Generations of European politicians dreamed of it. Armies of lawyers and bureaucrats spent years squabbling over the rules. But it has taken hedge funds to make it happen. Activist investors are changing the face of Europe, breaking down borders, building stronger companies, revitalising national economies and imposing their own rules of the game. Twenty-one years after the Single European Act and eight years after the introduction of the euro, the EU is finally delivering. And the eurocrats don't like it one little bit. In fact, they seemed determined to try to stop it.
What these European politicians can't stand is that they're not in control of the process. They got their first taste of how this brave new world might unfold two years ago, when a couple of hedge funds put the kybosh on Deutsche Brse's plans to buy the London Stock Exchange and forced its CEO out of his job. Then last year, hedge funds took on the French government and won over Arcelor, forcing the steel group to accept a bid from Lakshmi Mittal. This year, activists are on the rampage across the continent, demanding change and instilling terror in complacent boardrooms.
Backlash against hedge fund activists
A backlash against activists was bound to come and what has triggered it has been the battle for ABN Amro. A single letter to the board from Chris Hohn, the much-feared manager of The Children's Investment fund, put the firm in play. And ABN's attempt to salvage some degree of control over its destiny by tying up a cosy deal with Barclays boomeranged spectacularly when hedge funds successfully challenged the deal in court. Now ABN is the subject of a frenzied takeover battle between Barclays and a consortium led by Royal Bank of Scotland that will end in a carve-up. If that can happen to a company of the size and prestige of ABN, who is safe?
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No wonder hedge funds have shot up the political agenda. President Sarkozy made attacks on hedge funds a centrepiece of his campaign in last month's French elections. The Financial Services Authority, under intense pressure from other European countries, last week issued guidelines on how it would police activists, including rules to prevent them ganging up on boards. And Angela Merkel has gone so far as to put proposals for new controls on hedge funds near the top of her agenda for next month's G8 summit. "Don't be fooled," said a senior City figure involved in negotiations on these. "The politicians may claim they are worried about risks to the financial system. But all they really care about is activism. They hate seeing their big companies under attack."
Should the hedge-fund industry be worried? The answer is "not really", but it doesn't follow that the industry need not do anything to improve its standing. True, political efforts to put curbs on hedge-fund activities run up against the same old problems every time: what exactly can be done to stop them? They aren't doing anything illegal they are simply insisting on their rights under existing laws. How does one change the law without weakening rights for all shareholders? Politicians talk about the need for greater disclosure but what should they disclose, and to whom?
One idea is to force investors to disclose stakes of 1% or more, rather than 3% in many countries. But most hedge funds already conceal their stakes by trading in options and exchange-traded funds that don't have to be disclosed. Another plan, favoured by Merkel, is that funds should keep regulators informed of all their positions. But these positions change by the hour. Who on earth is going to sift through all this information? And what can they do with it? And who would pay for all the bureaucrats needed to take receipt of it? No wonder the UK and US killed Merkel's plans, leaving her to push lamely for a voluntary code of conduct.
Hedge funds need to manage their reputation
So hedge funds may not have much to fear from the current backlash, but they can't sit on their hands. As with the private-equity industry, they need to do more to explain themselves to the public. They may have supporters, but most people only see the huge amounts of money they make and assume it is mostly ill-gotten. If the industry allows attitudes to harden so that public opinion rallies behind beleaguered boards, it will become harder to drive change.
The answer for hedge funds is straight-forward. They should go to Merkel and offer to embrace her code of conduct. They should set up their own equivalent of private equity's Walker Commission to come up with guidelines. They should plough back some of their profits into good works. After all, Europe is a giant market with enough under-performing firm to keep activists busy for a decade. To allow such a huge opportunity to slip through their fingers for the sake of better PR would be careless. And if the result is healthier firms, more dynamic economies and the realisation of the dream of a genuine European market why, the politicians might one day even thank them.
Simon Nixon is executive editor of Breakingviews.com
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