Considered in Grand Committee
My Lords, these regulations amend the Open-Ended Investment Companies Regulations 2001 to introduce a protected cell regime for open-ended investment companies, or OEICs. They will ensure the segregation of liabilities of different sub-funds held under the same OEIC umbrella company so that investors in one sub-fund will not be liable to creditors in the event of another sub-fund failing.
I would like first to give a little background on why this legislation is needed. Open-ended investment companies are one of two major forms of pooled investment fund. UK regulations for OEICs were first approved by Parliament in 1996 to help UK fund managers compete more effectively in the European market. Collectively, there is around £580 billion in UK-domiciled funds and the work needed to administer those funds brings jobs to a number of parts of the UK, including outside the UK’s traditional fund management centres of London and Edinburgh.
Large fund managers generally operate a small number of OEIC umbrella companies with a large number of sub-funds within each umbrella, allowing them to operate a large range of funds more efficiently. The sub-funds, or cells, do not have a separate legal personality but are separately managed, charged, accounted for and assessed for tax. Under current UK law, there is no segregation of liabilities between sub-funds, so creditors of one sub-fund could have a claim on the assets of another sub-fund. While using multiple separate OEICs instead of sub-funds within a single OEIC would protect investors from this risk, it would make operations less efficient and add significant cost to end-users. In practice, the likelihood of creditors having a claim is small, both because OEICs must comply with borrowing limits imposed by the FSA and because feedback from the industry suggests that most credit agreements stipulate segregated liability. However, because this risk has never crystallised, it is not certain how these stipulations would be treated by the courts.
This legislation increases consumer protection and, by doing so, improves the competitiveness of the UK as a domicile for funds. Investors increasingly require segregated liability to address the small risk present in umbrella structures. Managers seeking to domicile their funds in the UK need to be able to offer this based on a statutory provision. This legislation does just that. It removes the risk of contagion by providing an effective ring-fencing of a sub-fund’s assets from the other sub-funds and the umbrella itself. The Government are introducing the regime to ensure that the UK can continue to compete with other jurisdictions that already operate protected cell regimes. Failure to introduce the legislation would risk funds being unwilling to domicile here.
In deciding how to implement this legislation, the Government have been mindful that, despite the undoubted benefits, there are some potential costs to operators in converting from their existing arrangements. We have, therefore, provided for a general two-year transition period, which may, at the FSA’s discretion, be extended for a further year. During this period, existing OEICs cannot enter into any new contract that is not subject to a protected cell regime unless that contract is subject to an existing master agreement which governs the terms of all contracts entered into under it. This should allow firms ample time to convert the necessary contracts, many of which will have come up for renewal in any case. For operators establishing new OEICs, the costs introduced by this legislation are negligible, so they are required to comply immediately with the new regime.
The Government’s Plan For Growth, published alongside the March Budget, also announced a moratorium on new domestic regulation for microbusinesses—firms employing nine staff or fewer—for a period of three years. The protected cells legislation complies with this announcement. Microbusinesses will be fully exempt from the legislation’s requirements for a period of three years. However, early indications are that they may seek to comply with the legislation earlier, given the benefits it brings.
The UK fund management industry has been calling strongly for a statutory protected cells regime and has warmly welcomed news of its introduction. The industry has worked closely with the Government to get the regulations right and they will bring considerable benefits to investors in UK funds and increase the competitiveness of UK industry. I hope that noble Lords will give their support to the regulations today. I beg to move.
My Lords, this is a fascinating example of the industry asking for regulation that the FSA seems to have been slow to introduce. This is an almost unique experience for the sector, which is normally grumbling that there is too much regulation.
I am intrigued that it is being introduced here purely under domestic legislation rather than within the ambit of any EU cover, and I wonder whether there is any prospect of OEICs, in this regard, being the subject of any of the many EU directives that are currently on their way down the track or being discussed. I note that, at the moment, the jurisdictions that already have this additional regulation are a mixed bag and include Jersey, Ireland and Luxembourg. I find it slightly surprising that it has taken some time for both the UK industry and the Government to get round to implementing this legislation, given that its benefit is that it will improve the competitive position of OEICs in the UK. It seems extremely sensible. I want to confirm what I think the Minister said: that there is no suggestion that this is being introduced because there has been any difficulty with any existing OEICs. Is it purely as a pro-competitive rather than as an anti-competitive measure?
My Lords, I make it clear from the outset that we support this order. I am looking forward to the Minister’s answer to the noble Lord’s questions about how the regulations fit in with the EU—questions which are particularly apposite at this moment. I will content myself with a few comments on the impact assessment and two or three questions.
The impact assessment is absolutely fascinating. From my reading of it—and I am happy to be corrected here—the net benefit of the regulations will be between £18 million and £360 million, which is a pretty wide range that will involve lots of sums to prove that. The only point that I feel I can take from the impact assessment is that, in all credible scenarios, the introduction of a protected cell regime will be favourable, and I think that we can all be satisfied with that.
I have just a few questions. First, new Regulation 11A(4) provides for an exception, which is referred to in the Explanatory Note. However, for myself I cannot quite see what sorts of transactions or assets the exception refers to. Like all exceptions, one is always slightly worried that the exception ends up negating the intent of the order. I am sure that it does not, but I pose that question for assurance.
Secondly, as I understand it—once again, I could be wrong—there will be a period in which PCR products and non-PCR products will be on sale at the same time. I may have misunderstood that, but if I am right in that assumption, what actions are the Government taking to ensure that there is no confusion in the marketplace during that period of overlap? I will be happy if there is no period of overlap, but if there is one then it is important that we do not introduce confusion through these very sensible regulations.
Finally, I like reading impact assessments, which is a little burden that I have to carry. The wonderful thing about impact assessments is that I always sense that they are written by rather more junior people— I was going to say with rather less care, but care is perhaps the wrong term—as you get that little hint from things. On page 10, the impact assessment states:
“The UK fund regime has been viewed as less favourable by managers and investors for a number of reasons, with the lack of a PCR being one of them”.
Perhaps the Minister could enlighten us as to what other reasons exist and what, if anything, he is doing about them.
My Lords, again those questions were short, sharp and to the point. Let me go straight to trying to answer them.
First, my noble friend Lord Newby asked about the interaction with Europe and what else is coming from Europe. The main thing that I see is an up-side opportunity in the link to the UCITS directive and the push to make sure that UK and other fund managers are able to sell products safely on a pan-European basis. I am not aware of any particular threats, but I am aware that, given the ongoing work that is looking again at the UCITS directive, there is further opportunity to complete the single market. UCITS 4 has just been implemented, and the UCITS 5 proposals that are expected from the Commission in 2012 are likely to include consumer protection measures on, for example, the use of depositories, so these regulations are part of a piece. As my noble friend said, these regulations are certainly pro-competitive but, as I touched on in my opening remarks, they also act to protect investors—they work for both the provider and the user of these products. Just to be absolutely clear, the regulations are being introduced not as a reaction to some disaster or something having gone wrong but because there is an untidiness and lack of clarity that we should tidy up ahead of the game.
I will answer the questions of the noble Lord, Lord Tunnicliffe. First, on new Regulation 11A(4), this refers to assets and liabilities which belong to the sub-funds; they do not belong to the umbrella company but have been billed to it for practical or legal reasons. They then have to be pushed down to the sub-funds. For example, there are certain generic costs such as Companies House fees and VAT for which the umbrella company, as the only entity with legal personality, is responsible but then needs to attribute to the sub-funds. It is put in there not as a means of driving a coach and horses through; it is there to deal with appropriate liabilities in particular, which have to be allocated down below the umbrella.
There was then a question about the transition period. The Government certainly recognise the importance of clarity for consumers. This is one reason why the protected cell regime will become mandatory after the transition period. In that transition period, the FSA rules require OEICs that are unprotected to make this clear in their prospectuses. Once an OEIC has converted, it will declare that it is protected. The FSA considers this approach to be proportionate and appropriate, given the low risks involved.
Lastly, there was a question about the impact assessment and the comment on page 10 about the UK regime being “viewed as less favourable”. Incidentally, this was not an impact assessment that I signed off myself so I had the pleasure of reading it afterwards. I am sure that when the noble Lord, Lord Tunnicliffe, mentioned junior people signing it off, he was referring not to my honourable friend the Financial Secretary or the officials who draft these things but to the authorship. The authorship is every bit as expert as is needed. It is great, anyway, to know that some people read the fine print. This is a long preamble to answering the noble Lord’s question.
The other major reasons why people might see the UK regime as less favourable concern perceived tax treatment of funds. The Government are taking steps to address this. For example, only last week the Government announced that they intend to improve the operation of the tax regime for property-authorised investment funds. This will mean that under some circumstances, investors may exchange their units in a dedicated PAIF feeder fund for units in the PAIFs, and vice versa, without incurring a charge to tax on capital gains at the time of exchange. This was a specific response to industry representations and will improve the competitiveness of the UK funds regime. We are responsive to other issues out there, which are generally around taxation.
I hope that that deals with the Committee’s questions. This is legislation that strengthens investor protection in a way that brings considerable benefits to the competitiveness of the UK as a domicile of funds. I therefore commend these regulations to the Committee.