Sorry Sid

Three years on, and the mood has shifted dramatically. An unconvincing Conservative election victory in June 2017, and the protracted uncertainty of the Brexit process, have significantly raised the prospects of a Labour government. Polling data puts a Corbyn-led Labour neck and neck with the Tories.

Many, particularly among the wealthiest members of the electorate, are running scared. A recent survey by wealth manager Saunderson House revealed that high-net-worth individuals’ greatest concern for their finances was the prospect of a change in government.  A total of 42 per cent of respondents listed the change as their biggest fear, well ahead of a collapse in the UK property market (26 per cent) or geopolitical instability (30 per cent). Some respondents cited worries over “Argentine-style savings raids” which might accompany a radical change in the tax landscape.

“Every meeting we have with clients now, it’s front and centre,” said Gareth Parsons, financial planning director at Saunderson House.

While the future tax landscape is unclear, Labour’s plans for renationalisation are far more certain, even if (like all political programmes) they do leave some room for flexibility. Following the party’s summer conference, it published an outline of its plans to renationalise the water industry, drastically cut pay for directors and senior executives, and remodel nationalised companies after Transport for London. Three decades after the ‘Tell Sid’ advertising campaign urged retail investors to buy into the privatisation of British Gas, the whispers among many investors may soon be whether to sell out now, before being forced to sell for a knock-down price.

Could these fears be justified? In part. While a land value tax proposed in the 2017 manifesto will only apply to “non-resident properties”, and Mr Corbyn and shadow chancellor John McDonnell are yet to set out plans for a wealth tax, the 10 per cent employee ownership plan offered at the most recent Labour conference could amount to a massive corporate levy.

The next election is not scheduled until 2022, so it would be easy for investors to dismiss the still largely unknown risks a Labour government might present. However, the uncertainty surrounding the Brexit negotiations has raised the political stakes, and the result is an environment seemingly more susceptible to surprises.

If whatever deal Theresa May strikes with the European Union is voted down by Parliament, the door could be thrown open to another election, just as there’s a further public swing against the Conservatives. In this sense, the likelihood of a Labour government lies more in the hands of the current government’s performance on Brexit than it does with Mr Corbyn or his team.  

That’s not to discount Labour’s popularity on its own terms. Mr Corbyn remains the bookmakers’ favourite to be the next prime minister and support for some of the party’s policies is high. YouGov polling on nationalisation versus privatisation shows overwhelming public support for public ownership of Royal Mail (RMG), railways, buses, water and energy companies.

In all likelihood, the election of a Labour government would lead to a radical overhaul of the business and investment landscape in the UK. Many of these changes – such as potential taxes on wealth and nationalisation – are a source of uncertainty. In this article, we assess the risks posed by each of Labour’s main stated and potential policies, alongside the actions investors can take to mitigate or even benefit from them.

A YouGov poll shows overwhelming public support for public ownership of Royal Mail

Equity for workers

It’s not just investors in utility providers who should weigh up the potential impact of Labour policy. Last month, Mr McDonnell sparked fevered debate either side of the political aisle after announcing proposals for companies to set up “inclusive ownership funds”. Under the policy, companies with more than 250 employees would be required to set aside 10 per cent of their equity for workers. These shares would then entitle workers to shareholder voting rights and dividends up to a maximum of £500 per person annually, with the remaining dividends going to the Treasury.

The thinking behind the policy is twofold: that greater employee ownership “increases a company’s productivity and encourages long-term decision making”, while providing a “social dividend” for investment in public services and social security. It was the latter point that led some to brand the policy a tax plan, noting that in many cases the Treasury would benefit more from the policy than employees. Take water giant Pennon (PNN). Under the proposal, each of its 5,000 employees would get £500 in dividends, for a total of £2.5m. However, the total dividends paid by the company in 2018 was £162m, so a 10 per cent ownership stake would divert £13.7m to the Treasury. Clearly, shareholders would take a hit.

Paul Mumford, fund manager at Cavendish, said the policy was “illegal and impractical”, adding that it would probably require a change in the law to implement. However, he also noted that measures to improve employee and shareholder engagement were potentially positive for companies as, because “the workers know a company better than the shareholders do, you might get some constructive ideas”. Companies should be encouraged to have a healthy dialogue with all of their shareholders, he added.

In an interview since the conference, Mr McDonnell played down the party’s commitment to the policy, saying it was open to hearing alternative suggestions. At this stage, the policy’s future is far from certain, so investors should hold off on taking action.

Nationalisation: an unknown cost

Aside from the prospect of higher rates of tax on incomes over £80,000 per year, the most profound threat a Labour government might pose to investors is a set of proposals to renationalise the railway companies, Royal Mail and the water and energy sectors. What’s more, the policy appears to have broad public support.

The original thinking behind privatisation was that the potential for outperformance would bring competition, innovation and growth to public sectors seen as sclerotic and inefficient. However, the perception has started to turn in recent years, and many now argue that misaligned incentives drive companies to prioritise shareholder returns above service to consumers or financial sustainability.

Indeed, ‘Alternative Models of Ownership’ a paper commissioned by the shadow cabinet, reported that increased reliance on private ownership had led to “a lack of long-term investment and declining rates of productivity, undermined democracy, left regions of the country economically forgotten and contributed to increasing levels [of] inequality and financial insecurity”.

Such claims, originating from a party advocating renationalisation, is open to accusations of bias. But criticism of private utility ownership has come from other directions, too. Earlier this year, then-environment secretary Michael Gove attacked the water companies for their use of offshore tax structures, urging them to “behave in a responsible fashion”.

For investors, however, the most important consideration is likely to be compensation, should Labour follow through on its promise. Despite, or perhaps because of, the sheer scale of change nationalisation would foster, research into the potential cost points to wildly different sums.

A generation ago, this would have been unthinkable. The fate of the privatised public industries looked to be sealed when Tony Blair scrapped Labour’s constitutional commitment to nationalisation in 1995. However, under Mr Corbyn the debate has reversed.

Water companies have been a particular source of ire, fuelled by research from the Universities of London and Greenwich claiming £18.1bn of the £18.8bn in post-tax profits made by the UK regional water and sewerage companies over the past decade have been paid out in dividends. Further research from the Public Services International Research Unit in September concluded that the privatised water industry’s “accelerating debt levels” and “disproportionate dividend payouts” over the past 30 years “may no longer be sustainable”.

However, small state advocate the Centre for Policy Studies argues the companies have upgraded infrastructure and improved service. The conservative think-tank also notes that customers are now five times less likely to experience unplanned supply interruptions than in 1989, while leakage has reduced by a third.

Even so, the majority of people seem to support nationalisation, regardless of where they sit on the political spectrum. Research from the Legatum Institute last year showed support among Conservative voters for nationalising rail, water electricity and gas was between 65 and 76 per cent.

It’s doubtful that typically right-leaning voters would opt for Mr Corbyn on the basis of one policy, but with the seemingly broad-based support it is unlikely Labour would drop the policy if it came to power. “A Corbyn-led government is a significant possibility following the next election,” says Andrew Millington, head of UK equities at Aberdeen Standard. “Given that nationalisation of utilities, in particular, is likely to be a key policy in the Labour manifesto, it would be difficult for moderate Labour MPs to vote against it.”

However, while it may be easy to claim to support renationalisation if you are a frustrated commuter, or are overpaying for energy, the question of how companies would be brought back into public hands – and what compensation investors could expect – is a far more complex issue.

Mr McDonnell has long said the price would be set by Parliament, in line with the legal precedent confirmed in 2012 by the UK Court of Appeal and European Court of Human Rights, when Northern Rock was rescued in 2008. The government took ownership of the bank rather than let it enter insolvency, awarding shareholders no compensation. However, while the legal framework is in place, the likely targets for nationalisation are far healthier financially, and it is difficult to imagine anyone arguing that shareholders of utility companies or energy suppliers should receive nothing in return for their shares.

One possibility is an equity-for-debt swap. A recent Labour statement on water utilities nationalisation said existing shareholders would be compensated for their shares with bonds, and that Parliament “may seek to make deductions” on the price paid based on pension fund deficits and asset stripping and state subsidies since privatisation.

This policy seems to put paid to the idea that any acquisitions would be based on market capitalisation. Other commonly-used methods for assessing the cost of nationalisation are the enterprise value and shareholder equity value of the companies. However, using either of these measures produces a wildly different price.

The Centre for Policy Studies estimated the cost of nationalisation could reach £176bn, although it based this on the cost of just the energy transmission and distribution networks, not the supply. Add in supply, and the think-tank reckons the price of the energy sector alone would rise to around £185bn, from £55.4bn otherwise.

Cost of nationalisation

By contrast, the rail lines could be nationalised by simply taking the franchises back into public ownership as they expire, limiting the government’s expenditure to the cost of rolling stock. However, many of the rail franchises expire in different parliamentary terms, and so would face the risk of a subsequent government abandoning the policy at a later date.

For all the talk of Parliament deciding the price for nationalised assets, “fair compensation” is complicated by the type of owner. Besides individual investors, UK pension funds are massive holders in formerly public sector companies. For example, Anglian Water has £1.3bn in committed funds from GLIL Infrastructure, a fund founded by five UK council pension funds including Greater Manchester, Merseyside and West Yorkshire. What’s more, foreign governments also hold significant stakes, and ‘big six’ energy supplier EDF energy is a subsidiary of Électricité de France, in which the French state holds an 83.5 per cent stake. Foreign powers are unlikely to roll over and accept the seizure of assets below their true value. The spectre of arbitration or diplomatic collateral loom.

The risks of nationalisation on the cheap therefore seem potentially higher than paying out the market rate. Aberdeen Standard has estimated a fair amount for the water companies would likely be “the best part of £100bn”. Labour has said it would fund the purchases through debt, which Mr Millington noted “is cheap today but may not be so cheap in that circumstance”.

Regardless of the likelihood of renationalisation, its reintroduction into the public debate has spurred government and regulators to prove their effectiveness at marshalling once public industry. Since Mr Corbyn was elected leader of the Labour party, the Conservative government has adopted – if only temporarily – an energy price cap previously proposed by former Labour leader Ed Miliband, while water regulator Ofwat has announced changes for the upcoming regulatory cycle that “would see customers share the financial gains made by water companies which have high levels of debt”.

Impact on foreign investment

While foreign ownership of UK plc could be one direct complication of nationalisation, the prospect of reduced foreign and private investment is potentially far more damaging. Labour has proposed a £250bn ‘National Transformation Fund’ to be spent on infrastructure over 10 years. Although considerable, this is a fraction of the £600bn currently in the National Infrastructure Pipeline for the next 10 years. What’s more, more than 45 per cent of the roughly £245bn planned from 2017-18 to 2020-21 is funded by the private sector, which could come under threat given the Labour party’s opposition to the private finance initiative (PFI) and public-private partnerships (PPP).

Clearly, this raises the stakes for a Labour government to pay a fair price for nationalised assets. Professor Brian Scott-Quinn of Henley Business School said: “You’re not going to get anyone investing in Britain’s infrastructure again because they’ll be scared it’ll be expropriated”.

Mr Millington concurs. “The UK has benefited hugely over the last generation or so from being seen as an attractive place to do business,” he said, adding that anything seen as challenging private property rights would undermine a business-friendly perception and dent foreign investors’ willingness to invest in the UK.

It’s too soon to act on tax

Apart from the nationalisation threat, investors are concerned about higher taxes under a Labour government. The party’s manifesto pledged 95 per cent of taxpayers would not face tax rises, with increases applying only to those earning more than £80,000 annually. In an interview with the Financial Times, Mr McDonnell said Labour had no plans for any form of wealth tax “at present”. When Investors Chronicle approached Labour for comment, a spokesperson did not give any further detail.

Some are taking the lack of detail on Labour’s tax plans as an ominous sign. The party has not laid out any plans for a wealth tax or changes to capital gains, but this has not lessened the belief that they might be introduced.

George Bull, senior tax partner at RSM UK, says his clients are more concerned about Labour’s plans than they were about Brexit, and that many have been taking steps to lessen the impact should wealth taxes be introduced. “The assumption is that at some point following a Labour victory there would be a wealth tax,” said Mr Bull.

However, the lack of certainty is leading individuals to act preemptively based on fear and speculation, he warned, taking steps such as borrowing against assets to drive down their net asset values, an approach sometimes used to reduce inheritance tax liabilities. However, with no guarantee any tax will materialise, nor any knowledge of what one might look like, investors are left in the dark. “I would urge people not to act in haste now,” Mr Bull said. “Better to act when the time comes”.

Bull he added that while fears of a wealth tax were common, there was “far less consensus” when it came to capital gains, which could affect all dividend-earners. Also, while increases to taxes on those earning over £80,000 a year were “a given”, very little is known about the rate structures.

More broadly, the professional consensus seems to be that a Labour government is likely to introduce wealth taxes, but that unlike equity markets, acting fast may not always be curative. Investors would be better off waiting until there is some clarity on what form these might take – if they happen at all – before taking action.

Wider market impact

Beyond the impact of tax changes, Mr Parsons said clients were frequently concerned about the broader market impact of a Corbyn premiership, with the common belief being that it would have a detrimental effect on asset values. Should Labour get in under Corbyn, sterling is widely expected to fall.

In addition, it seems likely that a higher corporation tax and minimum wage will erode profitability in UK companies. However, there’s a way to address this concern in the same way as other fears about UK markets – by merely diversifying into overseas equities.

“It’s about having diversification in terms of the investment wrappers they have and diversifying the way they receive income,” says Mr Parsons.

All in all, Mr Parsons said, it is too early for investors to panic. Investors Chronicle economist Chris Dillow concurs, adding much of the fear of a Corbyn government is overblown. Labour’s policies do not quite match their rhetoric, thinks Chris, who sees Labour’s proposals for looser fiscal policy and nationalisation as “pretty much standard European-style social democracy”.

“The people who think it’s going to be a disaster are imputing their personal antipathy towards Labour to what they expect markets to do.” Indeed, a level head is an important tool for every investor.