Draft Collective Investment Schemes (Amendment etc.) (EU Exit) Regulations 2019 Draft Long-term Investment Funds (Amendment) (EU Exit) Regulations 2019

Anneliese Dodds Excerpts

Wednesday 30th January 2019 General Committees

[Anneliese Dodds (Oxford East) (Lab/Co-op)]

It is a pleasure to serve on the Committee with you in the Chair, Mr Bailey. I am very grateful to the Minister for his explanatory remarks. Once again, I sit opposite him to discuss a statutory instrument that would make provisions for a regulatory framework after Brexit in the event that we crash out without a deal, which I hope is less likely following the House’s decision last night. On each previous occasion, my Labour Front-Bench colleagues and I spelled out our objections to the Government’s approach to secondary legislation.

The volume and flow of secondary legislation on our exiting the EU is deeply concerning for accountability and proper scrutiny. The Government have assured the Opposition that no policy decisions are being taken, but establishing a regulatory framework inevitably involves matters of judgment and raises questions about resourcing and capacity. Secondary legislation ought to be used for technical, nonpartisan and uncontroversial changes, because it allows limited accountability. Instead, the Government continue to push through contentious legislation with high policy content by using this vehicle. As legislators, we have to get this right. These regulations could represent real and substantive changes to the statute book, so they need proper, in-depth scrutiny. In this light, the Opposition want to put on record our deepest concerns that the process regarding these regulations is not as successful and transparent as it should be.

The Minister spelled out the fact that the first SI relates to the 2009 UCITS directive, which sets out a common set of standards for investor protection for regulated investment funds that can be sold to retail investors in the EU. The directive established a passporting system to enable UCITS to be marketed and sold to the general public throughout the EU, and to enable UCITS management companies to manage UCITS that are located in other member states. The directive was transposed into UK law through domestic legislation and FCA rules. Many would say that the directive has been successful: it has facilitated far greater choice for investors, and I understand that there are now more than 10,000 funds available to UK investors as a result of the directive. Almost three quarters of those are passported in from the EU27 under the UCITS directive. A large number of non-UK UCITS funds are managed by UK businesses under the directive—by asset value, it is £1.8 trillion-worth out of the £9 trillion industry across Europe. Some £375 billion-worth of that is held by UK investors.

I should express my gratitude to the industry for providing me with those figures. It has indicated that in the event of a no-deal Brexit, UCITS funds from the EU27 could not be marketed to UK investors in a straightforward manner. Furthermore, it would not be easy to list UCITS exchange-traded funds on the London Stock Exchange. Given that this SI largely preserves the status quo on the availability of UCITS funds and exchange-traded funds—albeit temporarily—there is support in the industry for the intention behind it, because there would undoubtedly be problems under a no-deal Brexit.

None the less, the Minister needs to answer some questions on this SI. It is essential that we properly understand its impact—not least because, in common with so many others that we have considered in Committee, it uses secondary legislation to amend primary legislation, which is of course the definition of Henry VIII powers. In addition, the FCA and others have raised considerable concerns about unregulated collective investment schemes, or UCIS. Many of us have heard horror stories about these, with examples that have badly let down their investors or even operated as Ponzi schemes. In the circumstances it is essential that regulations are sufficiently encompassing and do not lead to unsophisticated investors being presented with overly risky products. At the same time, the asset management industry, particularly people who are involved with investment in UCITS, is an important part of the financial services industry. Given that the industry supports one in 10 jobs in our country, it is a matter of regret that our Government have failed to prioritise seeking a better deal for financial services as part of their negotiations, and that the quest for passporting rights was quickly dropped in favour of some form of equivalence. Of course, whether to agree that will be entirely in the European Commission’s gift.

That has already led to economic activity in this area shifting out of our country. Companies from Hermes Investment Management to Legg Mason, Janus Henderson Investors, Jupiter Asset Management and Polar Capital all appear to have created additional positions, functions or operations in the EU27 rather than the UK because of the need to secure service continuity for current and future investors. As I understand it, the issue of delegation, which is essential in this area, is still not fully resolved. It remains unclear on what basis UK companies will be able to manage investments for fund companies based in the EU27. I hope that the Minister updates us on when he expects the Commission to give ESMA the green light to enable concrete discussions to take place on that score.

My second question relates to the legal basis for the draft regulations. They are said to be made under both the European Communities Act 1972 and the EU (Withdrawal) Act. Surely it is rather peculiar to have those two parent Acts, given that one is about giving effect to EU law whereas the other is about inherited EU law. Perhaps the Minister can explain why those Acts form the basis for the draft regulations.

Thirdly, we have been provided with an impact assessment for the draft regulations, albeit we received it just this morning. Clearly that is better than nothing, but it gave us limited time to acquaint ourselves with the impact assessment.

[John Glen]

Ten past 10.

[Anneliese Dodds]

Thank you. That impact assessment suggests there will be a need to charge inbound EEA passporting firms as third-country firms, but that to

“reduce the impact of leaving the EU on funds, the government has committed to reviewing Section 272,”

which governs this process. It adds:

“This will be done through a future legislative vehicle.”

It would be helpful if the Minister provided us with some details about that. Does he envisage that happening at the end of the three-year temporary permissions regime or at some other point? It would, of course, require legislative change.

I turn to the draft Long-term Investment Funds (Amendment) (EU Exit) Regulations. I am grateful to the Minister for explaining the basis for that instrument. As he explained, the EU regulation has been used far less than many would have hoped, given that it was intended to encourage long-term investment.

There are two issues with the SI. The first concerns empowerment of the FCA. My colleagues and I have frequently referred to the fact that the process of legislating for no deal has in many cases provided the FCA with unprecedented powers, potentially overshooting what is required to transpose the EU acquis. Indeed, colleagues will not have missed the conclusions by City A.M. following the recent Treasury Committee hearing on this subject; it stated that the process involves regulators being given “‘unprecedented’ powers”—its words, not mine. However, in this case, we seem to have undershooting, specifically in relation to the FCA’s powers to create a register of ELTIFs.

ESMA, the EU-level regulator, does not merely have the ability to create a register of ELTIFs; it is under a duty to do so. However, the draft regulations only empower the FCA to keep such a register; they do not require it to do so. There is a direct contradiction between regulations. Article 3 of the 2015 EU regulation on ELTIFs states:

“ESMA shall keep a central public register”.

The draft regulations do not just substitute “FCA” for “ESMA”; they give the FCA a power, rather than a duty, to keep a register. Regulation 6 states:

“The FCA may keep a central public register”.

I note the use of the word “may”, not “must” or “shall”. The Minister needs to explain that discrepancy before the Committee can accept this SI.

There seems to be a drafting mistake. The draft regulations seem to empower the FCA to designate ELTIFs as such across the EU, rather than empowering it to recognise them as such within the UK for the purposes of then recognising them as the new category of LTIFs. To try to explain this horrendously complicated area, I am going to differentiate my pronunciation of ELTIFs—European LTIFs—and LTIFs, the new category the Government suggest they are creating. This point is very difficult to explain without having the relevant pieces of legislation in front of us. The Minister will remember the comments of my hon. Friend the Member for Garston and Halewood (Maria Eagle) in a previous Committee.

[John Glen]

I do recall. On that specific point, I checked with my officials, as I said I would. Their understanding was that that was not common practice. So I am doing all that is expected, based on the practice of Ministers in this position.

[Anneliese Dodds]

I am grateful to the Minister for that clarification, if that is the case. However, even if it were not the case previously, there is a prima facie argument that it would be useful for Committees of this type to be able to see in the committee room the previous regulation and be able to compare it with what is being suggested. Otherwise, it is extremely hard for us to understand exactly what is being proposed in some of the very complex changes that are being implemented.

That difficulty had its apogee with the MiFID—markets in financial instruments directive—transposition regulation. I will not go into all the details; I have discussed the matter with the Minister many times. The Opposition had hoped to debate that subject on the Floor of the House because it was recognised in that case that a Keeling schedule was necessary, effectively to track changes. It would be helpful for Members in all such Committees to be able to see the direct impact of changes from this no-deal legislation. Otherwise, it is very difficult to understand.

[Kirsty Blackman (Aberdeen North) (SNP)]

Even if the documentation that was made available to MPs beforehand related to the relevant legislation, that would be a slightly better position than the one we are in now, and it would not require a Government Minister actually to bring the legislation with him.

[Anneliese Dodds]

I absolutely agree with the hon. Lady. She is right that it would be helpful. In many cases, we are talking about the initial legislation, which itself was relatively complex and has often been amended. It would be useful for all of us during this complex process to have some aid in that regard.

In its amendment of article 5.1 of the EU regulation, the statutory instrument would give the FCA an extra-territorial power that it should not have. That is obviously fairly problematic because, whatever kind of Brexit occurs, ELTIFs will continue to exist under EU as well as UK law. It is EU-level authorities that will provide their initial designation for the EU27. To explain that quickly, articles 4 and 5 of the ELTIF regulation set out the conditions for the designation and authorisation of ELTIFs. In the draft regulations presented to us today, article 7 amends articles 4 and 5.1 of the EU regulation in quite a strange direction.

Article 4 refers to LTIFs, but article 5.1 talks about applications for authorisations of ELTIFs and says that application for authorisation as an ELTIF shall be made to the FCA, and sets out the process for application for LTIFs. I am sorry that this is very complicated but it underlines the confusing nature of the SI.

It seems that the proposed article 5.1 as amended is wrong because ELTIFs will continue to exist under EU law after Brexit. It will not be in the FCA’s gift to recognise and authorise them outwith the UK. We need just a small change to article 5.1, which should read: “An application for authorisation within the UK as an ELTIF shall be made to the FCA.” Will the Minister assure us that he will look into that and seek to amend the legislation accordingly, if that concern proves genuine and is not just my reading of the text?

--- Later in debate ---

[John Glen]

Once again, I will begin by thanking the hon. Members for Oxford East and for Aberdeen North for their thorough examination of the statutory instruments; I will do my very best to answer in detail the points that they have made, and where I cannot, I shall write to them as soon as I possibly can.

The hon. Member for Aberdeen North discussed impact assessments. We now have an impact assessment, which was circulated, as she acknowledged, at 10 past 10 this morning and covers all the statutory instruments that will be laid until 11 February. There has been a desire on my part and that of my officials to meet the necessarily exacting standards of the RPC. As I say, that is my responsibility, but I would point out that this is an unprecedented process, doing 53 SIs for financial services, 45 of which have now been laid, and working on each one individually. I hope the existence of the impact assessments up to 11 February—obviously there will be some more after that—will give her some comfort, but the points that she made have been heard.

I will come on to the other points that the hon. Lady made, but I will now turn to the issues raised by the hon. Member for Oxford East. She made some initial observations with respect to the volume, flow and appropriateness of the SI mechanism that I may have heard before, but I acknowledge her sincerity and take them in the spirit in which they are intended. We are acting within the terms of the withdrawal Act, and I have never sought to pretend that this process is optimal, but it is a practical measure to give business continuity and give the industry the answers they are concerned about.

I also recognise that the degree of uncertainty is not helpful, but I draw the attention of the hon. Lady and the Committee to the remarks of Sam Woods, deputy governor of the Bank of England, who said in April last year that we would have 5,000 to 10,000 jobs moved by day one, which is between 0.5% and 1% of financial services jobs in the UK. There is an enormous resilience in the financial services sector, and this process is about ensuring that there is minimal disruption in the event of no deal.

Moving on to the specific points made by the hon. Lady, she said that in a no-deal scenario, EU UCITS could not be marketed in a straightforward manner in the UK. The temporary marketing permissions regime is intended to prevent the market disruption that would result from a sudden end to passporting rights. The regime ensures that the business model of EEA fund operators marketing into the UK can continue for a temporary period while we transfer to the UK-only regime. That includes the new sub-funds, and reflects our intention to allow EEA firms and funds to continue their business operations for a temporary period.

If we did not allow new sub-funds to enter the temporary permissions regime after exit day, there would be a significant risk to the role of the London Stock Exchange as a global hub for exchange-traded products. Therefore, including sub-funds in the temporary marketing permissions regime reduces the risk to the London Stock Exchange and ensures continued access for UK customers to new EEA funds in future. That was a direct change from laying this SI in November and December; we laid it again on 6 December in response to feedback from the markets. There is an iterative process, hence the time constraint that puts pressure on the impact assessment.

The hon. Lady raised the issue of assurances on ESMA and on portfolio delegation. I refer to the comments of the chair of ESMA, who said on 3 October that in the case of a no-deal Brexit, EU regulators and ESMA

“should have in place with our UK counterparts the type of MOUs that we have with a large number of third country regulators…ESMA has coordinated the preparations for such MOUs together with the EU27 NCAs.”

More recently, the Luxembourg regulator stated that the

“delegation of investment management, portfolio management and, or risk management to UK undertakings shall continue to be possible without any disruption post-Brexit”.

I wish it could be more transparent and sooner, but I am convinced and assured that that work is going on and that it will be completed in time.

The hon. Member for Oxford East raised the issue of why the FCA was not required to keep a register of LTIFs and the issue of the power not the duty. The power to keep the register is being transferred to the FCA. As there are currently no LTIFs set up in the UK, there is no register of those funds online. The FCA keeps a register of small UK AIFMs that manage similar funds, European venture capital funds and European social entrepreneurship funds.

The best thing is for me to obtain some assurance from the FCA about its plans, which are, in reality, at a relatively early stage because we are simply trying to transition over at this point. The detail of its ongoing regime and responsibilities will be a matter for it to convey in due course.

[Anneliese Dodds]

We have been told throughout the process that there will be no watering down of regulations under the withdrawal Act. I appreciate that this is an abstract case, because we do not yet have a category of investments operating in the UK that would fall into that designation, but that is not to say that one will not be created in future. If we do not have that requirement, there would surely be that resiling. Will the Minister endeavour to talk to the FCA to make sure that, if such investments start to operate in the UK, it will keep a register of them? Surely that is what the EU legislation requires.

[John Glen]

From my point of view at this point, it seems reasonable not to suggest that there will be a register for something that does not yet exist, but the hon. Lady’s point is perfectly reasonable. I will write to the FCA following what she has said.

[John Glen]

I am sympathetic to what the hon. Lady says, but she has to understand that the regulator is the regulator, and it will have reasons in terms of the market actors around that. My view is that it would be entirely appropriate for the regulator to have that register, and I would expect to see clear market-driven reasons for why it would not be necessary. Again, it would not be responsible for me to make a commitment without knowing all the background factors, but I will write to the regulator to express the Committee’s concerns and ask what its approach would be in the circumstances where those funds existed in the United Kingdom.

[Anneliese Dodds]

I am grateful to the Minister for what he has said, but the regulator is required to carry out what this House requires it to do. If we are talking about ESMA, it is meant to carry out what it has been required to do by EU-level policy makers. That EU legislation requires that the register shall be kept, so we need something more emphatic if we are to stick to the existing distribution of responsibilities.

[John Glen]

It is an interesting debating point. Had the hon. Lady seen the report of my appearance yesterday before the Treasury Committee with the chief executive of the FCA and the deputy governor of the Bank of England, she would know that we work collaboratively with the industry to do what is right. The intention of this process is not to deregulate in any way—there is no attempt by the Treasury to create some wriggle room to remove the obligation of the FCA. I understand the hon. Lady’s point, and I expect there to be continuity between the current and future regimes on the FCA’s reporting requirements. I will seek clarification on that point.