the times | Tuesday October 20 2020 1GM 41

CommentBusiness

Changing fund rules could come

to the rescue of economic recovery

E

arlier this month I joined

more than 100 Crystal

Palace fans in our annual

27-mile Marathon March

from Selhurst Park stadium

to raise money for the football club’s

official charity, the Palace for Life

Foundation. As chairman of

trustees, I had fretted with board

colleagues about the appetite of fans

and sponsors to support this year’s

march, not to mention the logistical

constraints of social distancing. In

the event, we just beat the

introduction of Tier 2 restrictions,

and are on course to raise a record

sum to support our work with

vulnerable young south Londoners.

Charities in the UK have suffered

badly from the economic

deprivations of the pandemic.

However, my recent conversations

with business leaders support the

anecdotal evidence provided by our

yomp around the streets and parks

of south London that with the

second wave of the virus is coming

an upswing in social awareness. It is

incumbent on companies to harness

this force for good and provide a

vital boost to the charitable sector.

Over the past couple of years, ESG

has become a term that appears in

every listed company board

meeting. Environmental lobbyists

have forced businesses to address

their carbon footprints and,

increasingly, the very essence of

their products and operations.

Governance specialists at the major

fund management groups have used

the threat of voting rebellions at

annual general meetings to

encourage boards to adhere to best

practice guidelines in the way they

conduct themselves, especially with

regard to executive pay.

The S in ESG — social — is often

squeezed between the high-profile

and sometimes contentious E

(environmental) and G (corporate

(governance). In part, this is because

it is difficult to identify yardsticks

for social contribution by companies

that can be applied across the

market. More insidiously, it is likely

to reflect in many a deep-seated

sense that “doing good” is somehow

incompatible with the imperative for

companies to generate returns for

their shareholders. Often I’ve heard

chief executives argue privately that

while it is important how their

business is conducted, ultimately

they will always be judged on profits,

dividends and share price.

This, though, is not likely to be the

view of their staff. In particular,

younger workers are proving much

more attuned to the social purpose

of their employers than their older

colleagues. While this may appear a

sweeping statement, and of course

we can all cite examples of both

young and old individuals that run

counter to the generalisation, staff

surveys do bear it out.

Institutional investors have yet to

focus on the S in ESG, which is

understandable given their own

positions in a competitive industry

in which generating returns for their

clients is the ultimate goal. But just

as they have embraced the notion

that good governance and

environmental awareness are

consistent with superior business

performance, so they are sure in due

course to apply much more scrutiny

to the connection between staff

attitudes to a company’s social

impact and its long-term returns.

Where the early weeks of the

current crisis were marked by

emergency responses from

companies unsure of their very

existence, and the summer by the

implementation of measures to

establish some semblance of

business as usual, the autumn

upswing in Covid incidence has

brought home the reality that this is

a long haul.

This is fertile ground for

boardroom discussions about the

purpose of companies, the way they

conduct themselves, and their

engagement with the traumatised

society of which they form a part.

For some, survival is still in doubt,

but for those enterprises that have

been able to take advantage of an

accommodating stock market to

solidify finances, there may never be

a better time for existential debate.

Ed Warner

Debt has been a

saviour in this crisis.

In March,

companies were on

the verge of

bankruptcy. The government did

what it could through the furlough

scheme, VAT deferrals and business

rate holidays, while banks parked loan

repayments and landlords cut rents.

But even with such extraordinary

measures, the Bank of England

warned that corporate cashflow

deficits this year would hit £200

billion — £135 billion among larger

businesses and £70 billion among

smaller ones.

The cashflow deficit measured the

amount by which projected spending

exceeded projected income.

Companies could absorb some of the

overshoot by dipping into their cash

buffers, the Bank reckoned, but those

wells were not deep enough. Which is

why the government’s business

interruption scheme and bounceback

loans, and the Bank’s Covid corporate

finance facility, have been so vital.

But debt is as much a destroyer as it

has been a saviour. In the recovery, it

threatens to hang like an albatross

around the economy’s neck. Officials

have been worrying almost since the

first emergency loan was made in

April about a “balance-sheet

recession” as debt strangles the

recovery next year, when the private

sector has nothing left for

investment after servicing its

borrowings.

Much of the focus has been

about resolving the debt

overhang from the 100 per cent

state-guaranteed bounceback

loans. There was talk of

converting them to grants.

The City UK suggested they

be switched to a tax liability

and treated like student loans. But

everyone agrees that what is really

needed is equity everywhere, and

lots of it, to rebuild balance

sheets or to seed new

businesses. Debt may

have saved

companies in the

recession but

it will be

equity

that

saves

them, and the economy, in the

recovery.

One thing we don’t need more of is

private equity. The last thing Britain’s

needs is vultures picking over the

economy’s carcass but, when it comes

to investment in unlisted companies,

which make up the majority of

corporate Britain, what’s the

alternative? Venture capital is

expanding fast, with roughly £10

billion committed last year, but its

high-risk, high-return model is not

suited to run-of-the-mill businesses

— the mid-tier manufacturers,

retailers or marketing agencies that

will be the engine room of recovery.

Which leaves private equity as the

monopoly system for broad-based

unlisted equity finance because there

aren’t any other structures.

Regulators want to fill that gap.

Part of the remit of the Bank’s

Financial Policy Committee is to

“support the supply of finance for

productive investment”. For

inspiration, officials have been

looking to some unlikely saviours:

open-ended commercial property

funds that nearly blew up after the

2016 Brexit vote and Neil Woodford’s

investment vehicles that did blow up

last year. Those two investment

structures were the closest the UK

has come to creating new fund

vehicles for unlisted business to rival

private equity. The problem in both

those cases was maturity mismatch.

“Open-ended” meant investors

could sell whenever they wanted

but the unlisted nature of the

collateral meant the

assets could not be sold.

The funds had to be

shut and investors

barred from getting

their money.

The reform needed

is obvious. The funds

need long notice

periods to buy time to

sell the underlying

assets. Germany, for

example, has a one-year

notice period on

commercial

property funds,

which reflects

how long it

might take

to sell a

portfol

io of retail parks in a recession. The

FCA is consulting on a 90 to 180-day

notice period for property funds. The

Bank has said it should be “at least as”

long as that. This nascent model is

now being used as a template for

completely new investment structures

for unlisted corporate equity.

Long redemption notices do not

completely solve the problem, though,

because they create a different one:

who will buy these long-term, closed

funds? Again, the answer seems

obvious. Pension funds and insurers,

whose entire business model is long

term. Regulators are now scrambling

to remove the pettifogging rules that

block productive investment. Brexit,

for once, may help. One of the few

advantages of leaving is that Britain

will be free of Solvency II, where

insurers are deterred from investing

in long-term productivity-enhancing

infrastructure, like the rail and green

projects we need. Andrew Tyrie, the

former Treasury select committee

chairman, called Solvency II “an

object lesson in how not to make law”.

One insider said that regulators are

now looking at “knocking down any

obstacles to anyone investing in these

[unlisted fund] structures”. Even a

small shift in investment patterns

could have a huge impact on the

recovery. Just 2 per cent of the

£5 trillion assets under management

in the UK are in unlisted equity.

Increase that to 3 per cent and

£50 billion would be ploughed into

vital mid-sized companies.

Large corporates will have little

difficulty accessing capital markets

when the recovery comes and

bounceback loans are not expensive

for viable small companies. With a

fixed 2.5 per cent interest rate on a

repayment term of ten years, the

loans, capped at 25 per cent of

turnover up to a maximum of

£50,000, will cost no more than 3.1

per cent of pre-crisis revenues.

Equity capital for investment and

expansion by newly-indebted or

simply new mid-tier businesses is the

missing piece, without the private

equity parasites.

If regulators can make unlisted

fund structures

work, that may be

every bit as vital for

the recovery as any

fiscal stimulus..

‘‘

’’

Philip Aldrick is Economics Editor of

The Times

Ed Warner, who sits on a number of

company boards, is writing in a

personal capacity

6 Patrick Hosking is away

It’s a perfect time for

companies to embrace

their social purpose

Debt is an albatross that

threatens the economy

Philip Aldrick

‘It is difficult to

identify yardsticks

for social contribution

that can be applied

across the market’