Rasmussen’s wrath: The full interview

Poul Nyrup Rasmussen has been pressing for a regulatory clampdown on private equity and hedge fund managers in the European Union for a number of years. As the former prime minister of Denmark he

Poul Nyrup Rasmussen

witnessed the controversial €13 billion take-private of Danish telephone operator TDC by a consortium of

financial sponsors in 2006. In his current position as president of the Party of European Socialists, his efforts to curtail the proliferation of “risky” investment products have garnered support among colleagues in the European Parliament. Draft regulation – in the form of the EU’s Alternative Investment Fund Managers Directive – was created last year and has since been the subject of constant, heated debate. The directive is currently being revised and amended before being put to the vote in the European Parliament in July. In an exclusive interview, sister publication Private Equity International finds out whether his stance has softened.

PEI: Do you accept that in many respects private equity fulfils an important role in the economies of Europe? Has it made a positive contribution to the economy in Denmark?

PNR: Only a portion of private equity activity, that is venture capital, has positive economic and social externalities, in that it supports innovation. If we are to achieve the transition of the EU towards the Lisbon Strategy goals – now the EU 2020 goals – we need efficient mechanisms to fund risky projects with very high growth potential. So I fully support the development of venture capital, and I believe we should be thinking of how public authorities could boost these activities, not only through regulation but also through public funding.

Denmark has consistently had the highest level of venture capital investment in Europe for several years, and it is also one of the most competitive economies in the world, particularly in the high-tech sector. It’s not by chance. There is an obvious link between the two.

This being said, ‘classic’ private equity activity – that is the largely predominant buyout segment – is mostly detrimental to the economy. A business model that relies on extracting value for the benefit of a few, as opposed to creating value for the benefit of many, cannot deliver efficiency at the macro-economic level. A company is not a 'bag of assets' that can be dismantled for the sake of short-term returns. I have seen too many healthy companies being badly disrupted by useless LBOs to be enthusiastic about the whole thing, to say the least.

PEI: How much is your push to curb the activities of private equity and hedge funds the result of the TDC buyout?

PNR: The TDC case is only one story among many others. We have been working on this issue for many years, with all our European and American friends. It is a fact that the overloading of debt has weakened the companies concerned. And this is why private equity has to be regulated.”

PEI: Given that large, highly leveraged buyouts like TDC are off the agenda for the moment, do you still believe that regulation is needed?

PNR: Maybe another mega-buyout seems impossible today, but what about tomorrow? Obviously the markets are still recovering from the downturn, and there is still a lot of deleveraging to come, writedowns to be offset, etc. But it would be very short-sighted to just assume that the market conditions will remain the same. With the economic recovery, markets will rebound, cash will flow again, leverage ratios will increase, new bubbles will inflate, until it all collapses again and we undergo another massive crisis ….unless we do something now. It might be in two or in 10 years, but if we don’t change the rules of the game today, we will face the same problems tomorrow. We cannot simply accept that.

Besides, the market for PE might be smaller than it was before the crisis and the business might have evolved a little, but fundamentally it has not changed. The way it generates returns is still a source of negative externalities not just for companies undergoing LBOs, but for society as a whole. The misallocation of resources, the lack of transparency, the financial instability generated by asset bubbles, the risk of bankruptcy for companies under a buy-out: none of these problems have been solved! And remember that over two-thirds of the market is still made up of the buyout segment.

PEI: How would you respond to criticisms that the AIFM draft has been drawn up too quickly?

PNR: I can assure you that it hasn’t. An expert group on [alternative investment funds] was set up by the European Commission four years ago, kicking off the normal EU legislative process. In the EP [European Parliament], I presented a report recommending that the Commission come up with a directive proposal in September 2008. This was largely drawn from previous work, notably a report drafted with the socialist group at the EP in March 2007. Since then, the Commission’s first proposal has already undergone two revisions, and is far from being adopted. So you can see that no-one is rushing on such an important matter.

PEI: Private equity industry associations are concerned the directive will hurt them and their portfolio companies at the worst possible economic time.

PNR: I would say three things. First of all, the political cycle and the business cycle are not synched. The crisis helped us to gain momentum for reform, it is now urgent to seize this opportunity if we want to avoid repetition of the crisis. When the US Glass-Steagall Act was implemented in 1933, it was a pretty tough time for financial actors, too. But it had to be done and could be done at that moment. And it worked, in providing nearly 40 years of financial stability.

My second point is that the very reason why private equity firms are at the worst possible time today, is because we lacked appropriate regulation prior to the crisis. A directive like the AIFM would have helped prevent some of the overleveraging and pro-cyclicality that have made the downturn so deep.

Finally, there is also a bright side in this new regulation: the ‘EU-passport’ means that the industry will benefit from a single private placement regime, making it easier to do business. You need to consider the new investment opportunities that will be generated by the new framework.

PEI: Do you think a lot of the complaints from within the private equity are simply disingenuous and self-serving?

PNR: I wouldn’t put it like that. From our perspective, a structurally deficient financial system caused the crisis, cost six million Europeans their jobs and €3,000 billion in extra public debt for the EU as a whole. Some excesses were made, and the responsibility for this failure has to be shared by the whole financial sector. They were all in the same boat. To that respect, yes some complaints are hard to swallow.

But it is only fair that some players fight against what they perceive as being detrimental to their business. It is our duty as politicians to explain why regulation is needed, how the reform will be carried through and what exactly it will change, in avoiding the shortfalls of both demagogy towards society and complacency towards the industry. It is also our duty to reassure the markets and present the good side of regulation to the industry.

PEI: Costs incurred will ultimately be handed on to the funds’ investors, which are comprised mainly of pension funds. Is this something that concerns you?

PNR: That’s a good example of a disingenuous complaint! If a fund wants to invest in a risky product, it will have to pay the price for it. And it is rather healthy that the cost of risk is corrected upwards. Don’t forget that the crisis started because of unexpected defaults, for the very reasons that risk had been underestimated and consequently undervalued for too long.

And furthermore, should pension funds really invest in risky AIF types of product? Should institutions that are being trusted by millions of people to deliver to them a means of existence once they are retired be allowed to gamble hard-earned savings? People who invest in pension funds should know what they’re getting. If some of them wish to take more risk for potential higher returns that’s fine by me, but I don’t think you can claim it was the rational choice of the thousands that lost everything in the crisis.

PEI: As it stands, the directive could catch real estate and infrastructure funds in its net. Do they really need to be regulated?

PNR: Yes they do. All financial institutions must be regulated in order to shut down for good the shadow financial system. It does not mean they are the same – in fact we acknowledge the great differences

between the various types of institutions. But all AIFs share a number of common characteristics, the most important by far being a general lack of transparency. This calls for an 'all encompassing' approach.

PEI: Private equity often raises its compensation model in its defence as incentivising genuine long-term performance. What are your thoughts?

PNR: I would not personally be too proud of being a 'genuine long-term performer' by extracting revenue and imposing a short-term view on the companies that I'd managed. This is in my opinion a very poor line of defence, because the higher the carried interest on profit is above the hurdle rate, the greater the incentive is for the manager to operate in a way that has great negative economic and social externalities.

Furthermore, it also encourages a greater concentration of resources and contributes to the explosion of inequalities we have been witnessing over the years in our societies. And we know what that means in terms of consumption and macro stability, not to mention the social consequences.

Finally, the specific compensation model of private equity results in extremely high fees for investors, which pushes even further the level of return needed. This is neither sustainable nor desirable.