Europe: Codes compared

Author: | Published: 1 Oct 2008
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Political and media debate about the merits of private equity have reached a fever pitch – not just in Europe, but in the US and elsewhere around the world. Many of the industry's critics have been calling for greater regulation.

Much of the debate has been misinformed, and it is clear that the buyout industry has to communicate more effectively with the wider public. But the private equity community has responded positively to criticism, and has acknowledged that some calls for greater openness and disclosure have merit. In particular, the national private equity and venture capital associations of the UK (BVCA), Sweden (SVCA) and Denmark (DVCA) have all now published guidelines to promote increased transparency and openness in their national private equity industries. In addition, the AFIC in France (Association Francaise des Investisseurs en Capital) has issued a voluntary charter which sets out several basic values and responsibilities for private equity firms.

The early success of Sir David Walker's pragmatic, principles-based recommendations in the UK helped to stave off calls for more black letter law: 32 buyout groups and 55 portfolio companies have so far signed up, despite some not falling within Walker's scope. It also provided the model for the Danish and Swedish reports.

Although purporting to do very similar things, the different recommendations vary considerably in the way they go about achieving their goals.

Code comparisons

Framed against a backdrop of less comprehensive private company law than in some other European countries, Walker's UK guidelines perhaps had to be more prescriptive than their Scandinavian counterparts. They are weighty and comprehensive. Whereas the Swedish recommendations seem intended as much to educate as to tie firms into rigid reporting requirements. For instance there is one page of recommendations, and seven pages explaining what private equity is.

The Danish guidelines occupy the middle ground: a softer focus than Walker's guidelines but a more prescriptive form than the Swedish equivalent. However, in various ways both the Swedish and the Danish rules go further than Walker. All three envisage a streamed approach to reporting requirements – at firm level, at fund level and at industry level.

To whom do they apply?

The UK guidelines apply specifically to UK, FSA-authorised private equity houses that are managing or advising funds that either own or control one or more UK companies (or who have a designated capability to engage in such investment activity), but only if the companies are covered by the enhanced reporting guidelines for portfolio companies. This two-limbed approach singles out those at the top end of the buy-out market (those that were the focus of the most criticism) and attempts to prevent the onerous reporting requirements being imposed on smaller firms for whom the cost and administrative burden would be disproportionately large.

The SVCA has a wider and more generic entry threshold. The private equity firm must be a member of the SVCA and either invest equity capital into portfolio companies in which they hold a majority or minority stake, or act as investment advisors to funds which undertake such investments. This is far wider than the scope of the UK or Danish guidelines and covers all members of the SVCA. The Walker guidelines apply to no more than 15% of the BVCA membership, while the Danish regulations only apply to DVCA members with committed capital of at least DKr500 million ($142 million). Private equity houses whose ultimate parent company is registered in a country other than Denmark fall outside the full scope of the regulations.

The same themes are repeated for portfolio companies. Sweden applies its guidelines to any companies headquartered in Sweden, while the Danish guidelines have a de minimis threshold based on Danish company-law size classifications: Class C (large) companies, which are categorised as those with revenue in excess of €32 million, assets in excess of €16 million and more than 250 employees. Unlike the UK criteria, the portfolio company does not have to be owned by a private equity fund that falls under the Danish guidelines. Instead, it is sufficient that a fund has a decisive influence over the company, and that fund may be Danish or foreign.

Walker's guidelines take a more targeted approach and apply to public-to-private transactions where the equity value of the company on acquisition was £300 million ($562.4 million) or more, or other acquisitions where the enterprise value was at least £500 million. These values are intended to be roughly equivalent; one referring to equity value and the other to enterprise value. They were designed to catch companies of equivalent size to those in the FTSE 350. The UK guidelines also only apply to companies that have 50% or more of their revenue generated in the UK, and employ over 1000 UK full-time employees or equivalent. The UK thresholds are therefore much higher than those in Denmark, perhaps reflecting the different average sizes of deals.

The reporting obligations

The SVCA offers a more thematic set of recommendations, suggesting topics to be covered, rather than formally specifying disclosure requirements. In many ways this mirrors the approach taken in the UK for reporting by private equity houses, highlighting those areas and themes that should be covered. It then leaves it to the private equity house and the portfolio company to decide how this information is to be presented. The difference stems from the fact that the Swedish recommendations sit within a more stringent statutory company reporting regime than in the UK or Denmark, with greater emphasis on employee participation. As the SVCA report states, Sweden and the Nordic region differ from other parts of the world in those respects.

Given the lack of a statutory role for trade unions or similarly strict reporting requirements for UK private companies, the Walker guidelines offer more detailed recommendations for the content of portfolio companies' reports. The focus is on substance over form and on economic reality rather than legal structure. The guidelines require portfolio companies to produce an annual report which identifies the ownership and board structures, and includes a business review substantially similar to that required by section 417 of the Companies Act 2006 for quoted companies. In particular, this requires firms to produce a report which details: the main factors affecting the future development of the business; information on employees, environmental and social and community issues; and information on those persons with whom the company has essential business arrangements. There is also a requirement to produce a mid-year update.

The DVCA also emphasises the more rigorous Danish requirements for company's annual reports. Under the Danish Financial Statements Act, companies must include a detailed management report in their annual report and so the guidelines aim only to supplement these legislative provisions. The Danish guidelines go further than Walker's in several respects. Most notably, a statement on employee turnover (including terminations, recruitment and the like), company constitution and related matters (among other things; responsibilities and duties, board member remuneration and shareholdings). Interestingly, in public-to-private transactions the guidelines require that portfolio companies continue to make interim and financial reports in accordance with OMX Nordic Exchange Copenhagen's rules for the first year of business as a delisted entity. Thereafter, an interim report is to be prepared that describes whether the company is pursuing the general aims published in the annual report for the previous year.

The role of national associations

All three provide for an increase in the role of the various national private equity and venture capital associations. Their role evolves from simple industry body to data collector and disseminator, and in the case of the British and Danish bodies, quasi-regulators. The associations are required to take responsibility for collecting and consolidating the information reported to it under the relevant guideline provisions.

That data will be aggregated on an industry-wide level with a view to providing a general account of the trends in the industry. The DVCA guidelines specifically state that to ensure consistency, their analysis will be developed in close collaboration with the Walker Working Group and the BVCA.

In taking the role of quasi-regulator, the BVCA and DVCA have set up committees to review and adapt the guidelines as they are implemented by the industry. The committees' membership structures vary slightly, but a common thread of informed independence runs through both. The Walker Guideline Monitoring Group is composed of an independent chairman and two other independents along with two private equity representatives. The DVCA committee is composed of the DVCA chairman, a state authorised accountant and an independent industry representative.

Pan-European guidelines

April 2008 saw the publication of two draft reports by the European Parliament relating to private equity, one of which was subsequently finalised and published as an official opinion at the end of May. These include some alarming and dangerous proposals and also urge the Commission to provide a legislative response. They will increase pressure for a co-ordinated pan-European response to the industry's critics.

The industry must resist the urge for knee-jerk blanket regulation, and it will have to do that even more strongly when a new European Commission is appointed in 2009. But, as the BVCA, DVCA and SVCA guidelines all demonstrate, that must be done without losing sight of the fact that each country has its own legal and political framework, which would make one-size fits all guidelines inappropriate.

If external regulation runs the risk of hampering an industry that contributes tens of billions of euros to the EU annually, then these voluntary guidelines have an important job to do. But policy makers have to give the guidelines time to work. At least one business cycle will be required before judgements can be made. And the industry must embrace both the letter and the spirit of the guidelines enthusiastically. The early signs are good, but sustained effort is essential.

The three private equity codes in detail
BVCA guidelines DVCA guidelines SVCA Recommendations
Which private equity houses are covered? - UK based;
- authorised by FSA; and
- managing or advising funds that either own or control one (or more) UK companies which meet the size criteria below.
- DVCA members with total commitments in excess of DK 500 million. - SVCA members; and either
• invest equity in companies in which they hold a majority or minority share; or
• act as investment advisor to funds which undertake such investments.
- Any company headquartered in Sweden.
Which portfolio companies are covered? Companies which were:
- acquired in a public to private transaction for more than £300 million (approx. ?380 million); or
- acquired in a secondary or other non-market transaction with an enterprise value of in excess of £500 million; and which have,
- at least 50% of its revenues generated in the UK; and
- at least 1,000 fulltime UK employees.
Danish companies with:
- revenue in excess of DK238 million (€32 million);
- assets greater than DK119 million (€16 million); and
- over 250 employees.
What are they required to do:
Private equity houses
- Publish in an annual review or on their website information about:
• how the FSA authorised entity fits into the house;
• its history and investment strategy;
• key executives and procedures to deal with conflicts of interest;
• a description of the UK portfolio companies it owns; and
• a description of investors including breakdowns by type and geographic location.
- supply relevant data to the BVCA;
- communicate actively with “stakeholders”.
- Publish on their website:
• information about themselves, their funds and strategies, and their investors and origins;
• a link to the management company’s accounts;
• where the carried interest programme for general partners departs significantly from the market standard, a general description of the programme is to be given;
• their policy on corporate social responsibility;
• information on assets and companies under management .
- Provide data to the DVCA
- Publish on their website information to include:
• the general fund and its structure;
• the key executives;
• investment strategy;
• information about each portfolio company;
• applicable guidelines for portfolio valuation and reporting to investors;
• policies regarding the handling of potential conflicts of interest;
• policies regarding CSR and environmental issues.
- Participate in data gathering by SVCA.
Portfolio companies - Publish enhanced annual reports and accounts on their website within six months, which give:
• the identity of the private equity house(s) which owns the company, along with the executives that oversee its management;
• the board composition and identity of those members who are representatives of the private equity house(s); and
• a business review which substantially conforms to that required by section 417 of the Companies Act 2006, including those provisions relating to quoted companies.
- publish a mid-year update; and
- contribute data to the BVCA.
- Publish an annual report to supplement the statutory one, which is to include:
• operational and financial developments;
• corporate governance;
• financial and other risks; and
• employee matters.
- Provide data to the DVCA
- Publish on their website information about:
• their operations and turnover;
• their ownership;
• board composition;
• some financial reporting and data;
• information about significant events, ownership changes, changes in management and board composition or other events of substantial financial importance;
• policies regarding CSR and environmental issues.

By Simon Witney and James Bromley of SJ Berwin

On January 1 2009 some changes to the German Foreign Trade and Payments Act (Außenwirtschaftsgesetz, AWG) will come into effect that are likely to have a significant impact on foreign investors wishing to invest in German target companies. Under the new regime, any such acquisition by foreign investors may trigger the right of the German Federal Ministry of Economics to investigate and even prohibit the transaction.

The reform

Who is affected?

Under the Foreign Trade and Payments Act, investors from non-EC countries that do not belong to the European Free Trade Association (EC plus Switzerland, Norway, Iceland and Liechtenstein) and that acquire shares representing 25% or more of the voting stock of a German company may have their acquisition investigated by the Federal Ministry of Economics. Shares held by companies controlled by the acquirer (by holding at least 25% of the voting stock) are treated as if they were held by the acquirer itself. Shares that are subject to voting agreements are also assigned to the acquirer.

If the Ministry comes to the conclusion that Germany's public order or national security are threatened by a transaction, it may prohibit the acquisition. Unfortunately, the Act does not contain any definition of public order or national security, so the Act brings a certain degree of uncertainty about which transactions fall within its scope. If the Ministry decides that a transaction falls within the scope of the Act, it may order that the acquisition (which may already be consummated) be reversed. The Ministry may also choose only to prohibit the exertion of voting rights of shares held by the foreign investor, thus restricting the investor's influence on the German target.

How long does it take to reach a decision?

Foreign investors are under no obligation to file their transaction with the Federal Ministry of Economics. However, they may do so after signing and will, in that case, receive a final decision on whether the transaction will be prohibited within one month. If the transaction is not filed with the Ministry, it may start an investigation on its own account within three months after the consummation of the transaction, with the effect that the transaction is put under the condition precedent of the Ministry's approval. The Ministry will immediately inform the investor of its decision to investigate the acquisition, which triggers the acquirer's obligation to provide the Ministry with data. The acquirer will be informed about the specific data required by the Ministry through an announcement in the Federal Gazette (Bundesanzeiger). The investigation must be completed within two months of receipt of the transaction data.

Aims and criticism

The reform seeks to protect sensitive branches of German industry such as the energy, telecom and military sectors. Potential threats are perceived to come from state-controlled funds (in particular from China, the Emirates and Russia) that may be used to influence German politics via investments in German key enterprises. State-controlled foreign corporations have also been classified as potentially dangerous.

The reforms have attracted much criticism. For example, the new powers granted to the Ministry of Economics are suspected of infringing the freedom of capital movement as guaranteed by Article 56 of the EC Treaty. The European Commission is planning to examine the Act for its reconcilability with Article 56 and the freedom of establishment (Article 49). Also, the scope of the Act is considered to be unreasonable because it not only restricts investment from foreign countries, state-owned funds or state-controlled corporations but foreign investors in general. Any private equity investor wishing to invest in Germany may find his transaction being investigated by the Federal Ministry of Economics.

The problem for foreign investors

The main problem is the legal uncertainty for foreign investors. If an investor has successfully completed a transaction, it may still be subject to investigation for a period of three months after the closing date. A further two months may pass until the Ministry has completed its investigation. The result may be that the transaction is prohibited and the acquisition must be reversed. This uncertainty is unacceptable for the seller, buyer, target, financing banks and employees of the target company.

Recommended course of action

Foreign investors wishing to acquire 25% or more of the voting stock of a German company should therefore adhere to the following guidelines.

Informal enquiry before signing

A foreign investor can contact the Federal Ministry of Economics before he signs a share purchase agreement on a confidential and informal basis in order to find out if the Ministry will investigate the transaction. A similar approach is generally taken if a bidder wishes to know the position of the German Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, BaFin) on a takeover process. There are no guidelines on how such an informal approach should be made, though any informal contact bears the risk that information may be leaked. A seller is therefore unlikely to agree to such contact.

Filing for investigation after signing

Therefore, a foreign investor should voluntarily file the transaction with the Federal Ministry of Economics immediately after signing a share purchase agreement. He should refrain from filing only if he and the seller are in no doubt that the transaction does not qualify for an investigation by the Ministry. If the investor intends to file the transaction, the share purchase agreement should contain a clause that makes the clearance of the acquisition by the Ministry a condition precedent for the obligation of the parties to consummate the transaction. After the Ministry has received all relevant data, it has one month to decide whether it will prohibit the consummation. In order to speed up the process, the investor should agree with the Ministry on which information it needs in order to come to a decision as quickly as possible. It appears likely that an investor will, in most cases, be able to get a decision before the German Federal Cartel Authority (Bundeskartellamt) has cleared the transaction. Therefore, the filing of the acquisition should not lead to delay in most cases.

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