Alternative Investment Fund Designation Bill [HL]

Baroness Altmann Excerpts

2nd reading
Friday 1st March 2024 Lords Chamber

Moved by

[Baroness Altmann]

That the Bill be now read a second time.

[Baroness Altmann (Con)]

My Lords, the Bill seeks to remedy legislative errors that have contributed to a haemorrhaging of funds away from UK-listed investment companies. Flawed interpretation of EU regulations, which no EU country has applied as we have, has stoked massive selling pressure, with pension funds, wealth managers and retail investors having to abandon listed investment companies here.

I am grateful to my noble friend the Minister, her officials and other Treasury colleagues, including the EST, my honourable friend Bim Afolami, for their engagement on the Bill. I am particularly grateful for the guidance, knowledge and insights of the noble Baroness, Lady Bowles, and Herbert Smith Freehills, who have helped to draft the Bill. I am also grateful to the officials in the Public Bill Office, who have assisted so ably; my honourable friend John Baron MP, who has raised this issue within government; many industry leaders, such as the London Stock Exchange, the Investment Association and the Association of Investment Companies; and colleagues across the House who support the aims of the Bill.

Investment trusts are a long-standing British success story, democratising investment for small savers and delivering excellent returns. They also provide the only way for most pension funds to gain access to expertly managed specialist portfolios of less liquid assets in UK sustainable growth, infrastructure, social housing and other areas, which pension investors want and need to diversify into and which the Government want them to support.

This important financial sector comprises over one-third of the FTSE 250, and 60% of these companies specialise in managing portfolios of real assets and small growth firms. But waves of selling have led to large discounts in these UK investment trusts and added to the overall weakness of the FTSE itself. Between 2014 and 2021, over £70 billion was raised by investment company IPOs and secondary fundraising, but under £1 billion has been raised since then. The problem has worsened since 2013, when UK-listed investment companies were unfortunately included in the EU-derived Alternative Investment Fund Managers Regulations—AIFMR—introduced after the 2009 global financial crisis, when regulators wanted to bring Wild West unregulated vehicles, like private hedge funds, that potentially posed systemic risk under some regulatory control.

By contrast, UK investment trusts were already well regulated under the requirements of stock exchange listing rules and pre-existing corporate and company law. Boards were providing the governance responsibilities that AIFM regulations were intended to provide for unregulated funds, and they were disclosing all their costs transparently in regular shareholder reporting.

As far back as 2009, our Investment Management Association had written to the EU Commission, stressing the importance of the UK listed-investment company structure to UK financial markets and investors, and stressing that they should be excluded from the AIFM classification. Listed investment trusts were far more extensive and important to UK markets than in other EU countries. Nevertheless, in 2013, all these companies were classified as alternative investment funds. This may have been a minor irritation for UK investment trusts, adding extra costs estimated at £50,000 to £100,000 a year for each fund. AIFM duties included cash-flow monitoring services, asset safekeeping and due diligence over net asset value reporting, which generally duplicated some liabilities of the board of directors. It also introduced potential conflicts of interest, as the investment adviser is allowed to double up as the AIFM. But the sector adapted, absorbing the costs.

Clause 1 would exclude closed-ended investment companies listed on a UK-recognised exchange from the 2013 regulations. In subsequent years, EU-derived MiFID rules for financial product distributors, PRIIPs requirements for retail investors, KIDs and further tightening of consumer charge disclosure rules were all unhelpfully applied to UK-listed investment trusts and REITs. The result has been a disaster for many UK investment companies, which must now disclose exaggerated and misleading investor charge figures. In line with the classic boiling-frog principle, each ongoing layer of regulatory change added extra burdens, now reaching the point of existential damage.

Of course, investors must be fully informed of all charges—those that they pay directly out of their investment each year. However, the combination of UK financial regulations, which have evolved to encourage investors to select investments on the basis of lower cost, charge caps introduced for workplace pension funds and flawed rules intended to give consumers full charges information so that they can make properly informed decisions is having the opposite effect.

Regulators decided that charge disclosures should focus on just one figure: the so-called ongoing charges figure, or OCF. I believe in full transparency with no hidden fees, but information must be clear and not misleading, which is precisely where the problems that this Bill seeks to address have arisen. The way in which the FCA applies the EU-derived PRIIPS and MiFID rules to UK investment companies misinforms investors, telling them that they bear costs that they do not actually pay. No other EU country, by the way, applies those same rules as we do. The inflexibility of the UK requirements, focusing on one reported high-level figure, has undermined this sector, worth more than £0.25 trillion. The corporate expenses for managing these funds and their business are labelled as “ongoing investor costs”, making them look artificially expensive to own and driving investors to switch into overseas companies or higher-risk individual shares instead.

The market dysfunction is exacerbated by UK-listed funds which have chosen simply to ignore the legal requirements, without any regulatory consequences, and by overseas competitors receiving unfair competitive advantage. UK wealth managers and pension funds must double-count or exaggerate investment costs, so they have been selling their holdings, despite large discounts. Also alarmingly, flawed OCFs have caused retail investment platforms such as Fidelity to remove UK investment trusts or incorrectly label them as extremely expensive, blocking retail access to funds that invest in areas such as wind farms, solar farms and battery storage—crucial areas for our future sustainable growth. Investors are now selling these good-value assets on the basis of flawed information. I believe that the obsession with driving down costs is also resulting in investors being misled into believing that the investment charge, the OCF, is more important than expected returns and ignoring the vital elements of investment decisions that need to be understood before purchasing assets, such as liquidity factors and discounts or premia to net asset value.

Clause 2 of the Bill would remedy a clear misinterpretation of the wording in the MiFID regulatory annexe, which the FCA has interpreted differently from everyone else. It states that charges which must be disclosed are any deductions from the value of the investment. For listed companies, consumer value is the share price. It does not, and should not, include the management fees or other expenses that are not deducted directly. But the FCA seems not to agree and refuses to bring its own interpretation into line with everyone else’s, despite the damaging consequences for the markets and our economy. This Bill could help Parliament take back control by excluding investment companies from MiFID disclosure rules which should never have been applied.

The Chancellor asked the FCA to remedy this problem urgently in his Autumn Statement, but its subsequent forbearance announcements, widely anticipated, made no difference in practice. It says that it cannot do more under current legislation, but this seems questionable, since it could simply adopt the interpretation that all other countries have given to these same rules. The FCA could just forbear on its own enlarged interpretation to end the misleading charge disclosures. Does my noble friend agree, or could she check with her department, that the FCA could just bring its guidance into line with everyone else in the world so that its own interpretation of the current legislation no longer causes this market and economic detriment?

Clause 3 seeks to remedy an erroneous interpretation of the PRIIPS regulatory disclosure requirements. These cost disclosures need apply only to funds with a redeemable value, so they should exclude investment trusts. Unlike open-ended funds, investment company shareholders have no right to redeem their investment at net asset value on the next dealing day; they must sell at the market price, possibly at a significant discount. The FCA has suggested that such investments are savings products. I am afraid that seems utterly misguided. They are not savings products; they are not used as such. Just because, for example, Sainsbury’s has a share option scheme does not make all Sainsbury’s shares a listed investment company. Removing those companies from PRIIPS charges disclosures would again stop the requirement to mislead the retail investor by telling them that they are paying costs that they do not directly bear. Of course, the costs are still fully disclosed in the relevant documentation that they must produce.

This Private Member’s Bill is a simple, short-form measure to correct regulatory errors that have had increasingly damaging consequences over time. It seeks to offer the fastest-possible legislative route to help industry and regulators uphold the principles on which our financial system is based, as instructed and intended by Parliament.

Sadly, the FCA has failed to take urgent action. Its eagerly anticipated forbearance statement is no resolution and may even add to investor confusion, because UK investment companies now have to report, or are able to report, two different OCF figures, one for the fund KID, which is more correct, and one for the distributor—the OCF—which is still wrong. So the European MiFID template, which is that used by the whole industry for the OCF figure, is unchanged. It is also important to note that the ongoing dithering and delays are leaving many excellent UK investment companies vulnerable to predatory takeover or even to collapse—a collapse that could be alleviated by the rapid issuance of new regulatory guidance, requiring the industry to use EMT data feeds accurately to display correct OCF information. By not requiring these firms to do so, the FCA is responsible for retail platforms and authorised corporate directors but is encouraging them to produce misleading information rather than going by its own statutory duty to ensure that information is clear, fair and not misleading. It is also breaching its duty to ensure orderly markets, maintain international competition and promote growth and sustainable investment in financial markets.

I hope the Government will support this Bill, notwithstanding the apparent concerns that my noble friend the Minister expressed in our recent meeting. Even better, I urge the Government to try to persuade the FCA that it should issue new guidance urgently so that the Bill is not even necessary. I hope that our unique interpretation and application of the legislation, which is damaging vital parts of the UK economy and cutting them off from capital flows at a time when the Government seek to encourage more pension and private funds into productive investments, can be remedied to the benefit of all in society. This Bill is both important and urgent. I beg to move.

--- Later in debate ---

[Baroness Altmann (Con)]

I thank my noble friend for her concluding remarks and engagement with this issue. I hope that she will indeed take some of the messages back to the department because, so far, they do not seem to have been taken on board as seriously as one might have hoped. We all want thriving capital markets in this country, and I thank all noble Lords—I will thank them individually rather than taking up the House’s time now—who each explained so clearly why this is so important.

That is where I would urge my noble friend to focus, because the SIs for PRIIPs and MiFID, even if they were introduced “quickly”—which presumably means in the coming months—would still require further consultation before anything changed in the market, unless listed investment companies are excluded from the definition of the CCI. But that is not the current proposal. We are actually keeping them in there, despite the industry unanimously recommending against that; hundreds of members of the industry have said that this needs to be done. If this is not achieved—and it sounds to me as if it may not be in the plan—the Bill would be the quickest way to resolve the problem that is affecting the market now.

I urge my noble friend to urge her colleagues to speak to the industry, because selling waves have begun again. This is depriving the economy and investors in this country of capital that otherwise would be directed here. It seems there is a sense of complacency at the regulator and a fear of change, even when it is clearly required. As so many noble Lords have said, we need to ensure that investment comes back to the UK.

Could my noble friend perhaps write to me—I hope that we can engage further on the Bill in the coming weeks—on whether it is the FCA’s interpretation of the legislation that is causing the problem? No EU country is interpreting the very same rules in the way that the FCA has applied them to our investment companies. No other investment company, either in the EU or anywhere else, is misleading investors in this same way. If that is the case, the guidance from the FCA could be brought into line with that everywhere else in the world, and that would solve some of these issues in relatively short order.

As I have said, I would be happy to withdraw the Bill or discuss amendments with my noble friend—for example, to add a clause saying that there must be consultation on removal from the AIFMR, if that is considered essential. I hope that the views of the House, which have been unanimously expressed, will prevail, as this matter cannot be left to languish any longer, because the industry of which we are so proud is under existential threat. Capital is fleeing this country and we need it to come back. I thank my noble friend for all her engagement.

Bill read a second time and committed to a Committee of the Whole House.