Financial investors, privatisation and regulation

EAPE-PRESOM conference in Delft

22./23.3.2007

2

Structure

1. Finance as driver for privatisation I: Excess private liquidity

2. Finance as driver for privatisation II: Lack of public finance

3. New financial investors: Private Equity and Hegde funds

4. The European agenda: More deregulation and market-opening

5. An alternative agenda: Stricter control of financial investors, a broader framework for the public sector

3

Industrial Capitalism

Households= Savers

Entrepreneurs= Investors

Financial markets are driven by enterprises who need money to finance their investments

Undersaving

4

Mature capitalism

Productive

Investors

Financial markets are driven by firms and individuals who have much money and search for profitable investment opportunities – which

become increasingly rare.

Oversaving

Savers:Rich individuals

Corporations

5

Finance-led capitalismProductive

Investors

Under these circumstances financial investors become the key actors in the game

Oversaving

Savers:Rich individuals

Corporations

Financial investors

Mergers + acquisitions

Speculation

Privatisation

6

Development of nominal GDP and financial stocks worldwide, 1980-2010

0

50

100

150

200

250Tr

illio

n $

Nominal GDP 10,1 29,4 31,7 44,5 63,3

World Financial Stocks 12 64 93 140 214

1980 1995 2000 2005 2010*

Source: McKinsey Quarterly, January 2007, Mapping the global capital markets, p.8

7

Financial stock as % of GDP worldwide, 1980-2010

109

218

292

316

338

0

50

100

150

200

250

300

350

400

1980 1995 2000 2005 2010

Source: McKinsey Quarterly, January 2007, Mapping the global capital markets, p.8

8

Internationalisation of Financial Markets I

Source: International Monetary Fund: Working Paper WP/06/69, S. 35

International financial stocks (assets + liabilities) as % of GDP

9

Internationalisation of Financial Markets II

International financial stocks as % of international trade (exports + imports) und Außenhandel (Export + Import)

Source: International Monetary Fund: Working Paper WP/06/69, S. 36

10

0,0

10,0

20,0

30,0

40,0

50,0

60,0Tr

illio

ns $

Financial assets invested by institutional investors, 1980 - 2005

World 3,0 13,7 36,6 55,0

USA 2,2 6,6 19,5 26,5

EU 0,7 3,5 10,4 15,6

1980 1990 2000 2005

Sources: OECD Institutional Investors, 2001; International Financial Services, Financial Market Trends Europe vs. US 2006, October 2006: 5; IFSL,. Fund M anagement, August 2006:

11

Institutional Investment 1992 - 2005

0

10

20

30

40

50

60tri

llions

of D

olla

rs

total 16 25,4 36,2 55

Pension funds 4,8 7,5 10,3 20,6

Insurance 6,3 9,4 11,5 16,6

Investment funds 3,4 6,2 11,3 17,8

1992 1996 2000 2005

12

Wage share in the USA, Japan and the EU-15, 1975-2005

65

67

69

71

73

75

77

79

81

wag

e sh

are

in %

of G

DP*

EU-15 USA JapanQuellen: European Economy, 6/2002 und 6/2004, Statistical Annex, jedw eils Table 32

* bereinigt um Veränderungen der Beschäftigtenanteile

13

Shares of profit and investment in the EU-15, 1975-2005

18

20

22

24

26

28

30

32

34

in %

of G

DP

share of investment

share of profits

Linear (share ofprofits)Linear (share ofinvestment)

14

Vicious circle: Redistribution, slow growth, unemployment

Redistribution Slow growth Unemployment

15

Profit share

Investment

Financial marketsUnemployment Wage shareGrowth

Consequences of slow growth and redistribution: explosion of financial markets

16

Corporate tax rates in the EU, 1995-2006

15

20

25

30

35

40

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

tax

rate

in %

* w ithout Cyprus and Malta; source: Schratzenstaller 2007, p. 93

EU15

8 New members*

EU23

17

Corporate tax rates in the EU, 1995-2006

15

30

45

60

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

tax

rate

in %

EU 15

EU8

EU23

Germany

UK

France

Poland

source: Schratzenstaller 2007, p. 93

18

Redistribution from bottom to top

Higher net profits

Lower net wages

More liquidity Growth of FM

Low investment

Weak growth

Pressure on Public budgets

Privatisation = Private investment

Public Divestuture

Higher profits

Threat for: - infrastructure - public services

Redistribution – Financial Markets - Privatization

19

Specifics of Private Equity

1. Limited number of ultimate investors (Banks, pension funds, HNWIs)

2. Offshore domicilation (EU: 60%)

3. High leverage (60-80%)

4. Active management5. Strategic perspective: sale after 2

-7 years

20

Non-quotedEnterprise

Investor

(Banks, Pension funds

HNWIu.a. )

Bank

PE Firm

Purchaseprofit

Loan

Investment

Cash-flow

Profit participation

fee

interest

Management

Fund

Sale ?

Private Equity: how it works

21

22

23

Problems

1. Short-term strategies at the cost of employees and strategic investment

2. Financial overburdening through rising indebtedness

3. „Recapitalisation“ through extra-dividends and bonusses

4. Increasing problems of exit

24

Specifics of Hedge funds

1. Offshore – domililation (>80%)

2. High barriers to entry (>10 Mill.$)

3. High fees and profit participation (20%)

4. Very high leverage (often >90%)

5. Strategies• Financial speculation• shareholder activism

25

Investor

(Pension funds

HNWIu.a. )

Bank

HF FirmLoan

Investment

Cash-flow

Profit participation

feeManagement

Hedge fund

Hedge funds: how they work

Arbitrage

SpeculationBonds, equity

Derivatives, currencies

„Shareholder activism“e.g. high dividends,

outsourcingProfit

Interest

26

27

Problems through Hedge funds

1.De-stabilisation through Speculation(securities-, bank-, and currency crises)

2. Impact on corporate governance (Shareholder Value Orientation)

28

Systemic Problems

1. Contagion to all financial investment through competition and proliferation

2. Enhanced financial instability (Securities-, bank-, and currency-crises)

3. Enhanced social inequality and suppression

29

The European agenda

For Financial Markets

- Fight against special rights für governments in privatised corporations

- Revision of the MiFID with the aim to remove national investment restrictions

30

The European agenda

For services of general interest

- preparation of a white paper on social services with a

- very extensive interpretation of „economic activity“

- = privatisation through the backdoor

31

Alternative Agenda

For Financial market regulation

1. More information and transparency

2. Restrictions on Leverage

3. For PE: No special dividends, bonuses etc.

4. For HF: Voting rights only after one year

5. For institutional investors: No investment in Hedge funds or similar instruments

32

Alternative Agenda

For public services

- Political definition of public sector as an alternative to private provision of services

- Services in the public sector are exempt from the competition rules

- Development of democratic management methods for the public sector.

- Re-nationalisation of privatised firms or sectors

33

Asset under Management, worldwide, 2005, $ trillions

privately managed

22,2

"Alternative" management"

1,5

Institutional management

55,0

total $ 78,7 trillions, of which:

34

Institutional Investors

Three groups

1. Pension funds: $ 20 trillions

2. Insurance: $ 17 trillions

3. Investment funds $ 18 trillions Total: $ 55 trillions

35

Privatisation Proceeds 1990-2000

0,0

20,0

40,0

60,0

80,0

100,0

120,0

140,0

160,0

180,0

Global 33,2 48,5 33,5 58,2 68,9 70,2 89,7 153,3 139,2 141,9 100,1

EU-15 15,6 23,9 48,9 30,6 27,5 35,5 46,6 67,5 60,2 61,6 46,8

CEE 0,1 0,6 1,0 2,3 3,2 7,1 4,1 4,4 2,9 4,2 5,7

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

source: OECD, Recent Privatizatuion Trebds, 2001

36

EU15 Privatization proceeds 1977-2004

10595

74,568,2

38,621,3

20,115,515

11,911,3

5,55,35,14,9

ItalyUK

GermanyFrance

SpainPortugal

NetherlandsFinland

SwedenAustriaGreece

BelgiumDenmark

IrelandLuxembourg

Billion Euro (PPP)Source: V.P. Morano, 2005, The Future of Privatization in Europe

= 497,2 bn. $