In March, the EU announced plans to restrict the operations of private equity funds. This is far from surprising, since US and UK firms have exhibited a nasty propensity to lever up firms, pull out a lot in the way of special dividends, and too often overdo the cash extraction and leave a bankrupt hulk in their wake. The irony is that while that is peculiarly seen as a legitimate way to do business here, most EU member states are not at all happy with it. The EU has been working on a proposal to restrict investors in the EU from putting funds in private equity and hedge fund firms outside the EU, and also limit the ability of foreign investors to buy European companies.
The amusing aspect of this initiative, as we noted in an earlier post, is the private equity industry immediately started threatening that the proposal would “seriously disturb” many of the world’s biggest PE funds. So? That would seem to be a feature, not a bug. Swedish Lex offered this observation:
What I find silly is that the Industry, in its efforts to convince the Parlamentarians, and the other relevant EU Institutions, are using the same bad old arguments like if you regulate in Europe, it will scare off investment and the pensions of ordinary people are jeopardized. Well yes, the EU does not welcome trashy short-term cancerogenus cash spreading from Cayman funds run by math nerds that design real nukes one day and their financial equivalent the next.
Yves here. The day after the EU announced its plan, Geithner swung into high gear to oppose it, looking like a complete industry toady. From our post then:
The next step was Geithner issuing a letter contending that the proposed EU regulations were discriminatory. While on paper that argument might appear sensible, it deliberately obscures a bigger reality: the way these firms operate, particularly the PE firm practice of using leverage, and the consequences of leverage (if you get it wrong, firms go bankrupt more so that if they had not borrowed, leading to unemployment) runs afoul of other government policies. This is a matter of sovereignity conflicting with an ideology that more open markets are ever and always better. You cannot have both in absolute form, and the EU is deciding to trade off one versus the other in a manner different than the US does.
Needless to say, the EU is not taking this lying down, and points out that some of the actions that Geither was taking aim at in his broadly-worded letter were in fact consistent with G-20 commitments….
While this is all very entertaining, the focus on the tit-for-tat misses the elephant in the room: what the hell is Geithner doing lobbying for hedge funds and PE funds?
The Volcker rule makes clear that the US does not regard these as functions integral to the operation of a healthy financial system and deserving of backstopping. The vast majority of PE and hedge funds, in terms of their staffing, are small businesses. Since when do small businesses have the Treasury secretary going to bat for them in a major international spat (this is the lead story in the Financial Times right now, lest you have any doubt).
Follow the money. Its “change” and populist pre election branding to the contrary, Obama raised more money from the financial services industry than any previous Presidential candidate. And the procurer-in-chief, Rahm Emanuel, concentrated his impressive fund-raising efforts on hedge funds and private equity firms (see here, here, and here). They expect a handsome return on investment, and it sure looks like they are getting it.
Yves here. The Financial Times reports that the effort to rein in the hedgies and PE firms continues to move forward, much to the consternation of the US and the industry, and now the UK:
European Union countries led by France and Germany plan to push through controversial new hedge fund regulations next week after turning down British pleas to defer a vote in Brussels. …
Britain looks certain to lose any vote and George Osborne, chancellor, could be forced to swallow plans requiring greater transparency from hedge funds and private equity groups….
Under the new rules, hedge fund managers and private equity firms could be forced to curtail the amount of leverage they use, make regular disclosures about their portfolios and would be forced to hold their assets with European banks.
Non-EU hedge funds could face similarly exacting requirements if they wish to market themselves to EU investors. Managers and investors have said the proposed changes could force much of the industry from Europe.
Yves here. This part is rich:
The directive has also caused concern in the US. In March, Tim Geithner, US Treasury secretary, wrote to EU officials warning that, if unchanged, the new regulations could trigger a transatlantic rift by unfairly locking US funds out of European markets.
“The Americans are going absolutely ape,” said a person involved in the negotiations. “There’s this overwhelming belief now in Europe that if we legislate first, then the US will follow what we do.”
Yves again. Did you catch that? Look at what the Europeans want: to regulate hedge and PE funds, as in prevent them from engaging in behavior proven to be dangerous (abuse leverage) and give investors more disclosure, and restrict firms that refuse to agree to play by those rules. That is hardly a radical agenda, yet Treasury Department is working in lockstep with the industry to defend its ability to operate with minimal constraints. And note that no one is mounting an argument that these businesses are socially productive and hurting them will hurt the economy because no such argument can be made credibly. Instead, an effort to impose “prudent regulation” is begin branded as “discrimination.” The problem is no one outside the industry will buy the argument. And Team Obama’s zealous defense of these firms again reveals how, despite its efforts to present a populist, pro-reform image, that it will never cross its best friends, the big financiers, in a serious way.