Social Entrepreneurship Funds (Amendment) (EU Exit) Regulations 2018
Venture Capital Funds (Amendment) (EU Exit) Regulations 2018
Considered in Grand Committee
That the Grand Committee do consider the Alternative Investment Fund Managers (Amendment etc.) (EU Exit) Regulations 2018, the Social Entrepreneurship Funds (Amendment) (EU Exit) Regulations 2018, and the Venture Capital Funds (Amendment) (EU Exit) Regulations 2018.
My Lords, as with the previous statutory instrument, the Treasury is in the process of laying statutory instruments under the European Union (Withdrawal) Act. These three statutory instruments are part of the same legislative programme and will fix deficiencies in UK law relating to the regulation of investments.
The approach taken in these SIs aligns with that of other SIs being laid and debated under the EU withdrawal Act by maintaining existing legislation at the point of exit to provide continuity, but amending it where necessary to ensure that it works effectively in a no-deal context. These instruments have already been debated in the House of Commons on 9 January.
The alternative investment fund managers regulations relate to the management, administration and marketing of alternative investment funds. Investment funds are investment products created to pool investors’ capital and invest it in financial instruments such as shares, bonds and other securities. Alternative investment funds are investment funds that are not covered by the directive for undertakings for collective investments in transferable securities, commonly known as UCITS, which are aimed at retail investors. Alternative investment funds include hedge funds, venture capital and private equity funds, and are often aimed at professional investors. The EU alternative investment fund managers directive—AIFMD—created the alternative investment fund framework, and was domestically implemented primarily through the Alternative Investment Fund Managers Regulations 2013.
The second and third SIs relate to two subcategories of alternative investment funds. Registered venture capital funds aim to promote investment into small and medium-sized enterprises, such as start-ups, whereas social entrepreneurship funds focus on social enterprises whose main objective is tackling societal challenges, such as youth unemployment. These regulations create a UK-only regulatory framework for alternative investment funds in the UK. Regulations for alternative investment fund managers, venture capital funds and social enterprise funds enter into what is to be known as a temporary marketing permissions regime. The alternative investment fund managers regulations create a temporary marketing permissions regime. Currently, European Economic Area funds can make use of the EU passporting regime, which gives funds the automatic right to market across the EEA. In a no-deal scenario, the passporting system will no longer operate and EEA funds would lose the right to market into the UK, and would not be able to continue servicing UK customers as they would have before.
In December 2017, the Government announced they would introduce a temporary permissions regime for inbound passporting EEA firms and funds. The draft alternative investment funds regulations create a temporary marketing permissions regime for EEA managers of alternative investment funds, including the European venture capital funds and European social entrepreneurship funds. This will allow EEA fund managers who currently have a marketing passport to continue to market funds as they could before exit day for a temporary period. This period is for three years. However, subject to an assessment by the Financial Conduct Authority as to the effect of extending, the Treasury can extend the period by no longer than 12 months at a time.
As outlined in my letter to the noble Lord, Lord Tunnicliffe, on 7 January, the Treasury has now committed that any extension of this or any other temporary regimes would be preceded by a Written Ministerial Statement issued to both Houses of Parliament. The Statement would give Parliament advance notice of the Government’s decision to extend the temporary permissions regime ahead of the extension SI being laid. This commitment responds to the concerns raised by the Secondary Legislation Scrutiny Committee and by my colleagues in this House. While it is our continued position that the negative procedure is appropriate, we take parliamentary scrutiny seriously and hope this commitment will allay the House’s concerns in this regard.
The temporary marketing permissions regime provides continuity and certainty for passporting funds that enter the regime and the UK customers they serve. The FCA will have the power to oversee operation of the regime and have supervisory oversight of all funds with temporary permissions. While in the temporary marketing permissions regime, fund managers will be directed by the FCA to notify under the national private placement regime, which is the current mechanism that allows non-EU third country fund managers to market in the UK.
On the other provisions of these instruments, first, all these draft regulations remove references to the Union and to EU legislation, which are no longer appropriate, and replace them with references to the UK and UK legislation. Secondly, in the alternative investment fund managers regulations, the definition and scope of alternative investment funds will be amended to reflect the UK leaving the EU. Any fund that does not meet the new definition of UK UCITS will be defined as an alternative investment fund. This will therefore mean that all EEA UCITS will be regarded as an alternative investment fund in the UK. UCITS funds are a simple and regulated type of fund intended for retail investors, whereas alternative investment funds are more complex, aimed largely at professional investors, and have additional requirements, such as transparency of reporting. Requiring EEA UCITS to meet additional requirements for an alternative investment fund would be disproportionate. Recognising this, this instrument removes certain aspects of the regime for alternative investment funds that were not designed for retail funds, such as reporting requirements. This will ensure that UCITS funds will continue to be regulated proportionally in the UK as retail funds.
As UK-located funds will no longer be part of the EEA framework and will be subject to the UK regime, UK-only labels will be created. These will replace EEA labels with the “registered venture capital fund” and “social entrepreneurship fund” labels for their respective regulations. This will ensure that the regulatory framework for investment funds and their managers in the UK is clearly distinguishable from the regulatory framework in the EU.
Moving on, in line with the general approach taken to the onshoring of EU regulations, these three SIs will transfer functions currently within the remit of EU authorities from the European Securities and Markets Authority to the Financial Conduct Authority, and from the European Commission to Her Majesty’s Treasury. The FCA, as the UK’s regulator for investment funds, has extensive experience in the asset management sector, and is therefore the most appropriate domestic institution to take on these functions from the European Securities and Markets Authority. The regulators undertook a public consultation on the changes they propose to make to binding technical standards, and the FCA will release consultation feedback and the final rules before exit day.
Furthermore, powers are transferred from the Commission to the Treasury, as the suitable government body, which will have powers regarding the rules and regulations of investment funds. For example, the Treasury will be able to specify conditions for alternative investment fund managers and their obligations to disclose information to investors.
These regulations will also maintain the eligible investment arrangements and rules for registered venture capital and social entrepreneurship funds. Currently, EU legislation sets out rules on what assets these subcategories of funds can invest in. To maintain continuity for investors, this instrument will maintain existing investment rules for funds located in the UK.
An amendment to the Alternative Investment Fund Managers (Amendment) Regulations 2018 will be brought forward under the related Collective Investment Scheme (Amendment Etc.) (EU Exit) Regulations 2019, which were laid in Parliament on 17 December 2018. This will amend Part 1 of the alternative investment fund managers regulations to bring forward the commencement date of the temporary marketing permissions regime to the day after the collective investment scheme regulations are made. This will ensure that the FCA has the powers to operationalise the regime. Specifically, it will give the FCA power to process notifications before exit day.
To summarise, the Government believe that these SIs are needed to ensure that the regulatory regime for investment funds and their managers will work effectively in the UK if it leaves the EU without a deal or an implementation period, and to ensure continuity for the UK customers, the funds and their managers that they serve. I hope colleagues will join me in supporting these regulations and I commend them to the Committee.
Once again, I thank the noble Lord, Lord Bates, for his explanations. I declare my interest as a director of the London Stock Exchange PLC as some of these provisions could cover funds that might list on the exchange, although nothing I say is to do with the London Stock Exchange.
The AIFMD was a controversial piece of legislation. It was improved greatly during its long passage through the European Parliament and through trilaogues with the Council and the Commission—I think it took us more than 20 trilaogue meetings, which is a large number. I used up every ounce of my patience and innovation to keep it going until everything was in an acceptable place.
The directive started life as a way of regulating hedge funds, which were in the firing line after the financial crisis for their perceived role in the eurozone sovereign debt crisis and for selling unsuitable investments to retail investors—particularly in France which, unlike the UK, did not have any retail consumer protections in place. It was expanded to cover asset stripping. There are anecdotes around why that happened but I will not go into them here—and as I have not written my memoirs, noble Lords will not get to know them. Some hedge fund managers congratulated me on the fact that the legislation ended up in an acceptable place with nothing silly, but many resented moving from an unregulated space into a regulated space and, in the words of one manager, “having to spend time reporting things instead of just earning money”. I am afraid that, as a consequence, the legislation became a recruiting sergeant for the Brexit cause, with funds to boot. That is its sad legacy. That little bit of history augments what has already been said.
Further arrangements were introduced for the specific funds we are also talking about: social entrepreneurship funds and venture capital funds. I considered those introductions very useful, not just in their own right but because it represented the first breakthrough where some people recognised that AIFs could be good; they were usually considered to be at the bad end of the spectrum.
I have no comments on the way in which the onshoring has been done in so far as it follows the kind of path we have seen before, with temporary permissions in place until transfer to the domestic regime—in this case, the UK national private placement regime—takes place. I do, however, have a couple of questions, and I gave notice to the Treasury of the first one.
I believe that, in his introduction, the noble Lord, Lord Bates, covered the reasons why there has been a change to the private placement regime’s reporting requirements. The reasoning, which I understand fully, is that EEA UCITs become AIFs and therefore slot into a regime meant to cover the sort of funds used by only professional investors, whereas it has protections that correspond to the retail case from the EEA UCITs. That was given as a reason for changing the reporting requirements for those under the national private placement regime.
However, I do not understand what power the Government are using for that proportionality, and here I refer to what is said in paragraph 7.10 of the Explanatory Memorandum concerning Regulation 10(9)e. Is it a continuation of the withdrawal Act powers or are the Government using another form of empowerment? I did not perceive the withdrawal Act as giving powers to amend the national private placement regime, but I may have missed something in the logic. I hope that there is an answer there; it is quite likely that there is, which is why I gave notice of my question. Paragraph 7.10 also references the “reporting requirements for funds” recognised as retail funds under Section 272 of FSMA. It is true that they are less risky, so less reporting is needed, but where has the power to amend the private placement regime come from? Has it come from FSMA? That may be possible. If so, that should be said. I decided not to spend yet another weekend trying to work out where it came from, but to ask the question instead.
My second question concerns asset stripping. The asset stripping provisions have been contracted to apply only to UK companies. Does that mean that EU funds that are allowed to continue in the UK under the temporary regime can come here to asset-strip EU companies that they acquire? Are we going to get ourselves a bad reputation—“Come to London and we will strip your EU assets”—or are they covered by the built-in requirement of their home member state? Could they separately acquire something that is somehow ring-fenced in the UK? When they are converted to the UK national regime, will it still have all the asset stripping protections? It may not be the place to correct that here but, on a point of information, will our NPPR have UK asset-stripping protections? That was a novel aspect that was introduced into the AIFMD.
I will move on to venture capital and social entrepreneurship funds. When they were proposed, they were said not to be attracting much interest in the UK; people said that we did not need this kind of thing and we had all the funds we needed. I wonder therefore whether there are any figures for the volume of assets under management or sold in the UK using this heading.
We come now to the interesting point I have already mentioned: symmetry and continuity of assets under management. This is an instance of where we are treating the EEA preferentially and not as a third country, so that these funds can still have EEA assets within them, which I fully understand—you would not want to have to rapidly divest assets. But when they were constructed, preferential bias was built in to try to help the EU and EEA companies. Will there be a review of that in the fullness of time, for example to restore in some way the benefit of the UK footprint rather than an EEA footprint? What has been done is sensible in the immediate, but it would be interesting to know the longer-term view, partly because the logic of coming under the same jurisprudence no longer holds. The other side of that is: why not open up so that they can have all funds, including third countries, in them? How are we going to deal with that?
That is probably all that I need to say. My question is, what is the justification? The choice was between three options and the continuity option has been chosen. But where are we going to jump to next? Are we going to shrink back to the UK or are we going to open up to third countries?
My Lords, I thank the Minister for presenting these instruments. I am sorry to sound like a broken record but I want to start with my concerns about the impact assessment. The Explanatory Memorandum says:
“A full Impact Assessment will be published alongside the Explanatory Memorandum on the legislation.gov.uk website, when an opinion from the Regulatory Policy Committee has been received”.
Is the Minister going to tell me that it is also de minimis or is this different from the last one? I had hoped that there would be an impact assessment, because I have absolutely no idea of the scale that we are talking about: I do not know whether we are talking about millions, billions or semi-trillions floating around. I would have found an impact assessment useful.
Nevertheless, I felt it important to scrutinise this SI as best I could, so I went through it and tried to précis it to understand what it was doing and whether it met my tests of being necessary and not a new policy. I did quite well. There is a bit on definitions of AIFs that sounded fair enough. A bit sets out the naming convention, which seemed okay. There was a bit that set out the FCA’s reporting requirements. I sort of understood that. A paragraph or two set out the transfer of functions from the Commission to the Treasury, from ESMA to the FCA.
But then I came on to the temporary marketing permission regime. I confess that I partly lost my place. It seems that this is, in the terms that the noble Baroness and I have used, an asymmetric situation. I would be grateful if the Minister could confirm that, but it seems to favour EEA managers and disfavours, or whatever the right term is, UK fund managers. I assume that there is a good reason for that, which I assume is something to do with the good brought to investors outweighing the disadvantage to managers.
I sort of felt that I had got on top of understanding this, until I came to paragraph 7.21 of the Explanatory Memorandum on third-country passports. Everything that I had read up to there seemed to say that there would not be any passporting. I would be grateful if the Minister could better inform me what that paragraph is doing. Is there a contemplation that third-country passports will be issued—I do not know what the mechanism will be—to EEA managers so that they can market in the UK after the end of the temporary marketing permission? Is it contemplated that such passporting, or whatever the right term is, is accompanied by a reciprocity regime? If it is, that will be a good thing; if not, it would seem a step too far.
Finally, we have the same debate again on the same question about what happens. The instrument comes into force on exit day. I am terribly sorry to confess that I cannot remember the definition of “exit day”; clearly, if we crash out of the EU, exit day will be 29 March, but if we go into the 21-month interim period, will exit day be at the end of the 21 months or is it still 29 March? If it is, the legislation will need either to delete the commencement provision or to put it under some control or other. I do not know whether the noble Baroness shares my concerns, but the more of these SIs we do, the more we have this worry that they might, almost by accident, seep into the future because the commencement provisions are not sufficiently clear.
Finally, this shows once again what a dreadful idea this is, because there would appear to be no mechanisms to require reciprocity. Therefore, it seems that at least part of the UK population will be served less well by this regime than it was before.
I thank the noble Baroness, Lady Bowles, and the noble Lord, Lord Tunnicliffe, for their questions and for their focus on and scrutiny of these important regulations.
I shall start with the impact assessment because there is a different answer to the usual one we have given of “de minimis”. The Government have undertaken an impact assessment on these instruments, which we hope to publish shortly. As a whole, these SIs will significantly reduce the costs to business in a no-deal scenario, as without them the legislation would be defective. In making these changes, we have attempted to minimise disruption to firms and their customers. We have identified the main costs to firms as familiarisation costs arising with the new legislation, transition costs because of changes in legal definitions and changes in the reporting requirements for firms using a temporary marketing permissions regime.
The noble Baroness, Lady Bowles, asked why the asset management stripping provisions have been contracted and how they will apply to EU AIFM firms in a temporary marketing permissions regime. Such firms will be able to market under the same conditions as they could pre-Brexit. That follows the consistent approach we have sought to take in drafting these SIs: by considering how they will work and consulting with the industry. They will therefore be subject to the asset-stripping provisions in their home member state, which of course—without wanting to give the noble Baroness flashbacks to her 20 trilogues in the European Parliament—will continue to govern such activities.
If I may gently challenge the Minister, he said that the Treasury has taken a consistent approach with these SIs but it has not. Sometimes it has chosen to be symmetric and sometimes it has chosen to be asymmetric. That may be perfectly reasonable if there is a good explanation—particularly for why it would choose an asymmetric approach—but such an approach, which at least disadvantages some parts of the UK’s financial services industry, should be justified by the fact that it gives greater benefits than not having that asymmetric approach available.
I hear what the noble Lord says. On that particular point, I was referring to the general objective of the onshoring process in which we are engaged. This is to effectively onshore the current rule book to allow for no or limited disruption to UK firms—and, most importantly, their customers and clients—in the unlikely event of no deal. I accepted that point on the previous SI. I will reflect on the point raised by the noble Baroness, Lady Bowles, and the noble Lord, Lord Tunnicliffe, about how the choice will be applied in future—how it will be arrived at—and I shall copy them in on my letter.
The noble Lord, Lord Tunnicliffe, asked me to clarify how the passporting regime will work for third countries post-Brexit. The passporting regime between the UK and the EU will cease in a no-deal scenario. There is a third-country passport, which is currently not in force. The SI transfers to the Treasury the Commission’s function of appointing the day when this passport comes into effect. If in force, the third-country passport can be used to allow third-country fund managers to be authorised to manage and market funds in the UK.
The noble Baroness, Lady Bowles, asked about opening up to third countries in the future, which is a pertinent question. This instrument deals only with the inoperability that comes with withdrawal from the EU in the event of no deal. However, the national private placement regime is a functioning regime for any third country to take advantage of.
I understand fully that to some extent we do not need a third-country passport because our national private placement regime is sufficient to do almost the same job. But in my question I was also talking about the assets that the venture capital funds and social entrepreneur funds are allowed to hold. Would those be opened up and be able to have third-country assets in the fullness of time? I do not mind being written to about that.
We may have to do that but I will go as far as I can with the information which I have. There is some more information which I can convey to the noble Baroness and the Committee. The Government recognise that the alternative investment fund managers regime and the UCITS regime aimed at retail funds do not intertwine perfectly. This is why we have made fixes, where possible, within the confines of the EU withdrawal Act.
Section 272, which the noble Baroness referred to, is to ensure that EEA retail funds are treated as any other third-country funds, in keeping with the UK’s obligations under the World Trade Organization rules in a no-deal situation. It is not possible for UCITS to buy or build a controlling stake in the securities of a company or to hold private equity interests. The small number of non-UCITS recognised under Section 272 are all subject to UK-equivalent rules for retail funds on eligibility of assets, borrowing and risk spreading. I undertake to reread the record of this debate and ensure that the noble Baroness’s point is addressed directly, if that did not quite cover it.
The noble Lord, Lord Tunnicliffe, asked about exit day. Is it 29 March and how will this instrument be switched off if there is a deal? Exit day is defined in the EU withdrawal Act as 29 March 2019. As I said in the previous debate, the withdrawal agreement Bill will contain provision to change the commencement date of the SI in the event of a deal.
The noble Baroness, Lady Bowles, and the noble Lord, Lord Tunnicliffe, asked about the volume of assets under management for these various fund categories. At the moment, the numbers we are referring to are fairly small. They combine fewer than 50 European venture capital funds and European social entrepreneurship funds in the UK, based on FCA estimates. But as a result of these changes and the temporary permissions regimes, we may get greater visibility of them. I share her desire regarding venture capital, which of course provides seed corn to many small and medium-sized enterprises that will be vital to our economic future, and regarding the importance of social entrepreneurship funds. I know that many departments across government are looking at those funds as a way to implement the sustainable development goals and leveraging private sector capital to meet those objectives.
I think that covers most of the points raised by the noble Lord and the noble Baroness. Again, I thank them for their assiduousness in looking through these regulations. I also recognise and thank the Secondary Legislation Scrutiny Committee for its work, which was extremely helpful in this regard, and I commend these instruments to the Committee.
Committee adjourned at 4.44 pm.