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Equity for private equity? Gulf going green and no longer contained

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.

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Monetary policy and the Treasury, trust and the Troika and spotlight on the Senate Parliamentarian

Policy preview: monetary policy and the Treasury
Indications of government policy do not always come from ministers briefing journalists or from whispers in Whitehall – occasionally they come via the civil service’s job board. To that effect, earlier this month HM Treasury posted a call for applicants for a new role as the department’s Head of Monetary Policy. While the posting may seem anodyne, it in fact raises serious question about how Prime Minister Boris Johnson and Chancellor of the Exchequer Rishi Sunak view the independence of the Bank of England.

Monetary policy is traditionally the remit of central banks. Economic orthodoxy for most of the last century has held that central banks’ ability to set monetary policy independently of the government is crucial to ensuring the long-term economic stability. The thinking has long been that if governments had the ability to set interest rates, they would be motivated to do so in a myopic manner designed to boost their electoral performances, such as by slashing interest rates to stimulate growth ahead of elections.

The breakdown in the relationship between unemployment, interest rates, and inflation – which has failed to run at an average of 2 percent or higher in developed economies despite over a decade of near-zero interest rates – has left many economists scratching their heads. However, so long as serious deflation is avoided, there are not many political opponents of low inflation. Yet concerns abound about how the poorly understood nature of this relationship is impacting monetary policy, most clearly evidenced by the conclusion issued by the Independent Evaluation Office on 13 January that the Bank of England did not have an explanation for how its quantitative easing policy worked, hindering its ability to build “public understanding and trust” in the programme.

Given the centrality of quantitative easing to not only the UK’s response to the COVID-19 pandemic and its economic impact but that of every other major central bank, renewing research efforts regarding monetary policy is indeed something that the Treasury and other Finance Ministries should prioritise. While the QE that followed the global financial crisis failed to result in inflation, the government has a responsibility to not just assume it will continue to have a non-inflationary impact.

The pandemic portends a crisis driven by a downturn in the real economy, whereas the post-2009 economic impact was demonstrative of the financial economy’s ability to precipitate a crisis in the real economy. Modelling how monetary policy may respond – in the face of renewed inflation or if it continues to remain absent – will be central to developing the government’s decision on whether austerity or continued deficit spending is preferable in the pandemic’s aftermath. The Bank of England’s independence will not go away, but with monetary policy to set to remain the driving tool in shaping the economy, the Treasury official tasked with interpreting its impact will prove extremely influential.

Dollars and sense: trust and the Troika
The global container shipping industry stands in a remarkably healthy position as the rollout of a number of vaccines means there is an end to the COVID-19 pandemic on the horizon. After being caught up in market turbulence as the virus spread across the world in the first quarter of 2020, shipping rates recovered substantially in the second half of 2020. As an billions faced unprecedented lockdowns, one common theme emerged – they still wanted to consume even if they could not venture out or splurge on services.

The resulting demand has proven a boon to the shipping industry, which had faced a torrid decade in the aftermath of the global financial crisis. Global trade peaked as a share of GDP in 2008 and has not recovered even as the world appeared to have put the worst impacts of the global financial crisis behind it before the pandemic and the industry was hampered by overinvestment on extremely large container ships that proved less adaptable to the new economic paradigms that emerged. Dozens of major businesses filed for bankruptcy, leading to industry-wide consolidation.

Some 85 percent of global container shipping is now controlled by three shipping alliances. Maersk and Mediterranean Shipping operate an alliance responsible for roughly one-third of container shipping. China Ocean Shipping Company, France’s CMA CGM and Taiwan’s Evergreen make up another alliance, responsible for nearly another third. The tie-up between Hapag-Lloyd and Ocean Network Express, Yang Min and Hyundai Merchant Marine controls another 20 percent.

If the promise of vaccines bears fruit, these firms stand to benefit further. Little new investment into container shipping has been made from outside these alliances as financing has proven hard to come by and the capacity glut caused by the long time-horizon of ship-construction has only begun to fade away.

Meanwhile the demand for shipping is likely to grow further as manufacturers seek to prioritise optionality, constructing multiple supply chains to hedge against the risk of further trade wars. While such a scenario should spell a return to boon times for the industry, the sector’s consolidation raises the spectre of renewed scrutiny.

In 2017, the US Department of Justice launched an antitrust probe into the global shipping industry. It quietly dropped the investigation in 2019, a result of political pressure and concerns that action could further strain the impact of trade tensions. While such a new probe is not likely until the pandemic is in the rear-view mirror, expect regulators in Washington and elsewhere to re-examine the industry’s competitiveness over the coming years.

Power play: spotlight on the Senate Parliamentarian

The post of US Senate Parliamentarian rarely garners significant attention. The officeholder’s role is to interpret the Senate’s own standing rules as well as its ethics and practices. Only six people have held the post since it was introduced in 1935. The incumbent, Eizabeth MacDonough, has held the post since 2012 when she replaced Alan Frumin, under whom she had previously served as senior assistant parliamentarian. The 50-50 divide between seats held by Republicans and those held by Democrats in the Senate, however, will see the role take on a significance not seen in the 20 years at least until the 2022 midterm elections.

MacDonough is not seen as party-political. Appointed by then-Senate Majority Leader Harry Reid, a Democrat, she was retained in the post by Mitch McConnell after Republicans took the Senate majority in 2014.

MacDonough may have successfully navigated the increasingly poisonous political environment in the Senate in recent years, but her largest challenges are still to come. Perhaps the parliamentarians’ most influential role relates to the interpretation of the so-called Byrd Rule, a longstanding Senate convention that allows certain bills to be approved by a simple majority rather than the 60-vote threshold required to overcome a single senator’s filibuster. Legislation is only eligible for passage under the simple majority if its primary impact is on government outlays, typically over the next ten years, rather than policy.

MacDonough faced a handful of rebukes from those on the Republican party’s right wing in recent years as they sought to repeal the Affordable Care Act through such a simple majority, which she ruled against. However, the ruling that most portends events in the coming Congress was the approval, then denial, of a motion brought by Republican Senator Josh Hawley last June. She initially ruled in favour of a move that he had brought requiring a Senate vote on withdrawing from the World Trade Organzation last June, although it rested on a technicality. Yet two weeks later she reversed her position, after the senior Republican and Democratic Senators on the Senate Finance Committee shared a new analysis of the move.

Hawley has since become a household name in the past month for his vocal endorsement of attempts to stop the certification of Joe Biden’s win in the November 2020 election. He has refused to apologise for his perceived role in fomenting unrest at the Capitol on 6 January, having welcomed the crowd as it gathered outside Congress. Hawley and his allies are likely to further seek to challenge the Senate’s established practices, and potentially seek to politicise the parliamentarian’s role. The fact Democrats lack a substantive majority, relying on incoming Vice President Kamala Harris, to serve as the tie-breaker will only heighten the importance of MacDonough’s interpretations of the Byrd rule and other Senate procedures.

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