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Private equity under populist rule

by The Drawdown 25 September 2018

This article, the first of our two-part series on geopolitical disruption in private equity, examines how the industry can better anticipate – and protect itself against – the policies from populist leaders. Our second instalment, to focus on lobbying strategies, will come out on Thursday 27 September.

In today’s volatile political arena, a tweet can change the world. All it takes is a dozen or so characters from US president Donald Trump to see stock markets tumble, oil prices change and industries teeter.

America’s “tweeter in chief” epitomises the new wave of politics coursing worldwide; a strong-man, unpredictable form of leadership that appears to favour emotion over evidence. His pledge to “drain the swamp“ and restore pride to a disenfranchised citizenship is echoed, at varying degrees, by Italy’s Matteo Salvini, Hungary’s Viktor Orbán and a growing number of alt-politicians worldwide.

[su_quote cite=“Lizzie Wills, WA Comms”]

Where consistency has been the norm, we’re now seeing change ... Trump, Corbyn, Macron, Farage, Wilders, Le Pen – all these politicians have generated far more political cut-through than we would have expected” [/su_quote]

“Where consistency has been the norm, we’re now seeing change. Where we’ve previously seen evolution, revolution is now the order of the day,” says Lizzie Wills, head of investor services at WA Comms, a specialist political and public affairs advisory. “Trump, Corbyn, Macron, Farage, Wilders, Le Pen – all these politicians have generated far more political cut-through than we would have expected even ten years ago, albeit with differing success at the polls.”

America first
Is the new generation of masters – and the wider anti-establishment sentiments that underpin it – a phenomenon worth private equity’s time? Invest Europe’s Michael Collins believes the rhetoric and concern around protectionism hasn’t created any “substantial” policy changes yet but some of the soundbites – see “America First”, a term linked to Trump but coined before his time – are being translated into legislation creeping into private equity activity.

[caption id=“attachment_4742” align=“alignright” width=“350”] The CFIUS reform will force US GPs to rethink the use of offshore funds and the level of foreign LP ownership, experts believe[/caption]

Foreign private equity investments into the US now face regulatory scrutiny after an overhaul, signed by Trump this summer, of the Committee on Foreign Investment in the United States (CFIUS). Law firm Hogan Lovells has been following the reform, which grants CFIUS powers to probe certain foreign minority investments, particularly those involving critical technologies and infrastructure. “Scrutiny of foreign investment is a trend we’re seeing across multiple jurisdictions, it’s going to cause issues in the US and elsewhere,” says Tom Whelan, global head of private equity at the firm. “Obvious red flags aside, it shouldn’t put most US deals at risk but it will automatically push up costs … it pushes up deal timescale and risk.”

The CFIUS reform was introduced as a trade war raged between the US and China. To Hogan Lovells, sanctions have become a “multijurisdictional” affair in a world where countries are fighting back at US measures by adopting their own trade retaliatory actions. This is having obvious impacts on investment decisions, says partner Aline Doussin, a trade sanction specialist at the firm. “At this stage, it’s clear we’re in an unprecedented trade war and everyone is trying to assess the situation as it comes,” she adds.

[su_quote cite=“Tom Whelan, Hogan Lovells”]

Scrutiny of foreign investment is a trend we’re seeing across multiple jurisdictions, it’s going to cause issues in the US and elsewhere,” [/su_quote]

For institutional investors, worries surrounding geopolitical disruption and the fallout from a full-blown trade war do not seem to top the priority list. One of Europe’s largest private equity investors tells this publication that due to the long-term nature of the asset class, trade sanctions and retaliatory measures taken by world leaders will likely have limited impact. “We can take a long-term view, unlike equity views that might be more short-term oriented,” they say. “We’re very happy with long haul positions, able to navigate through short-term volatility and reach a more attractive situation.”

The source at the LP acknowledges that today’s geopolitical troubles can be more unpredictable than conflicts GPs are more familiar with, such as last decade’s global financial crisis. However, they believe private equity’s typical investment targets makes it less exposed to trade sanctions and other issues. “Tariffs mostly affect manufacturers, while we’re more heavily invested in things like business services and software. We haven’t changed allocations as a result of Brexit or tariffs, but rely instead on managers to invest in sectors unaffected by this,” they say.

Pop M-EUsic
The US is not alone, with the populist tide stretching to European shores. As Hogan Lovells notes, protectionist policies are also spreading to the continent, an example being the recent UK reform of the Competitions and Markets Authority, which lowered the existing £70m threshold of transactions that might be investigated over national security concerns to £1m, in some cases.

[caption id=“attachment_4502” align=“alignleft” width=“350”] Talk of a no-deal Brexit has intensified after EU leaders rejected the UK government’s blueprint in Salzburg this month[/caption]

More generally, Britain’s decision to leave the EU, and the highly divisive campaign that came with it, continues to puzzle the bloc’s allies. While Theresa May’s Conservative government appears defiant about the possibility of a no-deal scenario – “it wouldn’t be the end of the world,” the prime minister recently told reporters – it is also rumoured to be seeking an extension to Brexit negotiations.

If the Brexit talks reach beyond the March 2019 deadline, the odds of them running into the EU elections heighten. It is no secret that populism is fast making in-roads across the continent. From France’s Marine Le Pen to Germany’s Alternative für Deutschland and Austria’s Sebastian Kurz, opposition to the establishment is increasingly prominent, but could this be replicated across EU institutions?

[su_quote cite=“Miriam González, Dechert”]

Could the rise of populist parties in EU institutions disrupt how the bloc regulates financial services? Not really; the EU institutional apparatus has enough checks and balances” [/su_quote]

“This has been growing on the back burner for a while. We can truly see that the populist movement is not isolated, it’s a European and international phenomenon,” says Sirpa Pietikäinen, an MEP from the European People’s Party. Pietikäinen expects populists’ EU presence will grow, given the efforts by key US figureheads to support counterparts across the pond. However, Pietikäinen points at the recent election of Emmanuel Macron as an indication that there could be a counterreaction at the EU level, bringing together anti-populist figures from the left, right and centre. “Populism could actually accelerate the integration of mainstream politics in the EU,” she says.

Whatever the outcome of the EU elections, Pietikäinen predicts the next candidate to lead the commission will retain the focus on a “constructive” capital markets union and better internal markets: “These things are in the genes, in the blood circulation of European governance, so this is a lead that is going to continue in my opinion.”

[caption id=“attachment_4691” align=“alignright” width=“350”] US political strategist Steve Bannon has vowed to back anti-EU forces as they campaign for more seats at EU institutions[/caption]

However, the same cannot be said for the upcoming AIFMD review. Pietikäinen, who helped lead the negotiation of the legislation on behalf of MEPs, claims that AIFMD has not delivered as much as she hoped for, and is concerned that the legislation could even be scaled back. “Knowing that member states are wary of an ever-closer union, the next Commission might pull back even further,” she adds.

For his part, Invest Europe’s Collins believes EU elections have historically been used as a protest vote and should not be taken as a “strong indicator” of broader political trends. Miriam González, partner at Dechert and former EU negotiator, echoes this, downplaying the transformation the elections could spark. “I don’t see that what happens to financial services is determined by elections like these but rather the political groups that hold the reins of leading national governments,” she argues. “Could the rise of populist parties in EU institutions disrupt how the bloc regulates financial services? Not really; the EU institutional apparatus has enough checks and balances to stop populists.”

Oh, Jeremy Corbyn
Whether it remains part of the bloc or not, the UK faces the prospect of a populist wave within its borders. With a “confidence and supply” agreement in place, the Conservative party holds a slim majority over the Labour party with support from the DUP. A newly branded opposition, led by left-wing campaigner Jeremy Corbyn, has seen membership swell to unprecedented levels.

A Corbyn administration might be a popular idea among younger voters but remains, surveys show, a top concern for the wider financial services industry. For some GPs speaking behind closed doors, it is even more of a worry than Brexit.

[su_quote cite=“Lizzie Wills, WA Comms”]

Often the first reading of this new normal can appear catastrophic, but once you drill down into the detail of the proposals, the effect may be more nuanced than initially anticipated” [/su_quote]

With manifesto promises to “rewrite the rules of a rigged system” and “overhaul the regulation of our financial system,” Labour plans to tax corporations more and break up the banks. These prospects could have private equity firms running for the hills, but industry associations, namely Invest Europe and BVCA, believe that diplomacy and working alongside government is the way forward. “We prefer to engage with all politicians to understand their concerns and introduce them to what it is our members do. When it comes to ministers, it’s all about improving perception and building relationships,” says Gurpreet Manku, deputy director general of BVCA.

[caption id=“attachment_4976” align=“alignleft” width=“350”] The rise of Corbyn has been widely linked to concerns on social inequality among younger generations in the UK[/caption]

González believes that while Corbyn is within touching distance of the UK’s highest office, he is a “temporary problem”, unlike Brexit’s more long-term effects. “The likelihood of his victory? It’s a possibility,” she adds. “Whatever the outcome, the only certainty is that this is a country split down the middle. There’s an intellectual civil war, a rift that won’t be healed through temporary fixes.”

Meanwhile, WA Comms believes the key is not so much Corbyn’s proposed policies, but to what extent they will be rolled out. Wills says that understanding the drivers and dynamics of the party’s leadership will be key to predicting which of Labour’s policy commitments will be prioritised and which will be shelved. “This will depend not only on the personal priorities of Corbyn and his immediate team, but also on what happens to his policy programme when it comes into contact with reality,” she says.

In a world still obsessively deciphering Brexit and Donald Trump, few believe political volatility is coming to an end. Whether or not the populist and protectionist winds will push private equity to a better place is a question only time can answer; some feel the disruptive road ahead entails opportunities, not just risks, for GPs. “This ‘new normal’ has meant more and more clients coming to us to understand what this means for them,” concludes WA’s Wills. “Often the first reading of this new normal can appear catastrophic, but once you drill down into the detail of the proposals, the effect may be more nuanced than initially anticipated, or in some cases positive, providing business opportunities for those willing to get behind these headlines.”

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