21 May 2007

FT: OECD says policy to blame for buy-outs

Lax monetary policy in countries such as China and Japan is fuelling the boom in private equity buy-outs that is worrying regulators and unions across the world, according to a report published today.

It is pointless for policymakers and the media to 'shoot the messenger' by blaming record buy-out activity on private equity groups or the investment banks that supply them with debt, says the Organisation for Economic Co-operation and Development.

The report says 'distortions' in the global financial system - similar to those created by the Louvre Accord to shore up the US dollar in the late 1980s - are being exploited by the use of new derivatives products.

The resulting excess liquidity is pushing up asset prices, increasing the risk of over-leveraged deals.

'It is a basic proposition that if one fixes the price of money in parts of the world economy, one will not be able to control its supply,' says Adrian Blundell-Wignall, deputy director of financial and enterprise affairs at the OECD, who wrote the report.

'The recycling of this money is an integral part of the arbitrage opportunity that is driving the private equity boom,' says Mr Blundell-Wignall, a former Citigroup analyst in Australia.

'Easily the main contribution to the measure of global liquidity in 2006 is Chinese foreign exchange market intervention,' he says. China, which has tied its currency to the US dollar, added $259bn (£131bn) to its already massive foreign exchange reserves last year.

Chinese ministers are heading for Washington this week for a meeting at which their management of the allegedly undervalued currency will be discussed. Last week it emerged that China was placing $3bn of its $1,200bn foreign reserves with Blackstone, the USprivate equity group.

The OECD report says 'private equity plays a valuable role in helping to transform under-performing companies'. But it warns that excess liquidity in the global financial system could create 'adverse consequences for investors' in the future.

'The current boom in private equity, as a share of the economy, is much stronger than the previous late-80s LBO [leveraged buy-out] boom - which did end in tears and a number of criminal charges by 1991,' says Mr Blundell-Wignall.

Regulators are putting the industry under the spotlight. Private equity chiefs have been called to answer questions from parliamentary committees in the US and UK after buy-outs reached record levels in number and size. UK buy-out groups have responded by promising a voluntary code of conduct.

The OECD identifies 'moral hazard' areas for private equity, notably the use of insider information to profit from share price movements before a deal is announced. 'Insider trading is evidenced by the movement in share prices and credit default swaps prior to the public announcement of deals,' it says.

Buy-out groups may be tempted to refinance a company's balance sheet to pay dividends to equity holders.

© Graham Bishop