Sony Kapoor Amsterdam

1. A few random thoughts on hedge funds, private equity, the financial system, tax justice & capital flight etc etc Sony Kapoor Amsterdam

2. The Context • Diamler Chrysler, Gilette & Hertz… • Calpers, Harvard, China & Dubai • Billion dollar earnings…….. • "remain anonymous, have no face, fall like a plague of locusts over our companies, devour everything, then fly on to the next one." • Etc etc etc….

3. The beasts… • Private Equity & Hedge Funds • The nature of the beasts….. • More than 1000 private equity deals worth almost $400 billion last year…now a $1 trillion war chest • Almost 9000 hedge funds with almost 2 trillion under investment.. • Large, not that large, but disproportionate influence….stock exchange, leverage, signalling impact…size of profits and returns, benchmark, regulatory and financial stability issues…

4. How Leverage Works… • 50 mill investment • 10% return • 5 mill profit and 10% profitability • 10 mill investment + 40 mill borrowing • 5% interest rate payable and 10% return • 5 mill return, 2 mill interest, 3 mill profit and 30% profitability….. • Multiplicative leverage….

5. Why the growth??? • Low interest rates… • Low risk premiums… • Regulatory Arbitrage… • Incentive Structures… • Greed is good... • Seeking returns…too much money…self fulfilling… • Tax havens, secrecy, tax leverage…etc… • Light touch regulation………

6. The world we live in • Inequality between nations rising • Inequality within nations rising – China, Malawi, Ecuador, Japan, US, EU • Inequality across people of the world highest ever – both wealth and Income • Almost 3 billion people less than $2 a day – almost half of that less than $1 a day - $13 bn Bonus • 0.1% - less than 300,000 richest Americans earn more than 25% - 1.5 bn of the poorest have more wealth than almost half the world • 70%-90% of wealth held by the richest 20% • The poor are financing the rich – US/ Capital Flight

7. Efficient Markets?

8. Random clips – the weak underbelly

9. Everybody loves anecdotes • Box: The Elite and Capital Flight • Raul Salinas, who was the brother of the late Mexican president, is 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. • 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 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 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 answered, ‘That’s what I was doing’. • “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 treasury. The remaining two came in equal halves from contracts that he put through his own shell companies and bribes from foreign contractors. Shortly after his death, his widow Mariam was stopped at Lagos airport trying to leave for Saudi Arabia carrying 38 suitcases filled with foreign currency. Reports vary on the amount involved, ranging from $50 million - $100 million. She said she was going to the Hajj”. (Robinson, 2004)

10. Haemorrhaging Money

11. Hedge Funds • At least 75% are located offshore…minimise tax liabilities, offer secrecy space and regulatory arbitrage.. • More than $11 trillion of assets located offshore …about $800 billion African… • Some invested in hedge funds… • Two tax aspects…Investor taxes due and manager taxes due…non trivial 2 by 20 to 4 by 30… • Most transactions are short-term, returns would be taxed as ordinary income. 40%-50%... – but even when you are onshore you can and do minimise the tax burden • You might own your hedge fund through a tax-exempt vehicle, or through an insurance wrapper. • A solution is an offshore hedge fund. Offshore, the income is treated as an equity interest

12. Hedge Funds contd… • A strategy involves private placement variable life insurance. Here, you actually own an insurance policy with sub-accounts invested in a hedge fund. The policy can be domestic or offshore. Insulated from tax on income.You can also defer the tax impact by taking the money, at some future date, by borrowing against the policy or drawing out the cash value as an annuity. Borrowing the proceeds are not treated as a distribution for tax purposes, further deferring the tax liability. • A more esoteric strategy involves buying the tracking stock of an offshore insurance company specifically formed to invest in hedge funds as part of the company's portfolio. Here the tax liability would belong to the company - if it were not in an offshore haven - and not to the individual share owner. • As an exit strategy you would simply sell the stock, converting what would otherwise be short-term gains into long. • Many wealth advisers also have proprietary strategies to mitigate the tax consequences of hedge funds. Typically, these strategies involve a marriage with another vehicle that can generate a tax loss.

13. Private Equity • “Any common sense person would say that a highly-paid private equity executive paying less tax than a cleaning lady or other low-paid workers, that can’t be right. . . I have not heard anyone give a clear explanation of why it is justified.” – Nicolas Ferguson • My own experience – LBO’s, leverage, Compensation, cost cutting….jobs…pension funds… • Negative redistribution in Private Equity – Inevitable?

14. Private Equity contd. • Privatizing gains, juggling profits around, the importance of leverage, past record – LBOs, the value of the taxes saved… • Two aspects – Company Taxes and Investor Taxes – Both Avoided • Company – leverage – interest tax deductible for all. Okish if interest income was retained and taxed– but crucial difference – payments go offshore – no withholding taxes for offhsore payments • US and UK and OECD – very worried about erosion of tax revenues…1 in 5 in the UK jobs…

15. Private equity contd… • Conversion of income taxes to capital gains…which is much lower…Non level playing field… • The “carried interest” problem –you own 1% of the fund, get 20% of its profits. The entire 20% profit share – and often some if not all of your 2% management fee as well – is taxed at the 15% capital gains tax rate now 10% in the UK after 2 years… • The public costs…The formula is simple: on average a fifth of jobs are cut and workers are paid £231 a year less than in publicly owned companies, while large tax breaks fatten profits.

16. Private equity contd… • Boots & 96 more pension funds in the UK alone collapsed due to private equity links, landing the taxpayer with the liability for bailing them out. • Other public costs…re IMF and FSA say private equity collapse is “inevitable”… • Irony - pension fund managers are being urged to invest more in pension-fund-destroying private equity • One study by Citigroup showed that if pension funds and insurance firms had borrowed money themselves and invested in a basket of companies in which private equity groups invested, they would have made higher returns than even the best-performing private equity firms.

17. For possible solutions….email Sony.Kapoor@gmail.com