a few random thoughts on hedge funds, private equity, the financial system, tax justice &...
TRANSCRIPT
A few random thoughts on hedge A few random thoughts on hedge funds, private equity, the financial funds, private equity, the financial system, tax justice & capital flight system, tax justice & capital flight
etc etcetc etc
Sony KapoorSony Kapoor
AmsterdamAmsterdam
The ContextThe Context
Diamler Chrysler, Gilette & Hertz…Diamler Chrysler, Gilette & Hertz… Calpers, Harvard, China & DubaiCalpers, Harvard, China & Dubai Billion dollar earnings……..Billion dollar earnings…….. "remain anonymous, have no face, fall like a "remain anonymous, have no face, fall like a
plague of locusts over our companies, plague of locusts over our companies, devour everything, then fly on to the next devour everything, then fly on to the next one." one."
Etc etc etc….Etc etc etc….
The beasts…The beasts… Private Equity & Hedge FundsPrivate Equity & Hedge Funds The nature of the beasts…..The nature of the beasts….. More than 1000 private equity deals worth More than 1000 private equity deals worth
almost $400 billion last year…now a $1 trillion almost $400 billion last year…now a $1 trillion war chestwar chest
Almost 9000 hedge funds with almost 2 trillion Almost 9000 hedge funds with almost 2 trillion under investment..under investment..
Large, not that large, but disproportionate Large, not that large, but disproportionate influence….stock exchange, leverage, signalling influence….stock exchange, leverage, signalling impact…size of profits and returns, benchmark, impact…size of profits and returns, benchmark, regulatory and financial stability issues…regulatory and financial stability issues…
How Leverage Works…How Leverage Works… 50 mill investment50 mill investment 10% return10% return 5 mill profit and 10% profitability5 mill profit and 10% profitability
10 mill investment + 40 mill borrowing10 mill investment + 40 mill borrowing 5% interest rate payable and 10% return5% interest rate payable and 10% return 5 mill return, 2 mill interest, 3 mill profit 5 mill return, 2 mill interest, 3 mill profit
and 30% profitability…..and 30% profitability….. Multiplicative leverage….Multiplicative leverage….
Why the growth???Why the growth???
Low interest rates…Low interest rates… Low risk premiums…Low risk premiums… Regulatory Arbitrage…Regulatory Arbitrage… Incentive Structures…Incentive Structures… Greed is good...Greed is good... Seeking returns…too much money…self Seeking returns…too much money…self
fulfilling…fulfilling… Tax havens, secrecy, tax leverage…etc…Tax havens, secrecy, tax leverage…etc… Light touch regulation………Light touch regulation………
The world we live inThe world we live in Inequality between nations rising Inequality between nations rising Inequality within nations rising – China, Malawi, Inequality within nations rising – China, Malawi,
Ecuador, Japan, US, EUEcuador, Japan, US, EU Inequality across people of the world highest ever – Inequality across people of the world highest ever –
both wealth and Incomeboth wealth and Income Almost 3 billion people less than $2 a day – almost Almost 3 billion people less than $2 a day – almost
half of that less than $1 a day - $13 bn Bonushalf of that less than $1 a day - $13 bn Bonus 0.1% - less than 300,000 richest Americans earn 0.1% - less than 300,000 richest Americans earn
more than 25% - 1.5 bn of the poorest have more more than 25% - 1.5 bn of the poorest have more wealth than almost half the worldwealth than almost half the world
70%-90% of wealth held by the richest 20%70%-90% of wealth held by the richest 20% The poor are financing the rich – US/ Capital FlightThe poor are financing the rich – US/ Capital Flight
Efficient Markets?Efficient Markets?
Random clips – the weak underbellyRandom clips – the weak underbelly
Everybody loves anecdotesEverybody loves anecdotes Box: The Elite and Capital FlightBox: The Elite and Capital Flight Raul Salinas, who was the brother of the late Mexican president, is Raul Salinas, who was the brother of the late Mexican president, is
widely known to have benefited enormously during the presidency of his widely known to have benefited enormously during the presidency of his brother. He has been in jail on charges of capital flight and tax evasion.brother. He has been in jail on charges of capital flight and tax evasion.
Just after he was indicted, Raul’s wife Paulina Castanon left Mexico for Just after he was indicted, Raul’s wife Paulina Castanon left Mexico for Switzerland to withdraw $84 million from one of Raul’s accounts at Switzerland to withdraw $84 million from one of Raul’s accounts at Banque Pictet where it was deposited under a false name. The Swiss Banque Pictet where it was deposited under a false name. The Swiss arrested her. At one point, the officer who interrogated her said he could arrested her. At one point, the officer who interrogated her said he could not understand why she tried to take $84 million which attracted not understand why she tried to take $84 million which attracted attention. He asked, ‘why didn’t you just take a little bit every time?’ She attention. He asked, ‘why didn’t you just take a little bit every time?’ She answered, ‘That’s what I was doing’.answered, ‘That’s what I was doing’.
““A best estimate is that he [Sani Abacha, the erstwhile dictator of A best estimate is that he [Sani Abacha, the erstwhile dictator of Nigeria] stole $4.3 billion, some $2.3 billion of it directly from the national Nigeria] stole $4.3 billion, some $2.3 billion of it directly from the national treasury. The remaining two came in equal halves from contracts that he treasury. The remaining two came in equal halves from contracts that he put through his own shell companies and bribes from foreign put through his own shell companies and bribes from foreign contractors. Shortly after his death, his widow Mariam was stopped at contractors. Shortly after his death, his widow Mariam was stopped at Lagos airport trying to leave for Saudi Arabia carrying 38 suitcases filled Lagos airport trying to leave for Saudi Arabia carrying 38 suitcases filled with foreign currency. Reports vary on the amount involved, ranging with foreign currency. Reports vary on the amount involved, ranging from $50 million - $100 million. She said she was going to the Hajj”. from $50 million - $100 million. She said she was going to the Hajj”.
(Robinson, 2004)(Robinson, 2004)
Haemorrhaging MoneyHaemorrhaging Money
Hedge FundsHedge Funds At least 75% are located offshore…minimise tax liabilities, At least 75% are located offshore…minimise tax liabilities,
offer secrecy space and regulatory arbitrage..offer secrecy space and regulatory arbitrage.. More than $11 trillion of assets located offshore …about More than $11 trillion of assets located offshore …about
$800 billion African…$800 billion African… Some invested in hedge funds…Some invested in hedge funds… Two tax aspects…Investor taxes due and manager taxes Two tax aspects…Investor taxes due and manager taxes
due…non trivial 2 by 20 to 4 by 30…due…non trivial 2 by 20 to 4 by 30… Most transactions are short-term, returns would be taxed Most transactions are short-term, returns would be taxed
as ordinary income. 40%-50%... – but even when you are as ordinary income. 40%-50%... – but even when you are onshore you can and do minimise the tax burdenonshore you can and do minimise the tax burden
You might own your hedge fund through a tax-exempt You might own your hedge fund through a tax-exempt vehicle, or through an insurance wrapper. vehicle, or through an insurance wrapper.
A solution is an offshore hedge fund. Offshore, the income A solution is an offshore hedge fund. Offshore, the income is treated as an equity interestis treated as an equity interest
Hedge Funds contd…Hedge Funds contd…
A strategy involves private placement variable life insurance. A strategy involves private placement variable life insurance. Here, you actually own an insurance policy with sub-accounts Here, you actually own an insurance policy with sub-accounts invested in a hedge fund. The policy can be domestic or invested in a hedge fund. The policy can be domestic or offshore. Insulated from tax on income.You can also defer the offshore. Insulated from tax on income.You can also defer the tax impact by taking the money, at some future date, by tax impact by taking the money, at some future date, by borrowing against the policy or drawing out the cash value as an borrowing against the policy or drawing out the cash value as an annuity. Borrowing the proceeds are not treated as a distribution annuity. Borrowing the proceeds are not treated as a distribution for tax purposes, further deferring the tax liability.for tax purposes, further deferring the tax liability.
A more esoteric strategy involves buying the tracking stock of an A more esoteric strategy involves buying the tracking stock of an offshore insurance company specifically formed to invest in offshore insurance company specifically formed to invest in hedge funds as part of the company's portfolio. Here the tax hedge funds as part of the company's portfolio. Here the tax liability would belong to the company - if it were not in an liability would belong to the company - if it were not in an offshore haven - and not to the individual share owner.offshore haven - and not to the individual share owner.
As an exit strategy you would simply sell the stock, converting As an exit strategy you would simply sell the stock, converting what would otherwise be short-term gains into long.what would otherwise be short-term gains into long.
Many wealth advisers also have proprietary strategies to Many wealth advisers also have proprietary strategies to mitigate the tax consequences of hedge funds. Typically, these mitigate the tax consequences of hedge funds. Typically, these strategies involve a marriage with another vehicle that can strategies involve a marriage with another vehicle that can generate a tax loss.generate a tax loss.
Private EquityPrivate Equity
““Any common sense person would say that a Any common sense person would say that a highly-paid private equity executive paying less tax highly-paid private equity executive paying less tax than a cleaning lady or other low-paid workers, than a cleaning lady or other low-paid workers, that can’t be right. . . I have not heard anyone give that can’t be right. . . I have not heard anyone give a clear explanation of why it is justified.” – Nicolas a clear explanation of why it is justified.” – Nicolas FergusonFerguson
My own experience – LBO’s, leverage, My own experience – LBO’s, leverage, Compensation, cost cutting….jobs…pension Compensation, cost cutting….jobs…pension funds…funds…
Negative redistribution in Private Equity – Negative redistribution in Private Equity – Inevitable?Inevitable?
Private Equity contd.Private Equity contd. Privatizing gains, juggling profits around, the Privatizing gains, juggling profits around, the
importance of leverage, past record – LBOs, the importance of leverage, past record – LBOs, the value of the taxes saved…value of the taxes saved…
Two aspects – Company Taxes and Investor Two aspects – Company Taxes and Investor Taxes – Both AvoidedTaxes – Both Avoided
Company – leverage – interest tax deductible for Company – leverage – interest tax deductible for all. Okish if interest income was retained and all. Okish if interest income was retained and taxed– but crucial difference – payments go taxed– but crucial difference – payments go offshore – no withholding taxes for offhsore offshore – no withholding taxes for offhsore paymentspayments
US and UK and OECD – very worried about US and UK and OECD – very worried about erosion of tax revenues…1 in 5 in the UK jobs…erosion of tax revenues…1 in 5 in the UK jobs…
Private equity contd…Private equity contd… Conversion of income taxes to capital gains…Conversion of income taxes to capital gains…
which is much lower…Non level playing field…which is much lower…Non level playing field… The “carried interest” problem –you own 1% of the The “carried interest” problem –you own 1% of the
fund, get 20% of its profits. The entire 20% profit fund, get 20% of its profits. The entire 20% profit share – and often some if not all of your 2% share – and often some if not all of your 2% management fee as well – is taxed at the 15% management fee as well – is taxed at the 15% capital gains tax rate now 10% in the UK after 2 capital gains tax rate now 10% in the UK after 2 years… years…
The public costs…The formula is simple: on The public costs…The formula is simple: on average a fifth of jobs are cut and workers are average a fifth of jobs are cut and workers are paid £231 a year less than in publicly owned paid £231 a year less than in publicly owned companies, while large tax breaks fatten profits.companies, while large tax breaks fatten profits.
Private equity contd…Private equity contd… Boots & 96 more pension funds in the UK alone Boots & 96 more pension funds in the UK alone
collapsed due to private equity links, landing the collapsed due to private equity links, landing the taxpayer with the liability for bailing them out. taxpayer with the liability for bailing them out.
Other public costs…re IMF and FSA say private Other public costs…re IMF and FSA say private equity collapse is “inevitable”…equity collapse is “inevitable”…
Irony - pension fund managers are being urged to Irony - pension fund managers are being urged to invest more in pension-fund-destroying private invest more in pension-fund-destroying private equityequity
One study by Citigroup showed that if pension One study by Citigroup showed that if pension funds and insurance firms had borrowed money funds and insurance firms had borrowed money themselves and invested in a basket of companies themselves and invested in a basket of companies in which private equity groups invested, they in which private equity groups invested, they would have made higher returns than even the would have made higher returns than even the best-performing private equity firms.best-performing private equity firms.
