Insights

Dollars and sense: Equity for private equity?
“The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing” Jean Baptiste Colbert

One policy choice may soon demonstrate whether post-Brexit Britain is set to hew closer to the US’ agenda or it will pursue the so-called ‘Singapore-upon-Thames’ model

It is a foregone conclusion that US President Joe Biden and the Democratic-held Congress will look to eliminate the carried-interest tax structure favoured by so many private equity firms. The position was endorsed by almost all major Democratic presidential candidates in 2019-2020 and it has repeatedly been suggested as a tool to help pay for recent infrastructure spending programmes. What may be more surprising is the amount of Republican support for such a move. While support is not as universal as on Congress’ left benches, ex-president Donald Trump campaigned on higher private equity taxes in 2016 and raised the bar for qualifying for such a tax in his 2017 tax reform., and again called for its elimination as recently as 2019.

The US, however, is not alone in allowing the general partners of investment funds to share in the gains of that fund, and pay tax on it as capital gains rather than as income. Britain has similar regulations, and with capital gains taxes for higher-rate tax payers set at 20% (28% for property investments) rather than the 40% income tax level for high-earners.

There have been occasional rumours that the Conservative government is considering raising the tax as well. The 2019 Conservative manifesto only pledged not to raise income tax, national insurance and VAT – and Chancellor Rishi Sunak’s March announcement that corporation tax will rise – undoing a decade of Conservative cuts – in response to the pandemic raising the spectre of private equity likewise being targeted.

The private equity industry has long sought to avoid taking its policy battles to the public, and to instead make its arguments persuasively directly to policy makers. Lobbying was crucial to getting higher carrier interest taxes removed from Trump’s 2017 tax reform, as acknowledged by Larry Kudlow, who would go on to head Trump’s National Economic Council. Yet Biden – and Trump’s continued rhetoric – shows it only slowed, rather than stemmed, the tide.

Private equity has proven a key investor in the UK, and its activity increased during the turbulent years after the 2016 Brexit referendum. The UK’s exit from the EU has made competition for the future of the services and financial sectors as sharp as ever, though many have seen New York as the real winner. The Biden Administration’s tax plans and continued US political tumult may put this in doubt, however. Meanwhile in the UK, Prime Minister Boris Johnson is in search of ways to demonstrate his support for traditional Conservative principles while shaking the party up with his so-far-successful ‘Northern Strategy’.

Private equity can fill these gaps by demonstrating its value to London, investment across the British economy, and to UK competitiveness. But it is a message that it must not just take to politicians, but through a pro-active communications agenda targeting both the public and the media, or otherwise risk repeating the scenario we see playing out today in Washington.

Power play: Gulf going green
“It was charged against me that the British petrol royalties in Mesopotamia were become dubious” T.E. Lawrence

The Gulf States are undoubtably concerned by the world’s major economies transitioning away from hydrocarbons, but the shift is already reshaping the region’s dynamics – and avenues for partnership, both commercial and political.

Some analysts suggest that we have already seen the peak of global oil demand, while even conservative estimates predict that demand will have peaked by 2030. Economies like Saudi Arabia and the UAE, which have historically relied on oil exports for revenue, are seeing this important revenue stream dry up – the Middle East is likely to see a 70% reduction of net oil and gas income by 2030. However, regional energy demand is set to double by 2040 – Gulf states are investing in renewables to ensure energy supply can keep up with demand.

These dynamics mean oil’s geopolitical role is changing. Oil’s historic role as a driver of allyship between the West and friendly Gulf states will diminish as Western states stop relying on them. Saudi Arabia and the UAE may decide that the likes of Russia and China – already a major supplier of solar panels to the region – make more worthwhile allies. This lack of interest in the West is already stoking greater competition between Gulf states. The recent OPEC spat is symptomatic of this. Rather than driving unity between the UAE and Saudi Arabia, oil is a rapidly shrinking pot. Oil-producing nations are seeking to maximise their own share at the expense of other members of the organisation.

Competition rather than cooperation will be the norm when it comes to resource politics in the Middle East. Qatar has already sought to establish itself as the region’s main player for natural gas, producing 178.1 billion cubic meters in 2019 compared to 23.7 in 2000. MENA states are making efforts to develop their renewable energy capacity, though currently only 11 per cent of the region’s electricity generation currently comes from low-carbon sources.

Huge expansion is planned as Saudi Arabia and the UAE recognise the need to competitively investing in domestic hydro and solar power projects. With a planned $100bn investment, Saudi Arabia has credible plans to increase its installed green capacity fivefold in the coming years. Many of these large-scale projects will be driven by state-owned firms and investment bodies, with companies owned by the likes of the PIF and Mubadala competing for tenders.

The interest in low-carbon energy projects in the Middle East will only increase as states’ efforts to ramp up energy production leads to aggressive investment and greater opportunities in renewable energy across the region.

Policy preview: No longer contained

“It is not the going out of port, but the coming in, that determines the success of a voyage.”

Henry Ward Beecher

This January, we wrote on the state of the global shipping industry and noting that the then-incoming Biden Administration was likely to take a negative view of the concentration of power among a small set of container shipping alliances that have been built up over the last decade. Container prices had already been steadily rising, but by June many benchmark prices had doubled, some even tripled. Though they have since retreated, container pricing has contributed significantly to higher-than-expected inflation indicators in Europe and the US.

This has escalated the urgency of the matter for the White House, as indicated by President Joe Biden’s 9 July Executive Order aimed at promoting competition in the US economy. The White House specifically noted the concentration of power among large container shipping firms and warned this risked “leaving domestic (US) manufacturers who need to export goods at these large foreign companies’ mercy.

The order only directly addresses this, however, by encouraging the Federal Maritime Commission “to ensure vigorous enforcement against shippers charging American exporters exorbitant charges”. The scope for US executive branch reproach is limited by the non-US domicile of major international shipping companies.

Nonetheless, we expect the US Department of Justice (DOJ) to announce a new investigation into the shipping industry – picking up the probe that it first launched in 2017 but dropped in 2019. However, the key US approach is likely to come via legislation, with Congressmen John Garamendi (D-CA) and Dusty Johnson (R-SD) leading bipartisan efforts to draft legislation on behalf of the House Transportation and Infrastructure Committee.

The key provision of the legislation is expected to seek to bar shippers from declining cargo bookings for exports – the rates for which are far-below those for US imports, which has led to many shippers even leaving American ports empty so as to faster reload for export to the US. Importers, however, will be weary that this will not lower their prices – and may even increase them.

Container prices will be a particular important feature of the economy not only for their impact on inflation, but will be further prioritised by policy makers as the diversification of supply chains to protect resiliency grows in the aftermath of the COVID-19 pandemic and amid ongoing global trade tensions. One area where a DOJ probe is likely to look – and legislators are expected to examine – is the relationship between container port terminal operators and shipping companies. Action to prompt diversification, and potentially even divestment, on this front should be expected.