Alternative Investment Fund Designation Bill [HL]

Baroness Bowles of Berkhamsted Excerpts

2nd reading
Friday 1st March 2024 Lords Chamber

[Baroness Bowles of Berkhamsted (LD)]

My Lords, I declare my financial services interests as in the register. I congratulate the noble Baroness, Lady Altmann, on her speech and on the great energy that she has put into seeking clarity for the consumer, and fairness for listed investment companies and their investee businesses.

A series of legislative time bombs planted under listed investment companies have culminated over the past two years to force misleading information to consumers and strangle a thriving sector that is over a third of the FTSE 250. The first bomb was the alternative investment fund managers directive, and this Bill starts by excluding listed investment companies from the UK version. Industry representations to the EU Commission in 2009 explained that listed investment companies were already significantly regulated and transparent, but they were never explicitly excluded—and indeed the UK itself then removed wriggle room that other countries use. This was the start of the UK ignoring the fundamental structure and regulation attached to a listed company.

AIF categorisation meant that these listed companies had to have fund managers and reporting requirements that are expensive and duplicative of listing requirements and set aside the proper role of company directors. Then the FCA further railroaded listed investment companies along a track that should never have existed. It was the start of pretending that they are the same as open-ended funds when they are not, and the start of misleading consumers into thinking that they should select by the same criteria, focused on assessed net asset valuations and fund manager costs rather than the real market value of shares, bought and sold using the established indicators of premium or discount that signpost market sentiment about assets, performance and costs or expenses. Explicit details of each of those were always presented anyway.

AIF classification seeded the treatment of a listed security as a financial product, which is remarkable given that the definition of a financial product is that it has a value derived from reference values not set by the market. But ignoring market valuation is a central plank of the FCA’s excuses for levering listed investment companies inside subsequent legislative bombs when the EU legislation itself actually did not.

Bomb number two came along with packaged retail investment and insurance products legislation. The clue is in the name—“products”—and as I have said, a listed security is not a financial product, but the FCA pretends it is. The PRIIPs legislation even contains its own definition of the collective investment undertakings to be included. The definition is:

“an investment ... where the amount repayable is subject to fluctuations because of exposure to reference values or the performance of one or more assets which are not directly purchased by the retail investor”.

But listed company shares do not have an amount repayable; you sell the shares on the stock exchange. This is among the issues I have challenged with the FCA. It reverts to suggesting—albeit in witnessed mumbled verbal comment rather than a written response, but witnessed—that there “can sometimes be amounts repayable, in some circumstances”, by which it means insolvency, hardly a mainstream interpretation. In Ireland, when the then FSA’s interpretation first became known, three counsels’ opinions were commissioned, all of which stated that listed investment companies did not fall within the definition, so Ireland kept them out, as did everybody else.

Listed investment companies can be found on stock exchanges all over the world but only the UK, through the FCA, maintains its own irrational interpretation that differs from common understanding. As a consequence, the tangle of ill-fitting and misleading disclosure requirements started which has destroyed the market. Clause 3 removes listed closed-ended funds from the misapplied cost methodology in PRIIPs.

The coup de grâce came via MiFID II in 2018, when Investment Association guidance—it insists that it follows FCA interpretation—resulted in the UK forcing firms to allocate listed investment companies’ corporate expense numbers into an EU-wide industry reporting data template, which then displays them as ongoing cost forecasts on platforms such as Hargreaves Lansdown, AJ Bell, Fidelity and so on. The displayed information indicates that there are ongoing charges in connection with holding listed investment companies. This is untrue, of course, because the share price has already factored them in: that is what you have bought, and that is why every other country puts “zero” in the template. It also feeds in to wrongly elevate the costs of funds holding investment companies. Everyone in this chain of misinformation, from authorised corporate directors to platforms, is part of an FCA-sponsored failure of consumer duty that has killed off investment by frightening away consumers and causing fake breaching of cost caps.

This coup de grâce would never have happened if the legislation were interpreted as written, but the FCA has, again, its own conniving explanation to wheedle listed investment companies into a slot where they do not belong. It deliberately misinterprets “value”. The annexe of the MiFID Commission delegated regulation is clear that only deductions from the value of the investment should be aggregated as ongoing costs, because that is what the investor loses. But the FCA insists that deductions from assessed net asset value must be included in the cost disclosure and, as a direct consequence, the investor is informed as if they have to pay them again, and annually, when the truth is that the efficiency of the company and its expenses are already taken into account in the actual market share price—share price undeniably being the investment value to the consumer.

Ignoring the harm, the FCA listens to voices urging this fake comparison with open-ended companies. You might as well compare ice cream and toothpaste—they are sometimes both white—even while the FCA’s own consumer panel is warning against simplistic measures such as these. Nowadays, even the superficial similarity with open-ended funds is gone, with most listed investment companies investing directly in real economy assets, not other listed equities. Meanwhile, the FCA takes no action against a few large firms that do not comply, probably knowing it would lose the litigation, showing inconsistency and further distorting competition, knowing that ACDs and smaller firms cannot take the risk.

The FCA also claims that it cannot help, as it has no leverage over an industry-run reporting template, despite the fact that it is based around the FCA’s core misinterpretation and all the actors are regulated by it. It would have to say only, “It is really a zero”, but the leading official has said—witnessed, in the presence of their superiors and more than once—that they do not want zero and “What’s the problem? They can always not list under chapter 15”. That means that they are reading different listing rules than I am. Clause 2(3) clarifies that, for closed-ended listed investment companies, the value is the share price. Other amendments clarify that there is nothing relevant in UCITs.

[Baroness Swinburne (Con)]

My Lords, eight minutes is guidance, but we appreciate it if people try to stick to it. If the noble Baroness will close, I will be very grateful.

[Baroness Bowles of Berkhamsted (LD)]

I will exercise my privilege to continue, if the House is willing. It is necessary for such an important subject.

The FCA alleges that it cannot change the rules to undo the misleading cost allocations, as they are in retained EU law, but as has been said, it has to change only its own interpretation. For the record, the damage that the FCA’s illegal, irrational and inconsistent interpretation is causing includes: some £15 billion and counting of lost investment in real UK assets that has largely gone overseas; depriving SMEs in manufacturing, technology and infrastructure companies in the real economy of investment, affecting jobs, tax revenue and causing cheap asset sales to foreign buyers; depriving consumers and pension funds of investment opportunity in the real economy; and causing reputational damage to UK markets and regulation. And, yes, we are being laughed at for this mess. EU people phoned me up at Christmas to tell me that.

Add to that harming international competitiveness and presiding over a market failure caused by knowingly tricking the consumer, and I ask myself how many jobs should go at the FCA. Do not be fooled into thinking that it cannot do anything. It is “won’t”, not “can’t”, and it is accountable for that. If nothing is done, our system is demonstrably broken. This Bill and Parliament can offer a fix.

--- Later in debate ---

[Baroness Vere of Norbiton (Con)]

I will come on to gold-plating. I am not entirely sure that everybody is in alignment on whether or not this regulation is implemented, but consultation is just good government. I do not see us making substantial changes to the regulatory scope on the basis of having not done it before we are not going to do it now. We need to get it right, but we absolutely support the investment company sector and want to get on with this. That is why I am so grateful to my noble friend Lady Altmann for bringing this forward, allowing us to have a conversation in the Treasury and beyond.

I turn to the second element: cost disclosures. My noble friend Lady Altmann has rightly identified that EU-derived legislation is not currently fit for purpose, as many other noble Lords, the Government and the Financial Conduct Authority would agree. The packaged retail and insurance-based investment products regulations, commonly and more easily known as PRIIPs, were originally meant to provide more transparent and standardised disclosure for retail investors across the European Union. Noble Lords are well aware that there are many problems with the EU PRIIPs regulation. It is prescriptive, misleading to retail investors and prioritises comparability over a wide range of financial products at the expense of consumer understanding.

That is why, as part of the Edinburgh reforms, the Chancellor announced that, as a priority, the Government would reform PRIIPs. We have already made significant progress on delivering this commitment. Most recently, at the Autumn Statement last year, the Government published a draft statutory instrument to replace PRIIPs with a new framework tailored to UK markets.

We understand industry’s concerns regarding broader legislation that prescribes firms to calculate their costs as they are required to do so now, and so the Government and the regulator have not stopped there. At the same Autumn Statement, the Government announced that they would bring forward the repeal of relevant cost disclosure provisions in the markets in financial instruments directive, or MiFID, alongside the replacement of PRIIPs.

Many noble Lords have mentioned that the FCA has published the forbearance statement, and some feel that it has not gone far enough. I will ensure that the FCA is made aware of the debates that noble Lords have had today. There has been significant criticism, which it will no doubt be interested in, and some suggestions of how it might be able to go forward.

I hope that this brief summary has provided sufficient reassurance to my noble friend Lady Altmann, and to all noble Lords, that the Government are treating this as a priority. We have a comprehensive plan to alleviate the harms faced by the investment company sector, but are committed to making sure that we get it right for the long term, to ensure that 150 years already gone by becomes another 150 years in the future.

I have mentioned consultation, so I will move on from that to cover some points raised in the debate on timelines. I accept that, for many noble Lords, and indeed Ministers, it is never fast enough. This was mentioned by my noble friend Lord Hannan and the noble Lord, Lord Macpherson. We are delivering a very ambitious programme to build the smarter regulatory framework for financial services. At Mansion House, the Government removed almost 100 pieces of unnecessary EU legislation from the statute book, and now we are looking at wider reforms—those mentioned in the debate today and others, including Solvency II—that will deliver the biggest potential benefits.

I note that my noble friend Lord Hannan would have liked us to go through things in a different way. The Treasury is very much focused on looking at where we can have the biggest and quickest potential benefits to economic growth. We are conducting a phased approach to bringing in this change of regulation because we must also ensure that the system and different financial sectors can cope with this change in legislation.

I note the invitation from the noble Lord, Lord Macpherson, to make commitments from the Dispatch Box on certain matters. I am not able to do so just yet—maybe soon.

There is debate around gold-plating. I hope that that will all be laid to rest as we are able to reform this and ensure that we have the right framework going forward.

My noble friend Lady Altmann mentioned investment companies being removed from platforms. We note and recognise the frustration that some investment companies feel at having been removed from investment platforms. I reassure her that, although this is a commercial decision, the Government and the FCA are well aware of this issue and are carefully considering what options are available. Ditto in the use of the EMT, the MiFID template. This is a voluntary template, but we understand that it may not be providing the best information to retail investors at the current time.

Many noble Lords have noted the competitiveness of the UK capital markets. That is what underpins the smarter regulatory framework. Despite recent challenges, the UK has many vibrant and dynamic capital markets, and they remain some of the deepest and strongest globally. However, we cannot rest on any laurels; we have to keep moving forward in this area. That is why the Government are delivering on my noble friend Lord Hill’s listings review, the wholesale markets review, and the Chancellor’s Edinburgh and Mansion House reforms.

The noble Lord, Lord Davies, mentioned the FCA’s activities and scrutiny of the regulator’s role. My noble friend Lord Reay mentioned the FCA’s D&I work, as did the noble Baroness, Lady Kramer. Parliament does have scrutiny over the FCA and many other regulators. Assimilated law is being replaced, in line with the UK’s domestic model of regulation. This means that the UK’s independent financial services regulators will generally set the detailed provisions in their rulebooks, instead of firms being required to follow EU law. This approach was following two consultations and it received broad support across the sector. Parliament debated this approach during the passage of the Financial Services and Markets Act 2023, and it secured parliamentary support then.

The Government recognise the importance of effective parliamentary scrutiny of the regulators, including their approach to rule-making and other activities that they may choose to undertake. That is why FiSMA 2023 introduced additional mechanisms to strengthen Parliament’s existing ability to scrutinise the regulators’ work, including requirements for the regulators to notify parliamentary committees, such as the new Financial Services Regulation Committee, of their consultations and to explain, when publishing final rules, how representations by parliamentary committees have been considered. I warmly welcome the formation of that committee. It will be hugely helpful, and it is quite right and proper that independent regulators are held to account by Parliament.

I will write with a few further comments on the investment in the UK capital markets by UK pension funds and on a few other issues which have arisen and need a fuller response. For the time being, I am very grateful to my noble friend Lady Altmann and many other noble Lords for their continued championing of the investment company sector.

[Baroness Bowles of Berkhamsted (LD)]

I am sure that my interruption is unwelcome, for which I apologise, but it is quite important. Further consultations have been measured and, as my noble friend Lady Kramer pointed out, the aspects of PRIIPs and MiFID where there has been gold-plating that is causing these problems were never consulted upon. It is within the gift of the FCA to make changes.

These cost disclosure issues have featured massively already in two consultations from the Treasury on PRIIPs and in evidence that was submitted to the Treasury last summer, after my own attempt to amend FiSMA 2023. On these discrete issues, legislation does not need to be amended; what the FCA is doing needs to be amended. Support has been heard from these Benches and the Labour Benches for the Government taking more intrusive action. Has that message been received or are we still bogged down in officialdom and consultations? That is what we want to know.