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In the context of the Withdrawal Agreement and political declaration on the future UK-EU relationship, the BVCA, in discussion with members, has identified the following as the key short term technical needs of the industry:
Below is further detail on the key short and longer-term Brexit regulatory challenges for the industry.
The BVCA’s view has always been that a “no deal”/cliff edge/disorderly Brexit would be a significant issue for the private equity and venture capital industry - for fund managers as well the businesses they invest in and the people they employ. This is because a “no deal” Brexit would mean there is no transitional/implementation period, effectively creating a "cliff edge" on 29 March 2019 whereby UK and EU firms may find that their levels of access to each other's markets are suddenly significantly reduced or, in certain situations, blocked entirely.
The lapse of existing pan-EU passporting regimes that private equity and venture capital firms rely on to undertake efficient cross-border fund marketing and to provide cross-border management and advisory services would necessitate a return to fragmented national regimes. In turn, this would lead overnight to increased regulatory complexity and costs, as well as potential disruption to the continuity of fundraising and the ongoing investment and management of existing portfolios. This would not be in the interests of the industry itself, its investors or the wider economies of the UK and the EU.
Firms have reviewed how they manage their businesses in light of Brexit uncertainty and in some cases have implemented, or started to implement, contingency plans. This type of contingency planning is expensive and typically only available to larger managers, given the costs entailed. It will also depend on the extent to which EU market access is important to firms and their fundraising plans. The majority of the BVCA’s members are also smaller firms that may only raise funds domestically or may not be able to incur the costs related to contingency planning that is difficult to reverse. A transitional arrangement is therefore even more important for smaller firms.
Conversely, an appropriate transition period can be used to provide a bridge to the future trading relationship between the UK and the EU and/or to institute a smoother path to the UK becoming a "third country" under EU law. For example, a number of provisions in EU legislation that refer to marketing or the provision of services by third country firms within EU Member States require appropriate cooperation arrangements and/or information exchange agreements to be in place between regulators in the relevant EU Member States and those of the third country (i.e. in this case, the UK).
Similarly, an EU AIFM cannot delegate portfolio management to a third country firm unless a cooperation agreement is in place between the AIFM's home state supervisor and the regulator in the relevant third country, which is important in the case of Brexit models proposing delegation from an EU AIFM back to a UK portfolio manager. While it is currently expected that national regulators will make every effort to ensure that such arrangements are in place prior to 29 March 2019, a transitional period would mitigate the risk of this not happening. The transition period would also allow national regulators more time to issue appropriate guidance to firms about the regulatory implications of the UK's withdrawal from the EU and any necessary resulting actions.
The November political declaration for a future UK-EU relationship is non-binding and is intended to be a very high level statement that proposes a comprehensive free trade agreement. The following has been proposed on financial services:
This follows the proposals the UK Government published in a White Paper and slides in July 2018. The White Paper stated that the UK cannot become a “rule-taker” given the size and global reach of the UK’s financial centre, which has “markets and products that are often very different from what is found elsewhere in the EU.” It recognised that passporting, as it currently operates, will no longer be available and explores an alternative proposal to maintain a degree of access between the UK and EU markets.
The UK identified a range of governance arrangements used by the EU in various proposed free trade agreements which could form the potential basis to govern the UK-EU future framework. For example, it suggested that this could involve the use of consultation prior to either party changing financial services rules relied on by the other, technical mediation, specialist financial services expertise to help resolve disputes and/or an annual dialogue to develop consistent standards. In recent speeches, UK Government ministers and UK financial services regulators have referred to an approach that is based on similar regulatory outcomes (like the EU’s recent deal with Japan) and not identical rules.
The White Paper proposed building on the system of "equivalence" under existing EU financial services law. "Equivalence" has a technical legal meaning in EU legislation. It applies to situations where single market access or recognition is given by the EU to third country persons for specified purposes. For instance, under MiFID II, EU investment banks are generally banned from trading shares on non-EU markets if those shares can be traded on EU markets. Where a non-EU market is recognised as "equivalent", this allows EU investment banks to trade shares on that market.
The current system of equivalence allows the EU to take unilateral decisions to grant or rescind equivalence decisions. The UK is concerned that this approach would fail to reflect the existing alignment between the UK and the EU. Whilst proposing that the new arrangement respect the autonomy of each party over decisions regarding access to its markets, it also proposes that the "equivalence" arrangements should be more certain for participating firms. These proposals have been referred to as “enhanced equivalence” in the UK.
Given the time spent on withdrawal matters, there have been limited substantive discussions on a framework for a future relationship with the EU. However, in July 2018, Michel Barnier publicly rejected the UK's proposals for enhanced equivalence, arguing that they would be an unacceptable interference with the EU's decision-making autonomy and its established policy of unilateral equivalence assessments.
The EU does not have a single "equivalence" regime governing all aspects of financial services. For private equity and venture capital firms, the regime of most relevance is AIFMD. The third country AIFMD passport regime, as currently drafted, is not appropriate for the UK private equity and venture capital industry and we are not in favour of it being activated, as there are a number of problems with the "equivalence" concept in this regime. In addition, EuVECA does not have a third country regime.
First, under AIFMD it is not currently possible for firms headquartered in a non-EU jurisdiction to market into the EU based on equivalence. This can only be activated by the European Commission after receiving a positive assessment from ESMA. The European Commission stated in December 2017 that third country passports “will not be granted until the right level of supervision and enforcement is in place” and that “it is not likely that we will take a decision on this soon…”. AIFMD itself would have to be amended in order to change this.
Second, it is not clear whether any UK firm would want to use the equivalence process to market AIFs across the EU or manage EU AIFs, rather than set up in the EU 27. The principal difficulty is that it would require UK AIFMs to become authorised in their EU "Member State of reference" as well as in the UK. The Member State of reference is determined according to a series of complex provisions set out in AIFMD. This structure is unattractive for two key reasons:
The regime does not, in any case, appear to be attractive for the industry because it requires full compliance with the AIFMD even if a firm is currently sub-threshold. In addition, it is unclear whether many firms would want to use it if they have already set up an EU AIFM in anticipation of Brexit.
Whilst a third country passport could be more efficient than accessing EU investors through individual EU Member State NPPRs, there are several other issues with it. Our key concerns are noted below:
The BVCA will formulate a more detailed position on a post-Brexit model for financial services as the parameters for the future arrangement with the EU become clearer. The detailed negotiations are not expected to begin until 2020 due to European Parliamentary elections and new appointments in the European Commission in 2019.
Following the UK referendum, we established the following key priorities for the industry, in discussion with our membership.
A key priority for our industry is to ensure that UK firms retain access to EU investors and vice versa. Choice is essential for investors to ensure portfolio diversity and access to the best returns for their ultimate beneficiaries, which include pension funds, university endowments and insurance companies.
Private equity and venture capital funds are generally structured as limited partnerships which classify as "Alternative Investment Funds" under the EU's Alternative Investment Fund Managers Directive. The ability of a fund manager to market their fund to EU investors is determined by AIFMD together with local laws specified on an individual Member State basis.
EU PASSPORT (full scope AIFMs):
For firms marketing with the passport, a sensible transitional arrangement between the UK and the EU27 needs to be in place to avoid a cliff edge on “Brexit day”. For example, without a deal in place, a UK-based fund manager partway through raising funds from EU investors using an AIFMD marketing passport, would cease to be an EEA AIFM mid-fundraise and would have to cease its activities, leading to significant business disruption. This would have a negative impact on the fund manager, its prospective and existing investors and indirectly, business partners and other financial institutions. Similar issues arise for firms that are using the AIFMD passport to manage funds in other parts of the EU on a cross-border basis.
Given that the fundraising cycle for a new fund can last from six months to two years, this poses a real risk. The risk for UK managers is that either (i) they may be unable to make new investments in the real economy because they are no longer able to raise funds due to the potential cliff edge or (ii) they decide to move staff to the EU and establish an office from which they can raise the fund in a way which avoids the cliff edge risk.
This issue also poses a significant risk for EU investors. Currently those investors rely on the passport system to invest into UK managed funds. Following the introduction of AIFMD, the added costs of compliance meant that there was not a simple and cost effective way for non-EU managers to access EU investors. As a result, many smaller managers (including many US managers) stopped making funds available to EU investors. There is a risk that this issue will be amplified post-Brexit for EU investors because of the significant investment made by such investors into UK-managed funds. EU pension schemes and insurers rely on their investments in UK funds to generate investment returns. Limiting their investment universe would affect them adversely.
NATIONAL PRIVATE PLACEMENT REGIMES (non-EU and small UK AIFMs):
A further risk is that UK firms start seeking to use NPPRs post-Brexit, if the EU passport is unavailable (as looks likely), but Member States then unilaterally restrict firms' ability to rely on these. Well-functioning European NPPRs are essential to maintaining global capital flows and must be preserved even if a third country passport under AIFMD becomes available. This is a point that has been made consistently by the BVCA and Invest Europe in representations on the Capital Markets Union project, as well as consultations on the AIFMD third country passport. There is a growing appreciation of the complexities associated with obtaining access to the EU’s single market through passport and equivalence regimes. This includes the practical challenges of using the proposed AIFMD third country passport in its current form and the sustainability of any future equivalence determination. As there is no date for the completion of this work, this area remains uncertain for an industry that requires a level of clarity in order to set strategic plans and make long term investments.
Therefore, as a minimum, European NPPRs must remain open to UK (and non EU) firms, even if third country access is granted to UK firms through a new relationship with the EU.
THE DELEGATION MODEL:
Some firms are implementing or have implemented contingency plans to secure continued access to EU investors post 29 March 2019 (the date the UK is expected to leave the EU). This option entails setting up an EU AIFM and delegating portfolio management activities to a non-EU firm. This is permitted under AIFMD and enables firms to continue to utilise the marketing and management passports available under AIFMD. Luxembourg and Ireland are the EU Member States being used for this option and Luxembourg AIFs are increasingly popular fund vehicles. The current rules on delegation under AIFMD operate effectively and must not be made more restrictive. The Co-operation Agreements/Memorandum of Understanding required to be in place between the UK and EU National Competent Authorities/Regulators must be agreed and put in place as soon as possible.
Between 2011 and 2015 the European Investment Fund (EIF) invested €2.3 billion into start-ups and SMEs via UK venture capital and growth funds, which mobilised an additional €13.8 billion of private capital. It is essential for UK start-up and SME growth that this funding is preserved post-Brexit and we have been recommending to Government this could be done via the British Business Bank's programmes.
We therefore welcomed the Chancellor’s announcement in 2017 of an action plan to unlock £20 billion of investment over the next ten years following the Patient Capital Review. The BVCA is working with the Government and the British Business Bank on the review’s outcomes and in particular the:
Below we have set out the implications of a “no deal” Brexit for the EuVECA fund market.
A workable arrangement between the UK and the EU needs to be in place to avoid a cliff edge on 'Brexit day'. This is as important to EU investors and businesses as it is to those in the UK.
The central concern arising from our discussions with members on Brexit is the uncertainty. Firms reviewed how they manage their existing businesses in light of this. This entails our members analysing whether or not to locate part of their business in another EU Member State to ensure continued access to EU markets. This type of contingency planning is expensive and typically only available to larger managers, given the costs of seeking professional advice and scoping out potential operational changes. The majority of the BVCA’s members are in fact smaller firms that may not be able to incur the costs related to such contingency planning. A set of transitional arrangements that increases certainty in the short and longer term is therefore doubly important for smaller businesses.
These and other issues relating to potential transitional arrangements are set out in the BVCA’s detailed response to the UK Treasury Select Committee’s call for representations on possible transitional arrangements.
For BVCA member firms, the key points related to the transition period are:
The BVCA’s view has always been that a ‘no deal’/cliff edge/disorderly Brexit would be a significant issue for the private equity and venture capital industry - for the fund managers as well the businesses they invest in and the people they employ. This is because a no deal Brexit would mean there is no transitional/implementation period and, for those firms that have opted to set up fund management entities in the EU with a ‘delegation model’ (as permitted under AIFMD), the co-operation agreements between regulators that are required for that model to work are unlikely to be in place.
The private equity and venture capital industry is people-driven.
UK portfolio companies cannot grow without access to the right people from around the world. This means a whole spectrum of employees, including the entrepreneurial, highly skilled and highly mobile segments of the global workforce.
Business growth is also dependent on the UK’s capacity to attract skilled and experienced investment professionals, with the ability to source capital and effectively deploy it where it is needed.
Continued access to the EU workforce at all levels is therefore crucial to the industry, and it is unsurprising that 52% of respondents to an Ipsos Mori survey of 200 key decision-makers at BVCA member firms thought that allowing businesses to continue to employ talented people from around the world should be the Government’s main priority in negotiations.
The BVCA has therefore been in discussion with Government on the areas the UK will need to consider as part of a new migration system.
One of the key tax issues on leaving the EU is that the UK may no longer be able to benefit from various EU treaties, tax directives and regulations. Firms are reviewing whether withholding tax could, in the future, be imposed on cash flows of interest and dividends up to UK holding companies within portfolio groups. This will impact investor returns in situations where investors suffer more tax on investments made through a fund than if they had invested directly.
All EU Member States are party to two European Directives which remove withholding tax on dividends, interest and royalties in most cases – the Directive on parent companies and subsidiaries in different Member States (commonly known as the EU Parent-Subsidiary Directive) and the Interest and Royalties Directive. If the benefit of these Directives is lost following UK’s exit from the EU, the use of UK holding companies for investments within the EU may be impaired due to potential for tax leakage on dividends and interest paid by an EU subsidiary to its UK parent. While it should still be possible for the relevant double tax treaty to apply, the UK’s treaties are not always as beneficial as the EU Directives because they do not always provide for nil withholding tax on dividends and interest. Any transitional and future arrangements would need to address this issue.
There is a range of ways that BVCA members can keep up-to-date with the latest developments affecting the industry. Members can sign up for updates in the following areas by logging in with their organisation e-mail and adjusting their preferences here, whilst non-members can sign up to receive certain updates here.
BVCA Insight is the weekly email delivering in-depth political analysis and commentary from our Director General.
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The BVCA Brexit Bulletin is a new monthly newsletter designed to provide our members with the latest developments related to the UK’s departure from the European Union.
The UK's decision to leave the EU has changed the priorities on our policy agenda overnight. The UK has not officially left the EU and so the current legal and regulatory framework we have in place continues to apply to our member firms. The FCA has made it clear that it still expects firms to continue to abide by their obligations under UK law, including that derived by EU law. Furthermore, this includes firms' implementation plans for legislation that is still to come into effect. Whilst we are fortunate we are not in the midst of negotiating an EU file as substantial as the AIFMD, firms will need to continue to navigate the implementation of MiFID II, the Market Abuse Regulation, PRIIPs and the Fourth Anti Money Laundering Directive.
These updates keep members updated of the work being undertaken by the BVCA's Taxation, Legal & Technical and Regulatory Committees, including that related to Brexit.
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The Brexit Primer sets out key information regarding the upcoming negotiations, the grounds on which they will be approached, the process for negotiations, relevant legislative developments in the UK, and the institutions that will be involved.
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In March 2016, we published the results of a survey of 200 key decision-makers conducted by Ipsos MORI. At the time, 83% of business leaders of companies backed by private equity and venture capital believed that remaining in the EU would be best for their business, while 78% felt Brexit would have a negative impact on the overall economy.
Ipsos MORI carried out a second survey following the EU referendum result, interviewing 200 key decision makers at portfolio companies. The results were published in October 2016 and found that economic confidence has fallen significantly since the previous survey from March. Forty percent of respondents now believe economic conditions have worsened over the past 12 months and 45% think they will get worse, an increase of 30 percentage points for both statements. There is a resilient optimism over their own prospects; 63% say that business has improved over the last 12 months - down a modest six percentage points - and 70% believe it will get better in the coming year – a decrease of 14 percentage points. Innovation and product launches were the most likely reasons for improvement.
The BVCA’s role in discussions with government and the wider business community is to:
Most of our conversations with policymakers now make at least some reference to Brexit. Here we have gathered examples of our policy work where the emphasis falls most heavily on Brexit:
Competitiveness: we hold frequent meetings with HMT and the FCA to explain and promote industry priorities, in the context of the government’s policy objective of increasing the competitiveness of the UK as a place to do business.
Patient Capital Review: we were an important stakeholder in HMT’s consultation on Financing Growth in Innovative Firms, and continue to promote UK venture financing and risk capital incentive structures. Read more here.
EU financial services rules: British private equity and venture capital has and will retain a strong interest in EU-derived regulation now and post-Brexit. We remain engaged with HMT and the FCA on UK implementation of initiatives like AIFMD II, MiFID II and other files (see below for more information on our engagement with EU institutions). You can keep up to date here.
Green Paper on Industrial Strategy: our response to BEIS’ Green Paper provides extensive detail on the benefit of a thriving private equity and venture capital industry and its role in the scale-up ecosystem. It also sets out a wide-ranging analysis of key issues for the industry in relation to Brexit.
Limited partnership law reform: in light of Brexit, the recent modernisation of UK limited partnership law promoted by the BVCA was a welcome step towards maintaining the competitiveness of the UK as a fund domicile. We are now working to avoid any future lessening of the impact of these reforms that might be caused by the government’s work on the abuse of Scottish Limited Partnerships. You can read more here.
Ongoing policy work affecting transactions: Please refer to our updates (available here) and policy submissions (available here) on areas that affect investments into UK businesses including, corporate governance reforms for large private companies (see here), the national security and investment review and pensions reform.
We work with Invest Europe, our sister-organisation in Brussels, to deliver influential messages to key bodies and individuals throughout the EU legislative process, from front line formulation (EBA and ESMA) through Commission (principally DG FISMA and DG Justice) proposal stage, then at the Parliamentary and Council levels, before going back to regulators during level three implementation.
We are particularly engaged on the Commission’s review of the European Supervisory Authorities, ESMA’s opinions on “relocations” from the UK, and the EBA’s proposals for a new prudential regime for investment firms (which would disproportionately affect UK firms).
Please refer to our technical updates available here.
We have close connections with the real estate, hedge fund, public markets, banking and general business communities. These relationships give our industry a range of valuable insight on the broader challenges posed by Brexit, help the BVCA to formulate common positions, and allow us to co-ordinate cross-sector engagement with the authorities where possible.
Organisations that we work particularly closely with include AIC, AIMA, AFME, AREF, BPF, CBI, CityUK, City of London Corporation, EMPEA, We Are Guernsey, ILPA, INREV, IRSG, Jersey Finance, JTAG, NVCA, UK Finance and others.
FOR FURTHER INFORMATION PLEASE CONTACT THE BVCA
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