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Financial Stability: Private Equity Firms

Volume 834: debated on Wednesday 13 December 2023


Asked by

To ask His Majesty’s Government what assessment they have made of risks to financial stability from private equity firms experiencing difficulty in the current high interest rate environment.

My Lords, the Bank of England’s Financial Policy Committee is responsible for identifying and addressing risks to the stability of the UK’s financial system. The committee’s most recent judgment is that the system of market-based finance, which includes private equity, has so far been able to absorb recent changes in macroeconomic conditions.

My Lords, I thank the Minister for her Answer; I think the key words in it may have been “so far”. If multiple private equity companies experience financial stress simultaneously, it could have systemic implications. This is especially true if those companies operate in interconnected industries, leading to a potential domino effect of financial distress that could spread to the broader economy. The UK is the second largest private equity market in the world, with nearly £80 billion of private equity going in in the last five years. Are the Government really assessing the situation and considering whether there need to be restrictions on the role of private equity in our economy and society, given how many companies have been taken over by private equity and subsequently closed down?

I am afraid I do not recognise the picture the noble Baroness paints, nor do I agree that private equity needs to be closed down. The Bank of England monitors the situation across the entire market-based financial system. The noble Baroness may be interested to know that the Bank of England is conducting a system-wide exploratory scenario, which will be a world first and will look at all the elements of the financial system and stress-test them in quite severe circumstances to ensure that there is no contagion. The noble Baroness is not right to say that there is a massive risk of contagion. The private equity sector is a very small part of our financial system.

I agree with my noble friend’s comments in respect of the private equity industry. I am sure she is aware that the private equity industry raised £70 billion last year but has £145 billion in dry-powder capacity in case of financial instability. Is not the real possible instability for companies in the UK the threatened changes to employment laws, which currently allow firms to respond to market conditions? I refer your Lordships to my registered interests.

My noble friend is absolutely right. We need the right flexible employment laws to ensure that private equity can continue to steward companies that employ millions of people. Indeed, the British Private Equity & Venture Capital Association estimates that private equity-related companies employ 2.2 million workers.

My Lords, the Minister should take the Question from the noble Baroness, Lady Bennett, very seriously. A very large part of the private equity market is heavily overleveraged, although that is often disguised through complex financial engineering; it is not just Thames Water. At the same time, there are serious questions about the condition of the public debt market, with gilt rates so dependent on volatile foreign buyers for their gilt sales. Has the Treasury looked again at the stress tests being used by the Bank of England to see if they encompass potential issues in these two markets? There is a real risk that not just one but both could have serious problems at the same time, with systemic consequences.

I reassure the noble Baroness that the Treasury works with the Bank of England and other regulators to monitor the system.

My Lords, private equity is part of the £131 trillion shadow banking system, which is largely unregulated even though it is much bigger than the regulated retail banking sector. Recently, IOSCO has said that the high leverage of private equity poses a threat to the world economy, so it is hard to see why the Minister is dismissing that. I ask the Minister to do two things: first, apply the banking prudential regulations to private equity; and secondly, end tax relief on corporate interest payments and thereby reduce private equity’s capacity to increase leverage and cause the next financial crash, which will inevitably be caused by private equity.

My Lords, there are £250 billion of private equity assets under management in the UK, versus £10.3 trillion of total assets under management. It is a smaller part of the financial system. The noble Lord is not right to say that it is unregulated: UK private equity managers are regulated under the alternative investment fund managers regime. They must also comply with the senior managers and certification regime.

My Lords, I declare my interests as set out in the register. It is hardly surprising that private equity is struggling to do deals and sell its portfolio companies in a climate of high interest rates and low growth. In fact, it is zero growth, as October’s dismal GDP figures show that we have seen no growth at all in the last quarter. In view of capital’s recent flight to quality, does the Minister agree that our lack of an economic growth strategy is the biggest drag on private equity in this country?

I do not agree with the noble Lord. As he will have seen in the Autumn Statement, the Chancellor set out significant tax cuts to encourage growth. That is where we are focusing our firepower at the moment.

My Lords, further to the original Question about high interest rates, at the last general election the Green Party was committed to borrowing an extra £95 billion to pay for its commitments. What would this have done to interest rates?

If private equity is so keen on employing people in this country, how come it is not so keen on paying the pensions? The private equity owners of Boots have just got rid of the pension responsibilities.

The noble Lord mentions a situation I am not aware of, but I will say that all owners of UK companies must abide by the Companies Act and their obligations therein.

My Lords, has my noble friend been following the speeches and articles written by the noble Lord, Lord King, the former Governor of the Bank of England, in which he suggests that it is so important for the Bank to concentrate on inflation and the price mechanism that it does not make sense to add to those responsibilities a green agenda, which will distract it and draw it into political activity?

I have not been following those interventions from the former governor, the noble Lord, Lord King, but I shall certainly look at them.

My Lords, the Bank of England has recently warned of the risks to financial stability posed by artificial intelligence and machine learning, with the bank’s Financial Policy Committee identifying the potential for system-wide risk, herding behaviour and increased cyber risk. Does the Minister believe that regulators have sufficient powers, and that existing powers are sufficiently future-proofed, to deal with emerging risks to financial stability from rapid technological advances, including but not limited to AI?

I accept that the AI regulatory system is still in development, but that is not unique to the United Kingdom. The AI summit convened by the Prime Minister made good steps in the right direction.

Can we send our deepest sympathies to Sir Jacob Rees-Mogg on the demise of Somerset Capital Management, and hope that this will now enable him to spend more time looking after his constituency?

I am not aware that there was a question there—but if the noble Lord wants to send his sympathies, I am sure they will have been heard.

Given the recent problems with the Truss Budget, was the Bank of England informed of the Budget before it was announced—and if not, why not?

I declare an interest in that I am involved in the private equity industry. If we in the industry do not calculate the risks properly, build into our modelling the necessary degree of leverage and allow for it, is it not right that we should be allowed to fail? We should not just be kept alive when we have shown incompetence.

I completely agree with my noble friend. Private equity is all about risk and returns, and not all firms will succeed in perpetuity. That is the way of a capitalist market, and it allows the correct allocation of capital within the system.

My Lords, I am glad that the noble Lord, Lord Young, pays such attention to the Green Party manifesto; it is pleasing to see. On the reference to so-called green environmental investments, does the Minister agree with me that it is essential for the future of the British economy, in meeting the needs of British society, that we invest in renewable energy and warm, comfortable, affordable-to-heat homes in order to effect the transformation we need for a healthy society?

Actually, I would flip that around the other way. I had a long conversation with the head of ESG at the FCA about this, and it is the public and investors in pension schemes who want to see investments in higher rated ESG organisations. That is the key driver: it is ensuring that the capital goes to the places the investors want to invest it in.