Jeremy Warner's Outlook: Hedge funds go the self-regulatory route

Governor King is not for turning; Killing horses at Cadbury Schweppes; Pearl bids but still no Resolution in sight
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One of the jobs Sir Andrew Large, a former deputy governor of the Bank of England, has been busying himself with since leaving Theadneedle Street is that of coming up with self-governing principles for the hedge fund industry. It's a shame in many respects that he didn't stay at the Bank. His skills would have been in much demand round there in recent months.

Yesterday's proposals are nevertheless a sensible enough stab at the problem. Sir Andrew has come up with a well-rounded set of suggestions for addressing public concern on transparency and accountability. Yet whether they are sufficient to see off the political clamour for a regulatory crackdown is open to question. The problem with voluntary arrangements is that the bad guys tend to opt out. These are the people who get the industry into trouble in the first place.

Even so, self regulation of these newer forms of finance is almost certainly preferable to statutory diktat, as proposed by Angela Merkel and some other European leaders. When the SEC tried to register hedge funds for regulatory purposes it soon got into the problem of definition and was eventually forced to abandon the endeavour.

Everyone in corporate America now agrees that Sarbanes-Oxley was a gross regulatory over-reaction to Enron and other turn-of-the-century scandals which has done untold damage to America's capital markets. Sir Andrew's proposals are therefore very much to be welcomed, but he needs to find ways of ensuring that they are a duty rather than a voluntary afterthought.

Governor King is not for turning

Whatever the lessons of the Northern Rock debacle, Mervyn King, the Governor of the Bank of England, remains unrepentant about the much-criticised way in which it was handled. In a speech on Tuesday night, which would plainly have had a lot more coverage were it not for the fact that it coincided with the pre-Budget report, he again blamed failings in the system rather than in the manner of its management, and he strongly defended the Bank's decision not to provide liquidity to the markets except at penalty rates of interest.

As for whether the Bank might be persuaded to follow the Fed and now cut interest rates in response to the credit crunch, the implied message was just forget it – interest rate decisions are governed solely by inflationary considerations. The Governor drew three lessons from the crisis, which will no doubt instruct the Chancellor's promised statement on reform either today or tomorrow. One is that concentration by prudential regulators on solvency capital needs to be supplemented by greater attention to a bank's liquidity position.

Another is the need for better deposit insurance. This in turn would help to address the perceived third failing, which was in the Bank's lender-of-last-resort functions. Smaller banks go bust all the time in the US, but nobody much bothers about them because the system ensures that depositors aren't disadvantaged.

Mr King concedes that, in this day and age, it may not be possible to conduct "covert" support operations, but he nonetheless wants to explore ways of retaining "quiet" methods used in the past. What he didn't address is whether provision of liquidity to the market at an earlier stage might have prevented the collapse. Nor did he seem minded to defend tripartite arrangements in which the Financial Services Authority advised him strongly to take evasive action of this sort.

What will be the Chancellor's view? He too will want to concentrate on the lender-of-last-resort and deposit-insurance function. But don't expect him to dismantle the tripartite arrangements. Labour invented them.

Killing horses at Cadbury Schweppes

So farewell then, Sir John Sunderland, chairman of Cadbury Schweppes. He's been with the company for nearly 40 years, the last two of them as chairman. Now he's decided to hang up his boots, but not before he has first overseen the demerger of the group's US beverages business.

Plans to flog these interests off to private equity have fallen foul of the credit crunch, with nobody now prepared to pay the irrational prices that seemed to be available only a few months back.

Managements nearly always prefer to sell for cash rather than demerge if they can possibly get away with it, since this allows them to keep some of the proceeds of divestment for the purpose of rebuilding the empire in new directions. Investors, on the hand, tend to favour the straight demerger. Any worthwhile investment plan can always be financed. Yet if managements have surplus capital burning a hole in their pockets, they invariably waste it.

What made the Cadbury case for a straight sale a little bit different was that the leveraged buyout boom of earlier this year had made the price of assets such as these genuinely silly. It seemed a shame not to take advantage of them before they went away. What's more, the demerger alternative was disadvantaged by the fact that many of Cadbury's shareholders wouldn't have wanted to own shares in a US-domiciled and listed enterprise.

Well, now they are going to have to get used to it. Demerger has by default become the only credible way of achieving the desired break-up. Deprived of the cash it wanted for reinvestment, where now for the confectionery rump? Merger with Hershey in the US continues to look one of the best options, but despite the trouble that Hershey finds itself in, it still looks to be unavailable.

Cadbury's chief executive, Todd Stitzer, found himself wondering why he had been invited to the table in recent talks after being informed that the only terms under which the Hershey Trust would contemplate a merger would be those in which it retained a controlling stake in the combined company. The trust, established for the purpose of educating orphans, has 75 per cent voting control of Hershey but only a 30 per cent economic interest. Given that Cadbury is the larger of the two companies, it was not immediately apparent to Mr Stitzer why he should cede control to a trust that seems only to have allowed its charge to be run into the ground.

You kind of feel in your waters that this deal will eventually happen. There are already strong links between the two companies, and they also have similar traditions and cultures. But until the trust is persuaded to sell all or part of its holding and invest the proceeds elsewhere, it is a non-starter.

In the meantime, Mr Stitzer is left with the challenge of improving margins over the next four years from the current 9 per cent average to a mid-teens target.

This was a big ask even when the commitment was made, and is an even tougher challenge now with fast-inflating raw material costs. In his conference call yesterday, Mr Stitzer said he had enough cost-cutting measures going on "to kill a horse". Never mind killing the old nag, what he really needs is for consumers to eat one, preferably of the cream filled, chocolate-coated, variety.

Pearl bids but still no Resolution in sight

What started out as a dull old insurance merger about as likely to set the pulse racing as a wet Sunday afternoon is turning into something of an epic. The original deal, a nil-premium merger between Resolution and Friends Provident, is presumably history, though neither party has yet given up hope and there is still support for it in some quarters of the City.

More certain still is that Hugh Osmond's Pearl, having swapped Standard Life for London Life as its partner, can't succeed with a bid for Resolution at just 660p a share. Nobody is going to sell to Pearl at 660p while they can sell in the market for 680p. Standard Life presumably couldn't bid on its own and is therefore out of the game. Swiss Re still hovers on the sidelines and may yet enter the field. Somebody else has been in the data-room, that's for sure. Whoever said insurance was boring.