Financial investors, privatisation and regulation EAPE-PRESOM conference in Delft 22./

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 capitalism Productive Investors Under these circumstances financial investors become the key actors in the game Oversaving Savers: Rich individuals Corporations Financial investors Mergers + acquisitions Speculation Privatisation

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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

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14 Vicious circle: Redistribution, slow growth, unemployment Redistribution Slow growth Unemployment

15 Profit share Investment Financial markets UnemploymentWage shareGrowth Consequences of slow growth and redistribution: explosion of financial markets

16 EU15 8 New members* EU23

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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 management 5.Strategic perspective: sale after 2 -7 years

20 Non-quoted Enterprise Investor (Banks, Pension funds HNWIu.a. ) Bank PE Firm Purchase profit Loan Investment Cash-flow Profit participation fee interest Management Fund Sale ? Private Equity: how it works

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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 Firm Loan Investment Cash-flow Profit participation fee Management Hedge fund Hedge funds: how they work Arbitrage Speculation Bonds, equity Derivatives, currencies „Shareholder activism“ e.g. high dividends, outsourcing Profit Interest

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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

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34 Institutional Investors Three groups 1.Pension funds: $ 20 trillions 2.Insurance: $ 17 trillions 3.Investment funds $ 18 trillions Total: $ 55 trillions

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36 Source: V.P. Morano, 2005, The Future of Privatization in Europe  = 497,2 bn. $