SIR DAVID WALKER

11 DECEMBER 2007

  Q20  John Thurso: I put it to you that actually, in a way, that is a very internal view of the private equity industry, because there are a lot of people who are stakeholders via the portfolio companies but, ultimately, who owns them is of considerable importance, and whilst I would happily concur that nobody is looking to see every individual executive's itemised reward package on public display, there is a strong case for showing aggregates for a fund and a process, and so forth, as much to simply prick the bubble of suspicion as anything else. Would you not feel that there really is something the private equity industry should be doing in that regard?

  Sir David Walker: If you are talking about the management fees and the carry arrangements, they do not change much, have not changed much and I would predict are not likely to change much from what is generally known. If the question becomes the other very important matter to which you referred, which is the remuneration of executives in private equity firms, in which there has be a lot of public comment that it is a lacuna, it is unsatisfactory that I have not required that, my answer is that, first, the analogy is false. The analogy that is frequently drawn is with directors of quoted companies. That is a mistaken analogy. Private equity executives and the general partners of the private equity firms are like institutional investors in quoted companies. Institutional investors in quoted companies do not reveal their compensation. If I look at Legal and General, of which I am Vice Chairman, the Chief Investment Officer's compensation is not revealed unless he were to be on the board of a quoted company. The remuneration of the hugely significant Chief Investment Officer of Fidelity, one of the biggest institutional investors in the world, is not revealed publicly.

  Q21  John Thurso: Is there not a fundamental difference, in that the public market is the protection in that case? Most institutions, while taking an active interest in the portfolio companies they own via the public market, do not actually take an active role in the management—I know one could argue that—whereas as the main distinction with private equity is that the whole point is that they do take an active role, a very close role, and there is therefore quite a different relationship? The point I am really driving at, and I will bring it to a close shortly, is simply that, because the suspicion exists in private equity which does not exist on the public market, this is the occasion to address it and a little now might go a long way, as opposed to having it dragged out of people at a later stage?

  Sir David Walker: I think the difficulty is it will be very difficult to drag out. Two observations: in the case of executives in quoted companies, there has to be accountability to the owners, and the only way of doing that, given, as you know very well, the huge number of owners in a typical FTSE 100 company, is by releasing it publicly. I am Chairman of the remuneration committee of a FTSE 100 company and I am very clear; my accountability in that role (and I have to produce a very substantial report to be incorporated in the report and accounts very year) is to our, I think it is, 165,000 shareholders in Legal and General. That is achieved by the management of these stakes in private equity to limited partners and can be done on a private basis. That accountability can be discharged in private. If you say (and I understand the question) there is a wider stakeholder interest in this, I have to say that if the United Kingdom in this very cross-border business were to be the only country in which private equity operates in which we sought to require the private equity, the carry that is enjoyed by individuals, to be released publicly, it would be a very straightforward matter for the relevant contracts to be drawn up outside the jurisdiction and we would not achieve the accountability that you seek. Since I believe there is a reasonable case for protecting that confidence, I have not sought to risk that sort of avoidance activity.

  Q22  Mr Dunne: Could I pick that up, Sir David. When you say it is a straightforward matter for contracts to be written outside this country, do you envisage a more widespread shift of the business and the employees and, therefore, jobs out of this country into other neighbouring jurisdictions? Is that what you are implying?

  Sir David Walker: No, I have to say, Mr Dunne, I do not like this argument, because if we think something is sensible in the UK, we ought to strive mightily to get people to conform to it. There are private equity firms, there are global private equity firms, who I think it would be fair to say dislike me intensely and would rather this process had never been embarked upon. I think there is acceptance that something like what I have been putting in place has to be done, and I am confident that they will all commit to it, but there had to be a judgment about parts of the structure, where some of you and the media would have liked more information, where I had to exercise a judgment of the kind that I have exercised. I think that the matter that concerns me most is the inadequacy of our understanding of the way private equity operates, and it is relevant to the previous question. I think it is unfortunate and, in a way, typical of the environment that we have in the UK, that most of the discussion has been about the distribution of the financial rewards of private equity and there has been virtually no discussion about the thing that really matters, which is the economic impact of private equity on our society and economy. If it is the case that private equity, as is suggested by very high quality survey work done by McKinsey, by Ernst and Young and, most recently, by the Harvard Business School, pretty systematically produces better economic performance, in particular in terms of jobs, productivity, enhancement of enterprise value, and so on, than quote companies, it is hugely in our interests that we devise a system which, if anything, encourages private equity to become larger in the UK and does not jeopardise its continuance here.

  Q23  Mr Dunne: Looking at the cut-off point that you posed in your interim report and confirmed in the latter report, can I be quite clear. You can take FTSE companies, overseas companies now listing and becoming members of the FTSE index. If they do not employ a thousand people in Britain they would be excluded from this disclosure regime if they were taken in private by a UK-based private equity firm. Is that correct?

  Sir David Walker: I would say they would not be included, yes.

  Q24  Mr Dunne: That would also go for British based companies that might have chosen to move the base of their operations overseas. You might take, for example, Standard Chartered Bank, I do not know whether they employ a thousand people here or not, I suspect they do not. If that was to be acquired by a private equity firm based in Britain, would that be subject to your regime, meeting the other test of being more than a £300 million business?

  Sir David Walker: The answer is, yes. I would say two things here.

  Q25  Mr Dunne: So this an either/or, is it? If you meet one of the tests of a thousand people or a £300 million transaction?

  Sir David Walker: No, they are an "and" and "and". So if the market capitalisation plus the premium for acquisition by the private equity firm is £300 million (which, incidentally, is a tightening up from the July document—I did not pick this up in response to the Chairman earlier—I have tightened, I have lowered the threshold in that particular respect) and they have a thousand employees, they would be brought into the net, but it is not either/or; these things come together.

  Q26  Mr Dunne: So in the case of my example, Standard Charter, should they have less than a thousand employees in the UK, they would not be included?

  Sir David Walker: No, they would not, but I think they do have more than a thousand. Could I take the opportunity to say that the £300 million figure appeared in my July document alongside, I think I did say there, a £300 million or a FTSE 250 company. I have eliminated the FTSE 250 and I have lowered the 300, and the way in which it is done is this. The FTSE 250 is too high. The medium value market capitalisation of FTSE companies is £1.1 billion. It has come down a bit since July. That is far too high. I want to bring in companies that are much smaller than that and I have retained the 300 million, but if you read, it is not the small print because it is clearly there. The 300 million is the market capitalisation plus the acquisition premium, and in private equity the acquisition premium is usually more than 20% and is sometimes as much as a third. So we are talking about companies from a public market that have a capitalisation of perhaps 225 million, which is below the bottom end of the FTSE 250.

  Q27  Mr Dunne: Do you have a sense for how many companies would be caught within that net?

  Sir David Walker: Yes. I am grateful that you asked me, Mr Dunne, for a sense, because we are not absolutely confident. A lot of work is being done on this now. The answer is 65 immediately. My expectation is that when the work is complete and a few private equity firms that are not members of the BVCA but are private equity firms authorised by the FSA have been brought into the net, probably we will have 80 firms on my criteria, but I would also emphasise here that this is precisely the sort of area where I think the Guidelines Review Committee will want to look in a year's time: has Walker put the thresholds in the right place? I think this is very much a matter for review. If, for example, there were companies that would have been the sixty-sixth or sixty-seventh that had 900 employees and it was thought, for whatever reason, that they ought to be in the net, let them be brought into the net.

  Q28  Mr Dunne: Do you anticipate that privately owned businesses that are not held by private equity firms, they are held by private individuals, will volunteer to disclose information?

  Sir David Walker: Realistically, no. The principle that I set out in the November document, which was not in the July document, having spent a lot of time in consultation on non-private equity, was a principle which, obviously, it is for this Committee and the Treasury and Parliament to gauge—if it is like private equity, in particular if it employs a lot of leverage, the presumption should be that we ought to find a way of bringing them into my framework—and the category I have particularly in mind (which was not really on the horizon, I have to say, in July, this has emerged very substantially in the autumn) is the sovereign wealth funds who do behave like private equity—there are some others also—and use prospectively a lot of leverage.

  Q29  Mr Dunne: Do you see any relevance to private equity specifically of extending TUPE regulations to transactions where businesses change hands through a share sale rather than a sale of assets? Is that a relevant consideration or something which is subject to our inquiry?

  Sir David Walker: I very much respect the concern that has been put to me by a number of the unions in the consultation process. I understand their concern, but I have to say, yes, I think it is relevant. But it is not uniquely a private equity problem; nor is it a matter for voluntary guidelines, Mr Dunne. As you know well, this is a matter of primary or secondary legislation but it is a matter for this House. I understand the concern, but I did not feel that it was something that I could address in my report. I would rather have a guideline which modifies TUPE though in one area, which I think is very important, I have been presumptuous and have removed derogation for private companies that was provided in primary legislation. We are going to talk about that, if it is of interest, later.

  Q30  Jim Cousins: Sir David, I wonder if you could tell us what exactly you expect private equity companies to tell the wider stakeholder community, including their employees, about their goings on?

  Sir David Walker: Mr Cousins, I have two answers to the question. I think it flows very well from the previous exchange, because in the guidelines I am requiring portfolio companies, which I think is the focus vis-a"-vis employees—the AA, SAGA or Alliance Boots, to take topical examples—to conform to the provisions of the Business Review Provisions of section 417 of the 2006 Companies Act, and it is very significant that Parliament chose to exempt private companies, which of course these now are, the companies I have mentioned, from subsection five of section 417, and that is the disapplication or the removal of the derogation, the sections attached as an annex to the report; and the provisions there require the company, first, in its report and accounts, to give an account of what it has been doing by way of communication vis-a"-vis employees in relation to the environment and its wider social responsibilities. That is a material obligation for which there is growing a body of precedent and experience in reporting by voted companies which I expect private companies, these portfolio companies, to have to conform to. It was, I thought, a very serious and deliberate decision to remove that derogation in the 2006 companies legislation. Secondly, in relation to employees, as I said in the report, I think the time of maximum anguish, nervousness, worry for employees, to which I am hugely sympathetic, is when something is happening like an acquisition, like a disposal, like a change of strategic direction, and I think it is (and I emphasise that in the report) at that point that portfolio companies should be particularly attentive to the interests of employees, and the moment the strategy, the acquisition (it might be a take-over) becomes public knowledge, they should give very full communication to their employees; but what I say here, I have to say, is only a modest part of the total picture. Remember that where there is a takeover of a public company, which has been the prime focus of concern in this Committee, I think, sparked by Sainsbury's, which might have been, and Alliance Boots that was, there is now, under primary legislation, the take-over legislation under the 2006 Takeover Directive, for a company to incorporate in its offer document for the target company very full information about the implications for employees in terms of jobs, in terms of conditions of service and pension schemes. So that is one major block. Another major block is the information and consultation regulations that again derive from primary legislation, which provide, from March of next year, the provision for communication and consultation with employees down to companies that employ only 50 employees. I say "only", not dismissively, 50 employees are very important; I was very struck that in the TUC's submission in the consultation process Brendan Barber said that he was not satisfied that those regulations were being adequately enforced by government; so there is a point to which I have drawn attention there. Finally, alongside what I asked for, is, I think, the enlightened self-interest of private equity firms to communicate effectively. In the evidence that was given to you in July by one of the private equity firms, I think Ronald Easton from Carlisle said that every time there was an acquisition he went before the whole workforce and communicated with them, listened to them and took account of views they expressed. I have said to the private equity firms in the course of my work, if you do this, and it would just be folly not to be doing it, why do you not talk about it and be more open about it? I think they have got the message, is the best I could say.

  Q31  Jim Cousins: I think, Sir David, it is important to recollect that when Parliament was guided by the Government in the 2006 company legislation to exclude private companies, Parliament did so on the basis that the private companies under issue then were small family firms. I think if Parliament were to revisit the matter, it might well decide that there was a new category of private companies, represented by private equity companies, that could not be treated in exactly the same way as small family firms. Do you not think that your own concerns to take out subjectivity—that was the phrase you used earlier in this meeting—point to the fact that there is a great deal of concern about what is in fact going on to generate value?

  Sir David Walker: I think, yes, I absolutely take the point of the question. On the first, your observation that if Parliament were looking now at these issues it might have sought to not exclude at least some private companies, it is obviously for this Committee to judge what Parliament would do, but I would think they would be wise to take that view, which is why in what I have done I have adopted—

  Q32  Jim Cousins: Wise to take which view?

  Sir David Walker: To take the view that larger private companies should be subject to the same regime as quoted companies, which is what I have done. Section 417(5) applies only to quoted companies. I have now sought to apply 417(5) to these big portfolio companies in private equity, so I have gone now precisely the line I think you were advocating.

  Q33  Jim Cousins: Do you not think, Sir David (another point that you made earlier) that if you introduce a regime in one jurisdiction that is considered in some way to be onerous, there is simply an evacuation into jurisdictions that are more favourable to base yourself for regulation, regulatory arbitrage between national jurisdictions? Do you not think that this simply could be a kind of competition in ineffective regulation that in the end is going to bring about a broad distrust of the way economic decisions are made?

  Sir David Walker: I well understand the question. I do not like the external, "If you regulate us heavily, we will go and do it somewhere else", argument, and I think none of us like that argument. My view is that it is extremely unlikely that private equity, which finds the United Kingdom, for all sorts of reasons, an attractive place to do business, is going to migrate its business elsewhere. I think there are some particular points where there could be avoidance. I mentioned, for example, a requirement that the carry arrangements of individuals will, I think, be extremely difficult to enforce, or, let us put it the other way round, very easy to avoid. The regulatory arbitrage that I am concerned about (which I think is extremely serious, and I think it is an area for much more work and I would like to be able to contribute to it through the better analysis of how private equity impacts the economy) is the question which I would specify in these terms. If it is the case that private equity really does perform better than quoted companies—I am not confident about that yet, we need better evidence based analysis, and we have not seen that, but if that is the case—there is a major question: why is it that quoted companies allow private equity to get ahead, and are we satisfied, secondly, that the regulatory arrangements that we have in place are not stimulating an arbitrage into private equity and inhibiting the ability of quoted companies to perform as well? I have to say, my own suspicion is that the answer to the second question is that there is regulatory arbitrage from public companies to private companies and it is something that is very important to look at. It is being certainly addressed in the recent very interesting Harvard Business School article: "Why is it that in the United States private equity does better than quoted companies?"—a major subject for attention in an economy like ours where we are all very concerned to achieve real improvements in productivity, for example.

  Q34  Jim Cousins: If there is that kind of regulatory arbitrage, and you seem to have put forward the proposition that there is, where does that leave us with regard to sovereign funds?

  Sir David Walker: I think in relation to sovereign funds, if the principle were accepted (the principle I enunciated, Mr Cousins, that private equity, like activity, and I tried to define that, it is not a unique definition is activity where a sovereign fund or major investor employs leverage in the acquisition of a large business) the example that was on the TAPI between July and now was Sainsbury's, though that has now come to an end, I think it is important to try to get those sovereign royal funds to commit to observance of the guidelines of the kind that I have proposed. You said, where does it leave us? I think there is a lot of initiative to be taken vis-a"-vis sovereign royal funds to tell them, "If you want to do business in the United Kingdom, you will be expected to conform to this sort of approach." There are wider questions, obviously—there are more being addressed in the United States than in Continental Europe—about do we want to be the capital protectionist? I think that has not been a consideration that has been raised in this country, but I think, as a minimum, conformity to this sort of guidelines structure is something we ought to be insistent upon.

  Q35  Chairman: Sir David, the Rake Committee has been established, or is proposed to be established with you with the Guidelines Review Monitoring Group. Should it not include other stakeholders, like investors and trade unions, who would provide a view and perhaps dispel any misconceptions around private equity? Would you agree with that?

  Sir David Walker: Had I agreed with it, Chairman, I suppose I would have made—I think it is a very serious question and I gave it a great deal of thought. It is an area where I would want to be—I am confident about my report, but diffident about some elements. My diffidence is overcome by the possibility of modification in a year or two's time. The reason I came to the conclusion that I did, not without very great thought—. I did think about having major stakeholders on the group and the two I thought of were the union employees and owners. It is very strange; there are no owners in my monitoring group. The conclusion to which I came was that, if I added to the three independents and two industry professionals, outside stakeholders, the group would become very large and potentially unwieldy, and that was, bluntly, the reason for wanting to limit it to a small group, at least at the outset. My submission, Chairman, would be what I had in mind: let us see how this functions over the first year or two and, if it seems that it would be desirable to expand the group to include stakeholders, they would conspicuously be the two groups to be brought in, owners and employees.

  Q36  Chairman: But you would not lose any sleep if Mr Mike Rake decided immediately to invite investors and trade unions?

  Sir David Walker: No, not at all, and I may say (I do not think this breaches any confidence at all) in conversations I have had, I can say, with Brendan Barber, I have suggested to him that in thinking about independents, on which no conclusions, as I understand it have been reached, that is a matter for the BVCA and Sir Mike Rake, let us think of people who have great experience of employment legislation and perhaps come from a union background.

  Q37  Mr Mudie: You said some big players in the industry disliked you. I find that hard to believe, Sir David.

  Sir David Walker: You should have been at the dinner.

  Mr Mudie: I was never invited!

  Chairman: It is a pity.

  Q38  Mr Mudie: Only the Chairman goes to dinner on this Committee! Knowing of this dislike and knowing of the fear that was in the industry a few months back, you clearly had to steer a path between persuading these firms to come in or actually putting something on the table that had real integrity and did the job. Who won? If you did the latter you clearly would not get the players to participate. It is a difficult one.

  Sir David Walker: I am happy to try to answer that. It is not binary, Mr Mudie. If you take, whatever it is, 16 global private equity firms who are doing this sort of activity around the world, most prominently in the United States but increasingly in Asia, some of them in particular are very apprehensive that an initiative of this kind in the United Kingdom, which is very significant in the private equity business, will be the beginning of a slippery slope that will not lead to a structure of this kind where people will commit to the spirit of the thing and it will be done, hopefully, practically, pragmatically, sensibly, like the takeover panel model which everyone outside has long respected, but will induce others (Continental Europe perhaps) to go down the legislative route. It was not so much that they did not like me, it was the apprehension that this is the beginning of a slippery slope. I think, for the time being, I have won the argument but the Committee will be entitled to say the proof of the pudding is in the eating, absolutely, that this is not the beginning of a slippery slope, this is a practical regime that is being put in place in the UK and hopefully will come to be emulated by people outside, but the message I have given to them very strongly is that if you do not conform to this and show your conformity in very short order, you are attracting the wrath of this Committee, the attention of the media, of Parliament and the probability of legislation will be greatly enhanced, but, most importantly of all immediately, firms that do not conform, and they have all said to me that they would commit to conformity but firms which in practice do not confirm, will attract a huge amount of attention and the last thing these people want, to take the experience of one of them earlier this year, is camels on their lawn, or wherever they are placed. I know that there is a disposition to say there needs to be an independent process of rules and people need to be named and shamed and all that, which ultimately is a sanction at the end of all this, I believe that enlightenment and self-interest of these private equity firms and their portfolio companies will lead to, let me call it, good behaviour in accordance with these guidelines, and for those who do not behave in that way, I think there will be a big price to pay.

  Q39  Mr Mudie: The Financial Times. You have mentioned attributive analysis and they spelt it out in terms of financial engineering, which we worry about and would like to know more about, multiple expansion, operational improvements and how that affects the returns of individual firms. The Financial Times are suggesting you said, and you backed it up in a Financial Times interview, that you took that out in terms of the firms because it required fairly serious subjective judgment, and you have repeated that today, and so you handed it to the association. The Financial Times has suggested that you did not really do that, you actually have handed it over to the association, who will not do it on an individual basis, but do it on an industry-wide basis which lessens the transparency. That was watering down, in The Financial Times' eyes, and in fact you agreed that you had watered it down in that respect in your interview. Is that not a concession too far: because it seems to me a very major concession?

  Sir David Walker: No, Mr Mudie, and I think The Financial Times understanding of it was in error. It is not a watering down. I said, I think, to the Chairman, right at the beginning, but I think it is so important I welcome the opportunity to repeat it and reemphasise it, attribution analysis, I think, is one of the most important parts of the whole structure, certainly in my recommendations, because until we have that welled out to a rigorous standard that commands trust, we shall not know what the economic impact of private equity is, and I think that is a very serious deficiency. In July my inclination was to do what you referred to, which is to ask individual firms to produce their attribution analysis. I had not had the consultation or spent enough time on this. When I got into it, and a huge amount of grey matter work has gone into this, not just by me but by others, in particular by one of the major accounting firms who have made this something of a speciality, it became clear to me that there is a lot of subjectivity in the process that we need to squeeze down, and when I said that there were perverse incentives in where we are, what I meant was that if I stuck to my July proposition and said each firm should do its attribution analysis, cynically but I think realistically, what I would expect to happen is that individual firms would give the most favourable possible spin on their performance in a previous period, and, as you rightly say, they would minimise the leverage impact, they would minimise the impact of the rise in market multiples and would minimise in a "Look what a good boy am I" way what they have accomplished through improvements in operating performance. That does not help anybody. That is a perverse incentive. So I decided the right course was not to water down; on the contrary, to commission a very substantial body of work and we have had a subgroup of my group working on this with two major private equity firms and accounting expertise to develop a template. I am not yet happy with the rigor of the template, but we are well on the way. It would not have been ready now to require all firms to conform to it. I hope there will be convergence around the template, which includes an adjudication, a sort of audit process, that "private equity firm A" is not cooking the books and fiddling the figures and putting the most favourable spin on their performance. I think we will be there inside a year or so. I would rather expect, and I have not discussed it with Sir Mike Rake, that Sir Mike Rake at that point to be very interested in saying, "Okay, this is the template. I am going to hold you to it. This is the mechanism. Now produce it on your"—