Resilient Recovery

The British people should benefit directly from the government’s actions to help British companies recover from the crisis.


Economic recovery is at the heart of everything. Growth must be at the heart of the Government’s strategy over the next four years. Yet that recovery, and the success of British business, needs to be achieved in a way that allows ordinary British people to directly benefit in that success. We should:

A) Create a Recovery Fund to provide capital to British SMEs – and once recovery is complete, the fund should be floated on the London Stock Exchange.  We should issue shares in the Fund, at a heavy discount, to frontline NHS workers and people aged 18 – 30, in both respects targeted to those who earn less than £30,000[1].

Problem

After this crisis has passed, we will have an overleveraged British corporate sector, especially for those companies that received cheap debt via Coronavirus Business Interruption Loan Scheme (CBILS). These will delay a recovery – distressed firms tend to implement labour reductions, sell assets, reduce investments and employment, and shrink their business, and they become reluctant to raise new capital.

There will be three types of business. First, the business which is very profitable, solvent, well run and managed, and for which the COVID-19 lockdown was a very temporary blip. They will pay off their CBILS debt without difficulty. Secondly, there will be businesses which do not have viable business models after the crisis, and they will fail. Where the company is insolvent there will be a write off, shared between the government and the banks, depending on the terms of the scheme. 

Thirdly, there will be a category of business, possibly quite large, where the companies are solvent and had been trading profitably prior to the COVID-19 lockdown, but where the burden of servicing their COVID-induced debt burden will make it difficult, if not impossible, for them to regain their growth momentum. These businesses need to be re-capitalised. Listed companies have shown over the last couple of months that there is investor appetite to provide them with more equity through placings of new shares. But SMEs that are not listed are not able to access funding in this way. These are the companies the government can help.

How would it work?

The Government should set up a COVID Recovery Fund, with £15 billion of capital – borrowed by issuance of gilts. This fund would be administered by a new division of the British Business Bank (BBB), with oversight from HM Treasury. The BBB would not make investments directly into companies itself, and all business owners will have a choice as to whether to accept the funds. Its role would be to allocate money to a range of FCA-regulated fund managers around the UK who have investment teams already in place which are active in making investments into private companies, with the intention of achieving broad geographic and sectoral coverage, at a capped, reasonable cost to the Exchequer. The Government will not be “picking winners” itself – the investments will be made on a professional basis. 

An important aspect of this is the sheer scale of the exercise we would be considering. First, we would generally be thinking of companies of revenues in the region of £5m – £100m, of which there could be several tens of thousands who might be suitable for this sort of equity investment. Many are financed by closely held equity and branch bank lending; they have little or no contact with professional investors; and yet their resilience and prosperity is vital to local employment and to the health of the economy as a whole. 

To put together a fund like this would be a huge undertaking. It would take a significant amount of work, bankers, lawyers, accountants, and start-up funding. There would also have to be a technology platform developed, which would enable a major part of the preliminary work to be automated.    

The mandate of the Fund would be to make equity or quasi equity investments (some of which would be converted from debt, such as provided under the CBILS programme) into private companies that fulfil certain criteria:

  • The company is incorporated in Britain and the majority of its operations and revenue is produced in Britain.
  • The company is not quoted on any stock market.
  • The company was trading profitably in the year prior to the COVID-19 lockdown.
  • The company has the potential to grow and be successful in the long term if the debt burden can be reduced.
  • The company needs more equity for working capital in order to resume its growth, and to repay debt facilities (including CBILS) that the company has drawn down to survive the impact of COVID-19.

It is important that there is a cap on the amount each company can receive, so that the equity is distributed sufficiently amongst UK SMEs. The fund could be floated after three to four years on the London Stock Exchange. If so, the shares would be offered for sale at the time of flotation to the public as well as to institutions. Frontline NHS workers and people aged 18–30, in both respects targeted to those who earn less than £30,000, should be issued shares at a heavy discount.


B) Inject £6 billion into British SMEs without raising new money from public or private sector.

Problem

As described above, British companies will be heavily over-leveraged after this crisis. That will hinder their growth afterwards. We need to give them more capital, and make sure the British people benefit from their recovery.

In 2013, HMT made the decision to allow ISAs for the first time to be invested into businesses listed on AIM. This has been incredibly successful in providing those companies with long-term patient capital, and it has contributed to the success of AIM. While there is no data on the precise quantum, we estimate that £5-10 billion (out of a total Stocks and Shares ISA asset base of ~£300 billion) has been invested into AIM shares over the last seven years, providing very valuable capital for that market.

If changes to legislation encouraged just 2% of the total amount held in ISAs to be invested into private companies, that would result in a c.£6 billion boost to British SMEs.

How would it work?

We could allow up to 20% of an ISA pot to be invested in British private companies (with the safeguard that any such individual who wished to must have at least £5,000 in ISA funds).

Investors would only be able to deploy money via an FCA-regulated ISA manager, and those ISA managers would only be permitted to invest into private companies for investors who had either a) taken advice from an FCA regulated financial adviser as to whether it is appropriate for them to invest into unquoted companies, given their own personal financial circumstances or b) were able to pass a detailed suitability test.


C) The Bank of England should: set a nominal GDP level target.

Nominal GDP level target

Confidence needs to be restored. British consumers and businesses, and the international bond and equity markets, need to know that this Government is one with a long-term plan to deliver transformative economic growth. They also need to know that the Bank of England is going to bring its considerable expertise to that task as well. The inflation target was introduced in the 1990’s in reaction to a long period of high inflation that wreaked havoc on the British economy, but has suffered from an inability to “see through” changes in the price level caused by supply-side factors: for example, if prices rise because of a rise in energy costs, strict inflation targeting would require the Bank to tighten policy, even though this may be inappropriate and may exacerbate the hit to employment that the real shock has already caused.

Nominal GDP level targeting would mean the Bank of England instead using monetary policy to target an annual growth in the level of spending, or nominal GDP, across the economy. This would mean monetary policy taking on a more explicit role as an automatic stabiliser, with more inflation during recessions to offset contractions in real GDP growth, and less during economic booms. This would not change the Bank’s position as an independent monetary authority: it would just change its mandate in line with the 1997 reforms that made the Bank independent in the first place.

The GDP level targeting would still have regard to inflation – as it is important that the UK remains wary about a runaway rise in consumer inflation, despite it not being an issue in recent years. We run a large current account deficit, and were the international markets to adopt the view the UK is becoming lax about the potential impact of high inflation, our borrowing costs would sharply rise. Therefore, we should consider issuing more index-linked debt alongside GDP level targeting.

It is notable that the UK already issues more index lined debt (as a proportion of total debt issued) than most similar economies.  In the five years prior to 2018-19, index-linked gilts accounted for around 25% of the government’s annual debt issuance, for which both the principal and coupon payments are linked to the Retail Prices Index (RPI). More recently, this figure has been reduced. According to the latest debt management report issued by HM Treasury, the 2020-21 financing remit includes a 5.9 percentage point reduction in index-linked gilt issuance compared to 2019-20[2].  Alongside a policy of GDP level targeting, I believe we should rapidly increase that amount again.

The Treasury’s Debt Management Office would probably be cautious about making radical shifts in issuance strategy, lest we disrupt markets.  However, I agree with Creon Butler at Chatham House that “issuing index-linked debt hedges the government against the high degree of uncertainty over the future course of inflation”[3]. Regardless of one’s guess about the long term chance of high inflation or low inflation or even deflation (and there are experts on both sides of the issue), if a government issues index-linked debt, its real cost will be the same regardless of what happens to inflation.

Secondly, issuing large amounts of index-linked debt could help reinforce the message that the government and central bank intend to grow their way out of high debt levels over the long-term, rather than resorting to an inequitable and distortionary inflation shock to devalue nominal government debt. This is the primary aim of nominal GDP level targeting. The markets, international businesses, domestic business and consumers will all be very clear. Britain is going for growth.

As well as making clear that Britain is a growing economy, it is important to ensure that the growth we have is inclusive growth, spread to all regions and all areas of society. The government will have to ensure that these growth targets are backed by policies that level up under-developed areas of the United Kingdom and that opportunities are opened up so that all groups benefit from it.

In particular, the Government should support initiatives to improve the number of women and BME investors and asset managers, such as the Diversity Project. This area should be of particular focus because allocating capital is one of the most vital aspects of the economy, and where significant economic power is exercised. The Government should also work more closely with private sector organisations on how they help to create better career development and opportunities for women, those from BME backgrounds, and those from disadvantaged working class backgrounds.


[1] This is intended for nurses, doctors, and other frontline NHS staff; not managers.

[2] https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file  /871876/03032020_DMR_off-sen_v2_FINAL_with_jpegs_v2.pdf

[3] https://www.chathamhouse.org/expert/comment/covid-19-how-finance-debt

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