Privatization in the 1980s was characterized by the initial public offering (IPO) with a simultaneous listing on several stock exchanges worldwide. The privatization of British Telecommunications (BT) in 1984 was held up as the classic IPO.
Privatization in the 1990s has broadened, with a wider array of legal techniques employed. Two variants are the trade sale and the voucher scheme. The trade sale suits the disposal of well-established state-owned entities which are sufficiently small and specialist not to merit an IPO. It is characteristic of the second wave of privatizations in the west. The voucher scheme is used in developing markets such as central and eastern Europe where there is an insufficiently developed market economy to make an IPO possible.
Lawyers play a crucial role in establishing the structure best suited to avoiding possible conflicts with the privatizing state’s policy objectives. The state’s reasons for privatizing may include raising money for the government, attracting new investment into the sector, introducing profit motivation into business as a matter of principle and increasing consumer benefit through competition.
These objectives can conflict. “For example, if you introduce competition into a sector, you may reduce what a buyer will pay for what was a monopoly,” says Patrick Wallace, a partner at Freshfields, a leading law firm for privatizations internationally. “If you introduce unmodified private-sector disciplines, you can sometimes put consumer prices up where cross-subsidies have been encouraged for social-policy reasons.” In the latter case, an unprofitable service can be transferred to the private sector along with a government grant which covers the additional cost of providing the required service. The bidder prepared to provide the service for the lowest subsidy wins the tender.
A similar approach was used in the privatization of the UK electricity industry. The government wanted, as a matter of policy, to foster renewable and nuclear energy sources. Since electricity is relatively expensive to produce using these generation methods, suppliers using them might not have survived in the new free market. “This policy conflict was successfully avoided by careful choice of privatization structure,” says Wallace, whose firm advised PowerGen and Scottish Power during the restructuring and subsequent privatization of the UK electricity industry. “As part of the privatization, legislation required all electricity producers to charge a levy on customers and pay it to approved producers of nuclear and renewable electricity. The sort of cross-subsidy which used to exist in the state sector was preserved but in a way which was operationally compatible with the free market which was introduced.”
An ongoing example of the trade sale is port privatization. There are over a thousand ports worldwide gradually being pushed into private management or ownership. Developing countries see port privatization as a way of attracting investment to facilities whose modernization will contribute to their economies by increasing trade. Privatization may stop short of outright disposal. Commercialization is a process involving private-sector participation in port operations – by bringing in a management company, for example. Full privatization – transferring a port’s assets and liabilities to a new corporate vehicle which is then sold – is likely to be favoured by interested privatesector acquirers because ports come with substantial landholdings which can be used for development purposes and as security for the financing.
The complications lie in preserving for the state a measure of control. In the classic IPO model this was achieved by reserving for the state a golden share which effectively gave it sufficient voting strength to block any fundamental shift in the newly privatized entity’s business. In the case of ports, the state may want control over future disposals of port assets in order to ensure that the port will be properly maintained and statutory obligations (for instance to maintain the harbour approaches, to regulate ship movements within the harbour and to offer cargo-handling services) will be discharged. Specific legislation may be required to facilitate the transfer. The state has to be sure that if the new owner defaults in any of these duties, it can step in.
This right of re-acquisition has to be squared with the interests of the financing banks, although one risk – renationalization – can never be excluded. Crucial to the port’s viability will be the amount that the new owner can charge users. “The state will want to ensure that its port continues to be attractive to international trade so, to avoid overpricing, the state may regulate the amount of port dues which a buyer can charge port users,” says Christoper Tite, a partner at Stephenson Harwood, who has advised on port privatizations internationally.
If the trade sale is an emanation of good old-fashioned M&A, the voucher scheme has its roots in investment management. In Poland, a mass-privatization programme involving 400-odd companies was implemented in mid-1995. The model adopted was that of the typical institutional investor, which has a handful of large core holdings and a larger number of smaller ones. In Poland, 15 national investment funds (NIFs) were created, each managed by a local fund manager in partnership with a western bank or investment management company. Each of the 400 companies has one NIF as principal shareholder with 30%, the state holds 30% and the remaining 40% is distributed amongst the other NIFs.
In this way each NIF has a small number of core shareholdings which it is expected to actively manage. In order to create ownership, each of Poland’s 27 million adults was given the right to buy a voucher from savings bank PKO/BP. The voucher entitles the holder to a share in each of the NIFs. Until NIFs become listed, these shares remain illiquid. NIFs do not themselves have capital to inject into their investments, hence the tag “nominal privatization” used to describe this technique of removing com-panies from state control without a fresh injection of capital. Fund managers can overcome this by raising capital internationally and setting up parallel cash funds which can take up new issues of equity by the companies that the NIFs are unable to through lack of capital.
Ironically, privatization can provide lawyers with new areas of specialization. One such is telecoms law, spurred on by BT’s privatization. State telecoms operators are what economists call “natural monopolies”. Once a fixed network is in place, it makes no sense for a competitor new to the market to try to build a rival one. For lawyers the challenge lies in constructing a regulatory regime to ensure a level playing field. This is one of the reasons for the present wrangling between BT and the FINANCIAL LAWYER’s telecoms watchdog, Oftel, with – no surprise – lawyers ever present behind the scenes.
