Yahoo Finance Compared to banking, private equity is practically naked in its exposure to Brexit - David Buik
With just Royal Bank of Scotland left to report its results for the half year on Friday, it appears that after eight toxic and painful years the UK banking sector may be in sight of regaining its poise or at least most of it.
Lloyds Banking Group, Barclays, HSBC and Standard Chartered Bank have all posted decent numbers or are close to completing their restructuring programmes. PPI has cost the sector nearly £30 billion, and though further provisions have been made by Lloyds Banking Group and by Barclays to the tune of £700 million each, spring 2018 will see the closing of this tawdry abuse of its retail client base.
However, the whole financial sector remains fraught with imponderable issues such as Brexit, excessive credit and contingency plans for LIBOR, which will be replaced with alternate means of pricing the cost of loans in 2021.
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Many major international banks are making understandable contingency plans to move some staff to Paris, Dublin and Frankfurt to handle focused EU business. However, it is as well to know that according to rankings in the Global Financial Centre Index, Frankfurt comes in 23rd and Paris 29th with London very much at the pinnacle of European financial markets – hardly cause for concern.
But Remain scaremongers have massed their troops, based on an investigation by consultants Oliver Wyman, which believes that a so-called ‘hard’ Brexit could drive a 4% cost rise and a 30% jump in bank capital requirements, which would necessitate subsidiaries being set up in the EU. Extreme action of this magnitude would result in 40,000 redundancies. Their prognosis looks to be bordering on hysterical to me.
Most people involved in the vagaries of financial markets in London and Brexit are mainly associated with banking. Although private equity is, in its own way a smaller but hugely influential sector, it is much more vulnerable due to the inconsiderate and ill-thought-out tax treatment of profits. The Treasury clearly has not clearly considered the ramifications of its proposed plans.
James Max, a former distinguished private equity manager and investment banking doyen at Morgan Stanley in his day, says that “the UK government has made changes to tax legislation making private equity firms less likely to wish to remain domiciled in the UK.
Here’s what else he has to say on the matter: “Setting aside the actual changes, to which I will refer in due course, the amount of new legislation, the complexity added to what is already a tax minefield and the reversal of policies and precedent that had been well established, has potentially dis-incentivised such companies to wish to be under our UK jurisdiction.
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“This is undoubtedly to curb what some may say is a favourable tax position to feed the obsession by headline writers and the court of public opinion. The uncertainty created has unnerved many in the industry and they could well relocate. Let’s not forget that whilst these people may be relatively few in number their skills and demand on a whole range of services that have become world leading (tax structuring, investment bank led, sources of finance and debt, advisory services, professional services and support for operating platforms) is profound.
“Sadly CGT is now paid on their chargeable gain over the deal and cannot be suppressed over time. Some managers used to put a loan in place instead of fees or simply remove fees all together and pay out from profits at the end of the deal. This is no longer allowed. Adverse taxation treatment could be detrimental.
“If a deal is longer than 40 months then CGT rates apply. If it’s less than 36 months; then 100% is classified under income tax with a sliding scale between 36 and 40 months. In effect a successful short term deal has a significant hike in tax rates applied, putting up risk considerably.
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“UK resident individuals that carried interest were not subject to UK tax provided the remittance basis regime was adopted by the individual. Now the carried interest will only be considered to be a foreign chargeable gain if the recipient of the carried interest performed their services relating to the generation of carried interest is outside the UK. Many of those in the industry are domiciled elsewhere but choose to live in the UK. The reasons are obvious; so why discriminate? Corporation taxes were dropped to 20% but not for private equity, where they remain at 28%.
“Often Private Equity deals used a range of loans to increase returns. However changes now mean that deductions are reduced to 30% of a company’s UK earnings before tax, depreciation and amortisation. Yes, it stops companies being stuffed with debt for tax reduction purposes but it also affects returns of the equity when it should be a commercial decision on how to use debt and not a tax related number crunch.”
HM Treasury – you have been warned, to throw the baby out with the bath water could prove to be an act of folly.
David Buik MBE is a market commentator at Panmure Gordon. The companies he has worked for mostly involved financial spread betting. He worked for BGC Partners from 1999 to 2011. He has appeared as a financial pundit on the BBC, Bloomberg Television, CNN International and ABC News (Australia).
