As you know, Chairman, I was not asked to look at taxation, so I have no comment to make about that. Plainly the taxation area is important.

  Q9  Chairman: Sir David, surely you had a free hand, as chairman, to decide what you wanted to do.

  Sir David Walker: I was given terms of reference that did not extend to tax, Chairman.

  Q10  Chairman: Did you make any comments to them about that?

  Sir David Walker: No, I did not.

  Q11  Chairman: It was lopsided then?

  Sir David Walker: It is lopsided, absolutely, yes, but if I had spent as much time on the tax questions as I have spent on transparency, openness and disclosure, I presume to give a view to the Committee, but I have not spent that time on the tax questions. On the question of remuneration, I spent a lot of time and have given it a lot of thought and those who seek disclosure of remuneration of executives in private equity firms will continue to be disappointed. Let me give briefly the reasons.

  Chairman: We will come on to that later on in some of the questions. Colin.

  Q12  Mr Breed: Thank you, Chairman. Do you accept that some people feel that you have produced a code which is the minimum you can get away with on a voluntary basis but that some of us feel in fact it only leads to potentially more support for a legislative process? Therefore, if the voluntary code had been somewhat more robust, there would not be the calls for legislation; whereas what we have got now is perhaps not a particularly satisfactory situation which may bring calls for heavy-handed legislation.

  Sir David Walker: Let me make two observations. First, my own view is that these are a substantial set of guidelines and rules. How can I say that? What is the benchmark by which you and I could seek to judge it? The answer is that this is unique in the world. No country in the world has even attempted a framework of the kind that is now in place in the UK on a voluntary, still less on a legislative, basis. So, I think we need to either approach this with a degree of diffidence, in the sense that I knew we were trying to do something that was unique but confidence that it was capable of evolving into something more substantial if that became necessary over time. The model I have had in mind, which started and for most of its life was on a voluntary basis, was the Takeover Code, and if I have an aspiration it is that what we put in place here could evolve and come to be seen externally as like the Takeover Code, which is the envy of the rest of the world. Let us see whether this proves to be that. As to legislation, I think there are powerful reasons why that will never be the right approach to this space, not never but not in the short-term. The first reason is what I call the asymmetry argument, which is that it is much easier to move from voluntary guidelines to a legislative solution than it is to move from a legislative solution to a self-regulatory model which has many characteristics that are very positive. The second is flexibility in a self-regulatory, voluntary guidelines model. This is capable of being modified—individual guidelines, the timelines the Chairman raised with me a moment ago—a year or two from now if, in the light of accumulating experience, that is thought to be necessary by the Guidelines Review and Monitoring Group that is now being set up. That flexibility, I think, is very important.

  Q13  Mr Breed: The fear is that the flexibility will be used to the advantage of the private equity firms and not to the people who are seeking the transparency; that, in fact, if you allow too much flexibility we are going to get even less than we thought we might do by interpretation and flexibility of rules.

  Sir David Walker: The knowledge of this flexibility carries a big obligation on the participants, and I absolutely take that, and it will be very important for the Guidelines Review Group to build a database of experience. My expectation is that that will be a tough process, but I would like to come to what I think is the most important reason for being, let us say, very cautious and thoughtful about going down the legislative path. I call it anti-avoidance. My belief is that if you have a voluntary guideline self-regulatory model that is felt to be owned by the industry, there will be a spirit of commitment to it, and this is what has happened with other self-regulatory regimes; and I am very encouraged by the evidence already today, 11 December, that private equity firms have committed to conform to the guidelines and some have already improved their websites, as you are aware, those proposing annual reviews. However, if you look at legislation, given the obligations, particularly of global corporates under their byelaws and, indeed, the common law, they have a fiduciary responsibility to maximise returns for their shareholders, and if there is put in place legislation which is one-country-centric, the fiduciary responsibility of the board of directors, or partners in a general partner, to maximise value for their owners leads them into looking at avoidance; and anti-avoidance, if you think about it, in some areas, the Chairman has just mentioned one of them, tax, is one of the main preoccupations of the Treasury. I saw recently, in a related but separate context, a formidable HMRC consultative document about corporation tax and tax deductibility of interest. Most of it is about anti-avoidance. I think it would be very unfortunate if we got into that situation fast here when I think it is worth striving, Mr Breed, to have the spirit of commitment to my guidelines.

  Q14  Mr Breed: Can I finally say that perhaps the alacrity with which many of the private equity companies have agreed your proposals gives us some concern. We would have perhaps liked a bit more screening.

  Sir David Walker: I can imagine that you would have complained that they were dragging their feet if they had not; so it is a heads you win, tails I lose, situation, if I may say so.

  Q15  John Thurso: Can I turn to the question of communication. Your final code gives private equity firms the option, the private equity firms of portfolio companies, of either an annual report or regular updates on the website; whereas, I think, your original proposals went for a full annual report. What led you to change your mind in respect of that?

  Sir David Walker: It is, frankly, of less profound significance than perhaps you are suggesting. I did not think this was a very big deal. I thought it was a more technological model, if you like, giving them the opportunity to keep their websites continually refreshed. My understanding is that most of them will not only keep their websites refreshed but will produce annual reports, but I thought some flexibility there made sense; so that if you want to look at the website (and they are meant to be very much more user-friendly than they have been in the past), at any moment in time you get an up-to-date statement, for example, of what the companies were in the portfolio.

  Q16  John Thurso: I put it to you, the reason why an annual report is useful, particularly if one is looking at a company, is you have got everything you want there, and if you read it diligently and go through all the notes and you know what you are doing, you can find out everything you are legally entitled to; whereas if once a week or once a month somebody whacks something new onto a website, you have a far harder degree of detective work to actually knit all the bits together to get the picture; so I was slightly surprised, if you were quite happy to keep the website, why one should not have an annual report as part of that. It did not seem a very big deal.

  Sir David Walker: I well understand the point. My expectation, not necessarily for all of them, is that they will actually do both, and some have already indicated their intention to do both, but in deference to your view, I would say that this is precisely the sort of area where I think the Guidelines Review Group might look at in a year's time and say, "Hey, would it not be better for the two or three who have not managed to get in your report to do so as well as keeping the website refreshed?" So, I will take that point.

  Q17  John Thurso: Can I turn to the question of remuneration and the fact that there are no proposals to disclose pay-off fees in your final set of recommendations and ask why you decided to go down that route?

  Sir David Walker: Are you talking about the remuneration of individual executives or the charges levied in the form of management fees and carry?

  Q18  John Thurso: I would like to ask you about both actually.

  Sir David Walker: As I last mentioned management fees and carry, if I start with those, they represent, effectively, the price that is being charged for a product or service, and if one thinks of other areas where price discovery has been a huge subject of discussion and is relevant, for example, in the MiFID legislation which is now on the statute book, price discovery is relevant for users. Those are the people who need good quotes from the Stock Exchange, for example, and the users in this case are the limited partners, of whom there are, compared with investors in the public Stock Market, very few, and they can all very readily find out what carry arrangements are and what the management fees are because they are not buying something off the shelf, they are actually going to have a contractual negotiation which leads to a partnership agreement which lasts for a long period of time. In my discussions, which have been very extensive, with limited partners—we have talked to them individually and we have had a web cast because many of them are outside the UK—I have asked them, is there greater transparency than is currently available that they need, and, pretty universally, not totally universally, the answer is, "We are well satisfied with what we have." So there is no demand from the users of the product or service for greater transparency.

  Q19  John Thurso: How can you say, therefore, that there is no interest for other stakeholders in having, not necessarily a detailed knowledge of precisely who got how much carried interest, but, for example, at the end of the life of a fund to know, broadly, how it performed so that employees or others who are affected can have some idea of what has happened?

  Sir David Walker: In relation to employees, of course, the portfolio company's report and accounts will give full detail, but if, as I rather expect and hope (to go back to a question posed earlier by, I think, the Chairman), the attribution analysis is published by individual firms, that is simply a question of developing a template, and that will take a year or perhaps a bit more. That information will start to be available as to the performance of the fund. As to management fees and carry, there is not much departure from what we all know, as I have set them out in the report, and although there is a little bit of diversity (some firms charge a bit more, some firms charge a bit less, it depends on the position in the cycle), the structure is not very different in the UK, in Continental Europe and in the United States, and, frankly, one of the reasons that caused me not to specify this report in the annual review of the private equity firms is, it is a bit like looking at the level of the sea, it does not move up and down very much, it stays the same, and I have said to private equity firms, if there are radical changes in your management fee or charging arrangements, you or the BVCA should be attentive and drawing attention to it.