There has been a fair amount of mainstream press speculation in recent weeks about the Conservative Party's alleged plans to restrict or even abolish the ability of companies to deduct the cost of interest on their borrowings. Although it is reassuring that the shadow chancellor George Osborne appears to have dismissed what is a radical idea with unpredictable consequences, it is an indication of the way in which the debate around the role of debt has lurched from one extreme to the other.
I have acknowledged for some time now that private equity did on occasion in the past decade get caught up in the cheap debt frenzy, with some taking on borrowings that have proven to be unsustainable. Leverage is great on the way up, but of course can also magnify losses on the way down. There is also little doubt that bank lending policies fed excessive consumer and mortgage debt and played a central role in the financial crisis.
Yet while recognising the downsides, policy makers and other should be careful to balance the argument by also acknowledging the important role that debt plays in the modern economy. It allows companies to fund growth which leads to more employment and tax generation; it enables many young people to buy their own homes; and, most crucially in the current environment, it facilitates company restructurings and rescues. It is the level, not the fact of debt which can prove destabilising. While it is sensible to ensure that banks have adequate capital to cover the amount lent out too businesses and individuals, attempting to impose hard and fast rules on how much companies themselves can borrow would stifle growth and suffocate businesses which need debt to restructure and survive.
As I have argued elsewhere on this topic, the danger of well-intentioned reform undermining business is obvious. At a moment when we are anticipating an extremely fragile recovery, we need greater certainty not ambiguity about the future regulatory environment and the BVCA looks forward to contributing to Mr Osborne's promised consultation on this issue and ensuring this certainty.
On the subject of regulatory certainty, the latest on the AIFM directive proposed by the European Commission is that the Swedes, which have just assumed the EU presidency, understand the danger to European economic recovery of a directive which would not only damage the private equity immeasurably, but would severely compromise the EU's entire financial services sector. We have six months in which to make real progress as we cannot be sure that a sympathetic environment will exist beyond the incumbent presidency.
The Mayor of London Boris Johnson recently spoke of the threat the directive poses to the City as the world's leading financial centre, a welcome intervention and the latest high-profile figure, if not an industry expert, to proclaim the directive ill-thought out and misguided. City Minister Lord Myners has also spoken out against the proposal, saying it needs 'major surgery.' Although I am not complacent, I am pleased that our arguments are being taken up by senior figures and the urgency with which we need to tackle this issue is now becoming clear. With well over half of all private equity funds in Europe based in this country we have more to lose than others.
While it has taken some time to make substantive progress in drawing the attention of British politicians to the regulatory threat emanating from Europe, we have had greater success drawing attention to the problem facing venture capital in the UK. We were therefore delighted with the announcement that the government is to cornerstone a fund-of-funds with £150m, with the expectation that the addition of private money will scale this amount up substantially, possibly to as much as £1bn. The problem this fund has been set up to tackle is immediate, and it is crucial that for this money to have a demonstrable effect it must start to flow sooner rather than later. We have a genuinely innovative and exciting stable of companies in the UK which can be central to tackling some of the biggest problems we face in areas such as clean energy and drug discovery and returns from investing in venture capital returns are also on the rise again following the technology crash. This fund should provide even greater incentive for LPs to return to venture investing and I expect the UK venture capital industry to build on its strengths and continue to lead in Europe and begin challenging the US as the global centre of excellence.
Finally, I was interested to read that minority stake investments are at their highest proportion of total private equity deals in more than three years. It is an interesting trend and one I expect will continue as firms seek different ways to put money to work. KKR provided the most recent example of a private equity firm investing creatively, setting up alongside German media group Bertelsmann to launch a venture which would acquire catalogues of songs. The music business is fraught with pitfalls and some say impossible to make money from; on the other hand, it could quite easily be an enormous opportunity. I hope Henry Kravis picked up the phone to Guy Hands before signing the deal.
