Select Committee on Treasury Written Evidence

Supplementary memorandum submitted by the Financial Services Authority

  1.  This Memorandum is submitted by the Financial Services Authority as a follow-up to the oral evidence given by Hector Sants and Sally Dewar on 3 July.

  2.  The Memorandum expands on our oral response to a question asked by Mr Cousins and provides answers to the four factual questions asked by the Chairman.


  3.  In Mr Cousins' question [Q510], he suggested that the FSA could not give assurances on two points, which we understand to be the following:

    —  Whether debt issued in connection with private equity transactions has ultimately resided within regulated entities; and

    —  Whether debt issued in connection with private equity transactions has ultimately resided in the UK.

  Hector Sants responded orally. We provide further detail below.

  4.  As other parties have noted in their evidence to the Committee, in recent years loan markets have undergone a rapid transition in terms of secondary trading and risk transfer. One consequence has been to allow some lending institutions, typically investment banks, to move from an "originate and hold" model to a "capital turnover" model, in which they originate, and then distribute, their exposure to specific loans. Our leveraged buyout survey, completed in 2006, found that of 15 investment banks asked, six said they follow a capital turnover model. Our future surveys of this market will enable us to analyse whether banks continue to change their lending model and the potential impact this may have. A potential positive consequence of this change, from a financial stability perspective, is that the failure of a specific transaction is less likely to have significant financial consequences for any individual creditor.

  5.  A further consequence of this change is that debt originated by UK-based companies can be distributed widely across the global market and held by entities which are not directly regulated by the FSA. Likewise, debt originated by foreign companies is now held in the UK. As we noted in our oral evidence, we believe that this does not affect our ability to discharge our mandate with respect to financial stability. Under our risk-based approach to regulation, we focus our supervisory attention on the areas which present the highest risk to our statutory objectives. In this case, our attention is appropriately weighted towards the FSA-regulated lending banks, which act as the transmission mechanism for exposure to private-equity owned companies to be distributed across the market. For many years our supervision of these entities has included reviews of the firms' management of their credit, market and underwriting risks in the area of private equity (as significant business lines). Our supervision of firms in this sector takes two main forms: "close and continuous" monitoring of individual firms, and "thematic reviews" of a number of firms to examine a particular aspect of their business or their controls. We will continue to emphasise to firms' senior management that their scrutiny of the progress of material exposures is an essential part of their risk management process. These firms are also subject to prudential supervision requiring them to hold capital in relation to the risks they are managing.

  Recognising the importance of monitoring the impact that leverage could have on our objectives, we are carrying out two projects to enhance our understanding of the market. One is the twice yearly leveraged buyout survey which we outlined in our previous written evidence to the Committee. This is being supplemented by enhancing our understanding of the risks posed by market developments to the restructuring of corporate firms in financial distress. We see our role here as raising the profile of potential market implications and encouraging participants to plan for such eventualities. We are working with the market in this regard through contact at the trade association and individual firm level.

  6.  This will allow us to highlight key areas of risk to the market, so that participants can prepare for the challenges that may lie ahead. We believe these steps will supplement our existing supervisory approach and provide appropriate mitigation against the current level of systemic risk we perceive to be associated with failure in a private-equity backed firm.


  7.  The Chairman asked four questions, to which we agreed to respond:

    —  What is the average duration of an investment by a private equity firm?

    —  How large is the private equity market?

    —  How many deals have been done by size?

    —  What is the geographical location internationally of the largest buy-out markets?

  FSA Authorised firms, including private equity firms, are required to submit periodic regulatory returns. These are used in our ongoing supervision of the market and are subject to rigorous scrutiny to ensure that we only request information which is necessary, and can be justified on a cost-benefit basis. We do not regularly collect deal specific data.

  The Chairman has asked for certain market information, not all of which is held in our records. We have therefore included data obtained from two other sources; Private Equity Intelligence (a 3rd Party data provider) and the Centre for Management Buy-out Research (CMBOR). We have found both to be reliable sources of objective market data.

8.  What is the average duration of an investment by a private equity firm?

  The "Average Time to Exit" for all UK private equity backed Buy-outs/Buy-ins (over the five year period 2002-2006 inclusive) was five years and four months. Over the 10 year period 1997-2006 the "Average Time to Exit" was five years and 0 months. This data is calculated by year of exit. For clarity, a firm purchased in 2000 and sold in 2005 would be included in the 2005 figures as a five year investment.

  For comparison, the "Average Time to Exit" for all UK Buy-outs/Buy-ins (including non-private equity backed transactions), over the same period, was five years and four months. Over the 10 year period 1997-2006 the "Average Time to Exit" was five years and two months. Source: CMBOR

9.   How large is the private equity market?

  We have used the metric of "funds raised"[118], a metric of potential impact that private equity could have, by investing these funds. In the calendar year 2006, UK based fund managers raised funds of £33.64 billion in the UK, compared with a global total of £223.24 billion. Historical data for a 4 year period is included under point 11 below. Source: Private Equity Intelligence.

10.   How many deals have been done by size?

Deal Range2000 20012002 200320042005 2006
Less than £5m9995 807586 9599
£5m - £10m36 40313221 2424
£10m - £25m70 55444351 4651
£25m - £50m23 34223137 3840
£50m - £100m27 15192327 2535
£100m - £250m23 18111130 2630
Over £250m1712 13913 2325
Total Number295269 220224265 277304

  Source: CMBOR.

11.   What is the geographical location internationally of the largest buy-out markets?

  Data is contained within the table below. This shows funds raised[119] by fund manager, according to the location of their head office. This data is not necessarily indicative of where funds have been, or will be, invested.

YearAsia Europe
Other UKUSGlobal
20030.406.18 0.9711.6924.31 43.54
20042.789.50 3.0012.1065.47 92.84
20054.1114.64 5.9033.52102.17 160.34
20068.1923.97 5.3733.64152.07 223.24

  Source: Private Equity Intelligence.

118   Data is by year of final close-ie when funds were closed allowing no further investors to commit capital. Back

119   By year of final close (see footnote above). Back

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