Alternative Investment Fund Managers (Amendment etc.) (EU Exit) Regulations 2018

Lord Bates Excerpts

Tuesday 15th January 2019 Grand Committee

Moved by

[Lord Bates]

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.

[The Minister of State, Department for International Development (Lord Bates) (Con)]

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.

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[Lord Bates]

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.

[Lord Tunnicliffe]

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.

[Lord Bates]

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.

[Baroness Bowles of Berkhamsted]

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.

[Lord Bates]

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.

Motions agreed.