Privatization is still keeping teams of lawyers from the largest US and UK law firms busy worldwide. Part of their battle when winning mandates is to make governments understand the fundamental role that lawyers play in ensuring the success of a transaction. “It’s no accident that the UK government almost invariably appointed the lawyers right at the start before any major privatization,” says Tim Clarke, the partner who heads the international privatization practice at Linklaters & Alliance. His firm has been involved in virtually all the UK’s major privatizations, commonly acting for the government.
Given the UK’s pioneering role in establishing the different privatization models, this has given Linklaters a head start – it has advised on more than 300 privatizations in 40-plus jurisdictions. But as Clarke is quick to point out: “Every privatization is different. Every country has to find its own way – compatible with its culture, history, traditions and legal system – to privatize. Lessons from one country may help in another and other people’s models may provide ideas. But simply following foreign examples will, most likely as not, end in failure,” he warns. However, privatizations have at least one common feature: the need to attract buyers or investors. “Privatization is about selling. The buyer will want to know what he is buying,” Clarke says.
This usually means that the industry in question has to be restructured to make it attractive to investors. This may begin as a reorganization, to separate the industrial activity from the rest of government, and so identify the revenue stream and cost basis attributable to it. This will usually lead to corporatization, under which informal trading arrangements – often with other public-sector entities – are formalised as arm’s length contractual relationships, ownership of particular assets is established and state guarantees are removed. The enterprise is turned into a company or companies whose shares are government-owned. Privatization then consists of selling those shares to the private sector.
The next step is to create a competitive environment. Though investors might prefer to buy a privatized monopoly, this is usually at odds with government aims that may include raising levels of service, driving down prices, modernizing the infrastructure, encouraging a market, developing skills and widening and deepening share ownership.
As Clarke says: “The greatest lesson to emerge from UK privatization is that you need to create competition.”
This occurs at two levels. The first is structural, by breaking up an industry into several undertakings. In the case of power this can include the creation of more than one generator and vesting the national transmission network and local distribution systems, operating at lower levels of pressure or power, in several entities. The transmission network can be granted common-carrier status, so it is accessible to all generators on equal, non-discriminatory terms. Regional distribution companies’ retail operations can be opened up to competition. “The recent international experience shows that it is possible, through restructuring, to introduce competition into the electricity sector, particularly on the generation side,” says Clarke. “Examples include Argentina, Australia, Hungary and New Zealand. Thailand and Korea look to be going the same way.”
The second level relates to the control and conduct of these entities in the private sector. The existing monopoly power or dominant position has to be controlled. “In addition to the continuing regulatory role retained by the existing competition authorities, it may be necessary to appoint an independent officer with specific powers and duties to carry out this task,” says Clarke.
All of this requires legal advice. As Clarke explains: “Restructuring an industry actually means creating a new one – at least where you are creating competition. You are creating a new market where none existed before. You are creating a network of relationships, on arm’s length terms, both between the new entities themselves and with their customers. Every aspect of that network involves a legal relationship and every one of those relationships has to be on terms that are acceptable not just to the parties in the industry but also to those who you want to invest in it. Regulation is part of this. Even when you are seeking to create competition, whether by encouraging new start-ups or by breaking up a previous monopoly, you will probably need regulation in the short term at least. There is probably only one sector so far where the importance of regulation may wane in time and that is telecommunications where the growth potential encourages competition on a major scale. Regulation is by definition a legal topic. It requires rules that are laid down and processes to enforce it. And it needs the ability to develop since the regulated industries will prove to be fleet of foot.”
There is a balance to be achieved between encouraging competition and making the sector attractive to investors. “Buyers look for transparency, bankability and stability,” says Clarke. “They will look for rights of recourse to protect their investment and to ensure there are no black holes or surprises.” Not surprisingly the lawyers play an active role in explaining the proposed legal structures to the international investment community.
Once an industry has been privatized, government may wish to retain a degree of control for instance through a golden share, which provides special rights of veto. “The golden share is an instrument of law,” says Clarke, “the rights of which government can enforce in the courts.” Where government retains a majority interest, investors will want protection from possible government action – ranging from dumping shares on the market to interfering in commercial decisions. “But government has to be sure that its wider social and political objectives are met. There is only one answer. There needs to be a legal mechanic that can be enforced in the courts to ensure that what is deliverable is delivered.”
All of this requires careful planning if government is to realize the best price commensurate with its wider goals. Earlier this year Clarke advised South Africa on the privatization of South African Airlines – a highly successful exercise conducted against criticism of the speed of the privatization programme in general. In fact the SAA privatization took just five years. “Margaret Thatcher, generally considered a lady of some forcefulness, announced that she intended to privatize British Airways in 1979,” says Clarke. “Even she did not achieve it until 1987.”
