The last captive
Published Wednesday, 28 July 2010 in Amy Carroll.
Anyone who has been interviewed by me knows – I would hope – that I am nobody’s patsy. And so, before we even begin, be assured that I have no intention of going soft on Real Deals’ investor LDC.
However, there is a story here that cannot be ignored. The captive private equity firm is on the brink of being regulated out of existence. Solvency II is poised to force the evacuation of insurance companies, while a punitive blend of capital adequacy measures and remuneration codes could spell the end for in-house private equity teams at banks.
Politicians, it would seem, are determined that the banking industry is protected from the corruptive forces of the alternative asset. No matter that it wasn’t private equity, or even the hedge fund, that threatened to unravel the financial infrastructure on which modern society is built. Why let the truth get in the way of some good spin?
Now, there are a number of in-house private equity teams that will be secretly rubbing their hands with glee at this turn of events. Having spent years edging their way out of captivity, these firms have just been waiting for the confluence of external forces it would take to enable them to break free.
It goes without saying that they would rather not be making their bid for independence in one of the most brutal fundraising environments in history. But an investor with a diverse LP base and true traction in the market such as Barclays Private Equity will be just itching to cut the apron strings and flee.
Elsewhere, NBGI Private Equity is rumoured to be toying with how best to extricate itself from a Bank of Greece cornerstone investment, and a raft of HSBC vehicles are now preparing to leave the parental home.
LDC, however, is the exception. Lloyds has kept its captive close.
Now of course, for many of its 29 years – in which LDC has never raised a penny from external sources – the firm has been dogged by rumours that it is being held against its will. Received wisdom has it that any captive management team must spend every waking hour plotting its escape.
LDC managing partner Darryl Eales will swear blind that he is a company man through and through, but there are many who simply choose not to believe him.
Given the unflinching parental support that has enabled LDC to dominate the UK-mid market for the past 18 months – much to the chagrin of its competitors – and given the monumental headache that raising a first-time fund would undoubtedly create, I personally buy his story. But Eales’s tales of domestic bliss are almost by the by – the fact is that LDC is an economic and strategic boon, and Lloyds simply doesn’t want to let it go.
The reality, however, is that vengeful and ill-conceived politics may soon mean that it has no choice.
This is important, not because of its implication for the career progression of a bunch of rich guys who may or may not have aspirations of a life outside the bank, but because politicians and regulators risk cutting off all sorts of noses to spite their face.
There are quangos and think-tanks galore dedicated to devising ways of providing finance to recession-strapped SMEs and reviving prosperity in the regions. And yet here the powers that be are slamming the door on an investment body that continues to plough hundreds of millions
into UK business.
Captive private equity houses will always come in for a rough ride from their peers and the animosity currently being levelled at LDC hasn’t been seen since – well, since the heyday of BoSIF.
But whether or not you believe that LDC is fundamentally mispricing risk, paying over the odds, using government money to skew the market, allowing a misaligned incentivisation model to influence decision-making or any of the other sour grape-infused accusations flying around the market – to all of which the response can only be, time will tell – the fact remains that first, it is not principal finance that has been the destabilising influence on bank balance sheets, and second, the bank captive has an indispensable role to play in supporting UK industry.
Let us not forget, after all, that 3i was originally a government initiative, set up by the Bank of England and the clearing banks to promote private-sector investment – before, that is, becoming independent, withdrawing from the regions and ceasing to finance SMEs.
LDC, by contrast, currently has the most comprehensive regional office network in UK private equity. And yes – as well as theory dictating that it has been a great time to invest – LDC’s aggressive deployment in recent times has been the perfect marketing message for a bank that wants to be seen doing the right thing.
If Lloyds is forced to cut LDC loose, history suggests it won’t be long before an independent team seeks to forge a new, perhaps more personally lucrative and certainly less politically convenient path. In a misguided attempt to reduce risk in the financial system, policy makers ultimately risk draining capital from where it is needed the most.
