FFS0010

Written evidence submitted by the Association of Investment Companies

1. The Association of Investment Companies (AIC) is the membership association for publicly traded closed-ended collective investment companies, including investment trusts, venture capital trusts (VCTs), real estate investment trusts (REITs) and non-EU investment companies.  Our non-EU members are primarily domiciled in Guernsey and Jersey.  AIC members are referred to, collectively, as “investment companies” for the rest of this paper.

2. The AIC’s membership represents 358 investment companies, managing assets of over £165 billion (representing 89% of the industry by asset value).  Further information on investment companies is set out in the Annex.  The AIC has focussed its submission on the issues specific to the investment company sector.

3. The UK is the only EU Member State with a significant investment company sector.  Investment companies available via UK markets include UK and non-UK (nearly all Channel Island) domiciled companies.  Wherever individual companies are based they overwhelmingly rely on UK market infrastructure and employ UK managers and advisers.  In contrast, half of other EU Member States have no investment companies available to their domestic investors.  Others tend to have only one or two.

4. The presence of a large and growing investment company sector is a significant UK asset to the UK economy.  It supports the City’s role as a global financial centre.  It enhances the UK’s capacity to offer diverse and innovative investment propositions to institutional and retail investors.  Investment companies have structural characteristics that enable them to offer a wider range of assets than open-ended funds.  This helps the sector deliver strong investment returns and act as an alternative (non-bank) source of funding for UK businesses and infrastructure projects.  The structural differences of investment companies create diversity in the funds sector that can help mitigate systemic risks arising from asset management.

5. Given the low EU investor demand for investment company shares (see the Annex for further details), primarily for cultural reasons, and therefore the reduced significance of market access, the AIC believes that the future relationship with the EU should accommodate a ‘differentiated’ system of funds regulation to maximise the UK’s global competitiveness.  This would involve setting separate rules for funds:

• Marketed in the UK and globally but not in the EU.  These should only have to apply UK derived rules. These funds should be available to EU investors where there is no active marketing into the EU under the Alternative Investment Fund Managers Directive (AIFMD) provisions on “reverse solicitation”.

• Accessing the EU on a country-by-country basis. This would involve applying both UK specific rules and the obligations required by the AIFMD National Private Placement Regime (NPPR).

• Accessing the EU on a passported basis.  While no passported access is currently available for third-country funds/AIFMs, the AIC anticipates that the UK will be seeking an AIFMD passport if this option becomes available, as well as trying to maintain existing rights of access for UK UCITS.  However, an AIFMD passport should only be secured as long as this does not mean losing state-by-state access on the current terms.

A tailored UK regime

6. For those funds which are not actively marketed into the EU and do not choose an explicit European opt-in regime, the AIC recommends that a tailored UK regime should be developed. 

7. This would not be a “race to the bottom” as far as UK regulation is concerned.  That said, many aspects of regulation introduced since the financial crisis have not fully recognised the characteristics of non-UCITS funds, such as investment companies.  EU funds regulation creates unnecessary compliance burdens and costs, particularly for investment companies, without benefiting investors.  Creating a separate rulebook for funds not sold in the EU could remedy and create a more sympathetic and commercially attractive regime while maintaining high standards of investor protection and market integrity.

8. Withdrawal from the EU will allow UK policymakers to reconsider, and recalibrate, UK regulation to:

• Reduce unnecessary compliance burdens while maintaining regulatory standards;

• Maximise the UK’s capacity to offer cost-effective, innovative, investor-focussed and internationally competitive investment products;

• Promote the UK’s position as an international financial centre;

• Support a range of investment products best able to secure strong long-term investment performance for institutional and retail investors; and

• Maximise the ability of the funds sector to provide capital directly to UK business.

See the Annex for a list of areas for possible reform.

Enhancing attractiveness of investment companies outside the EU

9. The FCA and the Securities and Futures Commission (SFC) of Hong Kong has entered into a Memorandum of Understanding on Mutual Recognition of Funds (MoU) concerning Mutual Recognition of Covered Funds and Covered Management Companies.  Whilst such an MoU is welcome, the AIC is concerned that the definition of UK Covered Funds is restricted to certain types of UCITS Funds operated by UK management companies.

10. In a speech given by Megan Butler, Executive Director of Supervision – Investment, Wholesale and Specialists delivered at the Pan Asian Regulatory Summit in Hong Kong on 8 October 2018 she said “At the moment, UK Undertakings for Collective Investments in Transferable Securities (UCITS) operated by UK management companies that can meet the eligibility requirements set out in the MOU will be eligible to apply.”  This suggests that the MOU could be extended further.  

11. The AIC would welcome any extension of the MOU between the UK and Hong Kong to closed-ended publicly traded investment companies and the negotiation of similar MoUs with other jurisdictions outside the EU to facilitate the holding of investment company shares by residents of other jurisdictions.

12. The AIC recommends that all future discussions over mutual recognition of funds, and associated issues, include consideration of investment companies as these structures are not currently covered by arrangements for mutual recognition of collective investment schemes.

Next steps

The AIC is keen to participate fully in discussions on the issues raised by this submission.  Please contact the AIC with any queries or observations on the points set out above.

March 2019

Annex

Background

1. Closed-ended investment companies are collective vehicles which pool their shareholders’ capital and hold a portfolio of assets to spread risk and generate investment returns.  Investments include listed securities, private equity, debt, property and infrastructure.  Investors access these funds by buying their shares, usually via the main market of the London Stock Exchange (LSE).

2. Investment companies:

•            have independent boards with legal obligations to operate the company in the best interests of shareholders;

•            are owned by shareholders and returns accrued from the underlying portfolio are paid out as a dividend or contribute towards the capital growth of the company;

•            often do not have employees. Most investment companies appoint an external investment manager and outsource other services;

•            are regulated via company law, rules designed for the ‘funds’ sector, notably the Alternative Investment Fund Managers Directive (AIFMD) which includes rules on leverage, and stock market rules e.g. the UK’s Listing Rules, Disclosure Guidance and Transparency Rules, and Prospectus Rules. Investment companies must also comply with the relevant accounting standards.

Current levels of access to EU markets

3. It is difficult to obtain specific figures on the value of investment company shares owned by investors based in other EU Member States as they are predominantly held via nominees, which obscures the identity of beneficial owners.  The AIC estimates that non-UK EU investors hold less than 5% of the sector.  This is explained by various factors.  Other EU jurisdictions tend not to act as domiciles for investment companies nor do their stock markets admit their shares to trading.  Investors in other Member States therefore do not have a cultural or commercial familiarity with funds of this nature.  Fund distribution in other Member States is often via banks and insurance companies, which customarily offer open-ended-funds.  Undertakings for the Collective Investment in Transferable Securities (UCITS) dominate the EU funds market, with around 80% of market share.  When combined with non-UCITS structures, open-ended funds represent over 95% of the EU funds market.   However, UK domiciled open-ended investment funds had funds under management of just over £1 trillion with less than 5% held by overseas investors (source: Investment Association). 

4. Investment companies have had the ability to access EU investors for many years.  The Consolidated Reporting and Admissions Directive (CARD) and the Prospectus Directive created a framework for their shares to be admitted to trading on EU markets.  This opportunity has never provided significant benefits to the sector. 

5. The AIFMD also allows investment companies to access investors in other EU Member States. This can be done with a passport where a UK-domiciled investment company has a ‘full scope’ Alternative Investment Fund Manager (AIFM).  Companies with a small UK AIFM, or those domiciled outside the UK, can secure access on a state-by-state basis under the National Private Placement Regime (NPPR).  Currently these involve making disclosures and adhering to the ‘private equity’ provisions (as required by Article 42 of the AIFMD).  UK AIFMs, and AIFs, would also have to comply with any additional requirements set by Member States.  Where the AIF is available to retail investors, the product manufacturer would have to ensure that a Key Information Document (KID) is available (as required by the Packaged Retail and Insurance-based Investment Products (PRIIPs) Regulation). 

6. No significant investor demand from the EU has been realised as a result of these mechanisms.  Generally speaking, investment company AIFMs have not actively sought to make public offers or placements to investors in other Member States.  Also, investment company shares have not been the subject of wider, general, marketing/financial promotion efforts.  There are occasional cases where such activity has occurred, but this is exceptional.

7. Where investment company shares are held by investors based in other EU Member States, often these holdings have been secured via ‘reverse solicitation’.  That is, without the benefit of active marketing, where the purchase is at the instigation of the investor.

8. Retail investors are a significant component of investment company shareholders. The AIC estimates that half of the sector is held by retail investors.  The AIFMD allows Member States to prevent retail access or impose additional obligations for sales in this market.  This reduces further the benefits of access to the EU for the investment company sector.

Review of EU rules to create tailored UK approach

9. The AIC recommends that the UK’s intention should be to implement an active programme to review these provisions with a view to creating a tailored UK approach.  In the first instance, this process of review and revision should include prioritising a number of key policy areas. 

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