The scale of private equity funds and their acquisitions globally is attracting attention because of actual and potential market effects. Corporate raiders and robber barons stalking the markets are seen to threaten the established order.

History has hardwired humanity to be wary of the rich and powerful. History also tells us robber barons can open up new opportunities. The question has always been how to keep a balance (and the peace).

Liberal democracies have devised the rule of law and regulation as the balancing mechanism for mixed market economies. While business currently mounts a general challenge to regulation, private equity seeks to outflank it. Corporate governance and regulatory requirements are seen as bad for investors.

Modern Australian corporations law sits comfortably with the most dynamic and successful business market Australia has ever seen, with record levels of mergers, acquisitions, profits and tax revenues. It is also currently the safest mass market Australian investors have ever experienced. There are a number of reasons for that, but beefing up the law and the regulators after the horrors of the 80s, and after Enron, HIH and others, has produced good dividends. Literally.

The contrary view to low regulation spruikers is that scrutiny and regulation are better for the market than their absence, and secure good returns and a lower risk environment.

In evidence last November to the Joint Parliamentary Committee on Corporations and Financial Services on a private equity issue, ASIC Deputy Chairman Germy Cooper pointed out:  “It is a delicate balancing act about not dampening something that might be beneficial while being alive to the potential downside.”

The fears are these. If private equity funds broaden their market activity substantially they can affect the economy and the stock market. If, as a consequence, the market is exposed to much higher risk, then so is Australia exposed to much higher risk. By private equity funds replacing equity with debt in their targets, we go back to over-geared vulnerable business balance sheets. By requiring the servicing of higher levels of debt, tax revenues fall. By going private, investors are exposed to greater risk because of less regulation and limited scrutiny.

Legislators, regulators and governments just don’t know whether these fears are justified, and what large scale private equity will mean to markets and economies. Private equity funds are legitimate market participants that add variety and choice to investment vehicles, but legislators want to find out more. It is their duty to find out more. That is why my fact-finding reference to the Senate was unanimously supported.

The inquiry announcement provoked provoked an immediate alert from private equity. Within hours the PR man for the rich and powerful, (from what some call The Firm), was on to me. That quick response is always a good sign — we are on to something.

Senator Murray’s reference: That the Senate, noting that private equity may often include investment by funds holding the superannuation savings or investment monies of millions of Australians, and because of the actual and potential scale of private equity market activity, refers the following matters to the Economics Committee for inquiry and report by 20 June 2007:

(a) an assessment of domestic and international trends concerning private equity and its effects on capital markets;

(b) an assessment of whether private equity could become a matter of concern to the Australian economy if ownership, debt/equity and risk profiles of Australian business are significantly altered;

(c) an assessment of long-term government revenue effects, arising from consequences to income tax and capital gains tax, or from any other effects;

(d) an assessment of whether appropriate regulation or laws already apply to private equity acquisitions when the national economic or strategic interest is at stake and, if not, what those should be; and

(e) an assessment of the appropriate regulatory or legislative response required to this market phenomenon, if any.

Peter Fray

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