FSA alarmed by leverage in buyouts

The City watchdog yesterday voiced fresh concern about potential market abuse by private equity firms and the "excessive level" of borrowing they use to buy out public companies.

In a report released just a day before the Treasury Select Committee begins an inquiry into the increasingly controversial industry, the Financial Services Authority said it believed its statutory objectives were at risk from both.

But it stopped short of imposing new rules, preferring instead to increase the supervision of private equity companies and the banks that lend to them.

Yesterday's report said: "This risk of market abuse presents significant detriment to our statutory objectives with respect to the prevention of financial, consumer protection and, if not mitigated, overall market confidence." The watchdog ordered firms to "demonstrate a clear understanding of their regulatory obligations". Heavy fines could be the result if they fail.

The regulator has become increasingly concerned that the sheer number of people and organisations involved in ever larger private equity deals inevitably means that privileged information is leaking out. The regulator also rejected arguments from private equity firms that its concern over "excessive" levels of debt used to finance private equity deals was misplaced and that use of the term excessive was alarmist.

It said: "We maintain a risk exists that leverage [debt levels] in individual transactions increases to excessive levels, making the financial viability of the underlying firms unsustainable. As we highlighted ... this makes the default of a large private equity backed company or a cluster of private equity backed companies seem inevitable.

"This has the potential to create market instability and presents risk to our statutory objective to promote market confidence. We therefore consider this risk to be appropriately titled."

Because of its concern, private equity firms will have to provide more information on their borrowing, while banks face a review of their exposure to private equity deals every two years.

The FSA will also chair a private equity task force to further examine developments in the industry being set up by the International Organisation of Securities Commissions (IOSCO).

FSA's managing director of wholesale business, Hector Sants, said he wanted to be sure the oversight of the private equity industry remained "highly focused" on these key issues.

However, the industry was breathing a sigh of relief last night that the regulator had not opted for tougher controls before what is expected to be a bruising hearing of the Select Committee today. The committee's interest has been sparked by mounting controversy over the activities of private equity firms. This has been heightened by the buyout of high street names such as Alliance Boots and the AA.

Unions have been vocal, accusing private equity firms of "asset stripping" and claiming that workers suffer from lay-offs and reductions in terms and conditions following buyouts. Consumer groups have voiced concern at service levels. Last week the UNI union federation unveiled plans to fight private equity bids in Japan. And the TUC is expected to have harsh words when general secretary Brendan Barber appears before the committee tomorrow.

However, John Moulton, head of Alchemy Partners, has defended the industry, saying companies owned by private equity funds create more jobs than public companies and are often better run. He said it was unfair to paint all private equity in a bad light, saying there was good and bad in the industry just as there were good and bad public companies.