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The globalisation of finance is forcing a new world order and countries need to wake up to this new reality.

The private equity model is not new and has been around for 40-50 years. Private equity includes a spectrum of investments from venture capital to financing a start-up. There are funds which like to enter a business at a later stage of its growth. This can be done through buyouts or acquisitions of an established business. Though there are differences in the way private equity funds operate, the end goal of all these ventures remains the same value creation.

While private equity has been around for almost half a century it has really come into its own in the last 15-20 years. The headline breakthrough in this arena was the Kohlberg Kravis Roberts (KKR) buyout of RJR Nabisco in 1988 for US$25bn. This was the second largest leveraged buyout in history and has been surpassed by the announced 2007 buyout of TXU, an energy company, valued at US$45bn, also led by KKR. It was the first time that a private equity fund was taking a marquee name and buying out the company. KKR then used the assets of RJR Nabisco as leverage to raise capital. The buyout also saw the fund working closely with the management of the company to create value and then exited the business. The latter can be done either by a public listing or a trade buyout. The KKR-RJR Nabisco has since become the dominant model in the private equity space.

The private equity cult spread geographically across the world from the US, first as venture capital investments and then as outright buyouts. In Europe it caught up first in England, the second-most mature financial market, and then spread to other parts. Scandinavian countries have been a hotbed of venture capital as a number of technology based companies like Nokia and Ericsson started there. The private equity cult is slowly catching up in Asia. Though we have still not seen large-scale buyouts happening as yet it is just a matter of time before it becomes big. For example, India is expected to attract US$13-14bn in FDI in 2007, half of which will be in the form of private equity. In 2006 private equity funds invested US$3.5bn in India. A large part of this was invested in family-owned businesses as expansion finance.

Holding companies have existed in the US since the 1970s. A holding company owns different types of industrial investments. For example, Berkshire Hathaway has interests in portfolio management, insurance etc. Compared to holding companies the private equity structure is more institutionalised as it sees participation from banks, pension funds et al through a partnership agreement. The norm is to work out ten-year (plus one or two years) agreements. Typically, the first four to five years are the investment phase and the next five years is used to divest the business so that the stakeholders get back their money along with a profit. Secondly, in a holding company the assets are held on for many years. If you look at the books of Berkshire Hathaway, there are investments in companies like Coca Cola that have been sitting on their books for decades.

Globalisation of finance

World over, markets are seeing an increasing globalisation of finance and countries are witnessing an attendant free flow of capital. A number of countries which had restrictions on their financial markets are bringing down barriers to attract capital. The globalisation of exchanges is a manifestation of the trend Borse Dubai acquired a 20 per cent stake in Nasdaq and a stake in the London Stock Exchange, Nasdaq on its part has taken a stake in Sweden's OMX AB. The New York Stock Exchange had earlier acquired the Paris based Euronext. In such a globalised environment, capital will flow freely to countries where it can get the highest returns and where it is used most efficiently.

The huge wealth being created in the Middle East (ME) and Asia is the other factor, which is changing the contours of global finance. With oil prices hovering over US$80 per barrel, countries in the ME like the UAE, Qatar and Saudi Arabia are sitting on huge piles of petrodollars. In Asia, China has foreign currency reserves of US$1.3tn and India, because of its incredible domestic growth, has built up formidable reserves. As a result of this there has been a significant shift money is being generated in certain parts of the world which have traditionally not had such amounts of wealth. Most of this shift has been happening under the radar.

This has put large sums of wealth in the hands of sovereign institutions. Abu Dhabi Investment Authority (ADIA) is estimated to manage US$1.3bn. Temasek of Singapore manages a portfolio of over US$100bn. Qatar Investment Authority is sitting on hundreds of billions of dollars. China has set up a US$200bn investment fund recently. The fund made its first investment in the US-based private equity fund Blackstone.

Traditionally, private equity has been private in the real sense of the term. It was handled by a small team who did things discreetly. With sovereign players entering the realm of private equity, the repercussions are going to be multifold. One, the size of investments is going to increase astronomically. Two, investments by sovereign entities may lead to increased friction. We are already seeing some of this happening. Last year Dubai Ports Worlds was forced to sell its rights over six major US ports that it acquired as part of a deal to take over the London-based Peninsular and Oriental Steam Navigation Company. Since a private equity player has a significant influence on the management of a company there is bound to be greater sensitivity when that is a government controlled entity.

Regional capital market

The ME markets still do not have the same level of maturity as some of the developed markets but there have been some big changes in the region in the last two years. Dubai International Financial Exchange (DIFX) opened in September 2005 with the intention of becoming a regional exchange. Another reason holding back the development of capital markets was that most of the growth in the region was driven by bank-led finance. Most family owned businesses were able to raise adequate capital from banks but as competition from global players intensifies there will be a need for better financial sourcing. The advantage of being a newcomer is that it can learn from the success and failures of others.

Saudi Arabia, Kuwait and Dubai are the biggest markets in the region. And these bigger markets are looking at attracting companies from other countries. With a lot of cash chasing a few investment options the valuations of deals have shot up. If the region is unable to absorb the available capital it will move into new markets like India, Turkey or to traditional equity markets like North America.

Talking about best practices, technology plays a big part. India has invested a lot in making its markets technologically competitive. Countries also need to strike the right balance between a good regulatory regime and an overbearing one. There has also been a trend towards developing alternative markets in the same country. Alternative International Market (AIM) in London has companies listed on it from all over the world in an effort to raise capital. Countries in the region can learn from these examples as they move ahead. (As told to Mayank Singh)

Vijai Gill is CEO, Oman Investment Fund