It all started a little over a year ago with a speech British Prime Minister Tony Blair made decrying the lack of venture capital activity within the UK. While there has been significant speculation surrounding the inspiration for his criticism, there is no question that Gordon Brown, Britain?s Chancellor of the Exchequer, understood the message.
Soon after Blair?s speech, Brown announced that he would commission a review of institutional investment in his budget, and appointed Paul Myners, chairman of fund manager Gartmore Investment Management, to recommend methods to promote venture capital investing in the UK. The final version of Myners? much-anticipated, much-ballyhooed review was released publicly earlier this month, and has since caused quite a stir within the nation?s financial community.
At first glance, Myners? recommendations to do away with the Minimum Funding Requirement and soft commissions seem to barely skim the surface of Britain?s private equity issues, but Brown has said he will support them if they are brought to bear. If such an event does occur, it could cause an unprecedented shake-down in the British investment management arena.
Abolish The MFR!
When Brown originally commissioned Myners? review, at issue was the Minimum Funding Requirement (MFR), a complex piece of legislation put into place by Parliament in the early 1990s after infamous media tycoon Robert Maxwell raided his Mirror Publications? pension funds.
Essentially, the MFR attempts to assess the present value of pension funds? future liabilities, using the yield curve on bonds issued by the UK as its reference point. In its most basic incarnation, it was meant to deter pension fund managers from investing in risky alternative asset classes such as private equity, companies outside major stock market indices and high-yield bonds.
Indeed, as pensioner liabilities have increasingly become a significant portion of pension funds? liabilities, the traditional view has been that assets covering such liabilities should be weighted toward less risky classes, because they will need to be covered in the short term.
Britain?s pension fund industry is worth about £8 billion ($11.3 billion), and its institutional investors ? mostly pension funds and life insurance companies ? are key participants in UK equity markets, controlling about 45% of quoted equity investments, according to Myners? report.
Conversely, UK pension funds typically invest about 0.5% of their assets in venture capital, whereas their USequivalents invest about 10 times that, around 5%, the report stated.
That is not to say that the UK?s VC arena is short of funds, however. Actually, it is the second-largest venture capital market in the world after the U.S., said Michael Queen, chairman of the British Venture Capital Association?s investor relations committee and a managing director with 3i Group PLC, one of the UK?s most active VC firms.
In an effort to further stimulate private equity investing down the road, Myners proposed that the MFR be scrapped entirely, claiming that it induced a “herd-like” effect because the legislation made it difficult for pension fund managers to invest in alternative asset classes.
The investment performance of Britain?s pension funds usually is measured against their peer groups, so in the past fund managers often have been forced to stick to stock market indices when making their allocations.
According to published reports from the UK, Chancellor Brown seemed to agree with Myners? recommendation, although it isn?t likely that legislation to amend or abolish the MFR will be passed before the end of this year and, should it pass, widespread adoption from pension funds could take as long as five years, Queen said.
Making Shady Business Practices Transparent
Myners? report doesn?t stop at recommendations for eradicating the MFR, however.
He ostensibly has called for a minor overhaul in fund-management practices, encouraging institutional investors to produce more accountability, transparency and professionalism.
Furthermore, in what many Brits have deemed a surprising move, Myner recommended that Chancellor Brown put an end to soft commissions, incentives securities firms provide to fund managers ? often in the form of additional analyst research ? to ensure that institutions channel brokerage business their way. In that context, he calls for fund managers, pension-fund trustees and their consultants to adopt a new code of ethics on how investment decisions are made, according to a report from The Economist.
In addition to requiring that und managers be paid for their legal responsibilities for pensioners? savings and opening opportunities for fund managers to be more assertive in exercising their shareholders? rights, particularly in underperforming companies, those best practices would include increased transparencies regarding soft commissions.
Currently, the way UK brokers are paid is not at all transparent. In fact, pension fund clients have little to no say in deciding which brokers get their fund?s share-order business, and the incentives often prevent fund managers from ferreting out the best services the market has to offer. Hence, doing away with soft commissions would mean that fund managers would have to consider the cost of broker fees as an ordinary business expense, and therefore seek the best services for their money, as opposed to blindly dishing out fees for the research they get now on a soft-money basis.
One industry expert said he was not at all surprised by Myners? mandate to abolish soft commissions. “Myners has always abhorred soft commissions, and he?s always wanted to tackle the issue,” he said. “He?s certainly been given a tremendous platform to do it.”
James Marler, a managing director with eTrade UK, said that Myners? report could have major implications for the brokerage industry, although he feels it?s too early to tell how it will play out. “It will be interesting to see how the discussion process evolves,” he said. “It?s going to be a lengthy process. Companies that are used to getting bundled services are going to have to start pricing the research they get from brokers.”
He did not say whether or not eTrade had previously taken soft commissions.
Too Much Talk, Not Enough Action
Myners? report also brings under fire pension-fund trustees, which he believes do not receive enough training and spend too little time looking after the funds under their advisement. Nearly two-thirds had no qualifications, he wrote, while 49% spent three hours or less preparing investment issues before a meeting.
Additionally, a majority of trustees rely heavily on the advice of just four major consulting firms, which are “not usually assessed or measured,” Myners contended in the report.
Myners? critics ? and there are many ? argue that, while he presents some very compelling findings, he has not followed through with viable solutions, which ultimately leaves the execution of his recommendations in the government?s hands and slows down any overhaul efforts.
Moreover, if the new regulations result in a sudden influx of capital into the market and not enough good investment opportunities to absorb it, then pensions could be left high and dry as they previously feared. Queen said one solution is to boost the supply over the medium and long terms, then encourage more people to enter the market.
Interestingly, he also said that 3i hasn?t had much difficulty raising money from pension funds. Russ Planitzer, a US-based managing principal with Lazard Technology Partners, which just finished raising a $300 million early-stage fund, agreed.
“We were fund-raising in Europe last summer, and we got maybe $40 million to $50 million out of pension funds,” he said. “In the UK, the advisors to the fund managers were keenly aware of the asset class, and they knew they were underweighted in the class compared to their [European counterparts]. But everyone we talked to knew they had to educate themselves and made it clear they needed to learn. Some had already determined they wanted some exposure in the class. So I think that?s consistent with what Blair wants, which is more VC investing.”
He may get his wish yet.
Robyn.Kurdek can be contacted atStory Feedback.