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December 2020 saw the United Kingdom (UK) and the European Union (EU) agree on a trade deal which allows both parties to continue trading in goods free from tariffs and quotas. The EU and UK Trade and Cooperation Agreement replaces arrangements under the Withdrawal Agreement (transitional period). The UK is now out of the single market and became a “third country” under EU law on 1 January 2021. This Agreement also has implications for the UK private equity venture capital industry. UK firms no longer benefit from free movement, free provision of services and freedom of establishment and have also lost automatic right to offer services across the EU. The end of passporting means that UK firms will now have to comply with the rules of individual Member States which may differ from one another. The Agreement does not cover financial services access to EU markets, this will be determined by a separate process where the EU will either unilaterally grant equivalence to the UK and its regulated firms or leave firms to seek permission from individual Member States.
The BVCA and Invest Europe have jointly welcomed a Multilateral Memorandum of Understanding (MMoU) published by the UK Financial Conduct Authority (FCA) and European Securities Markets Authority (ESMA). The joint statement welcomed the commitment made by UK and EU competent authorities to cooperate and exchange information going forward as this is needed to ensure cross-border activities continue to operate effectively. The MMoU does not supersede applicable legislation and does not limit the use of existing mechanisms of crucial importance to our inherently cross-border industry. Invest Europe and the BVCA will continue to engage with the FCA, ESMA and other national competent authorities on the way our industry operates.
The UK and EU have published a high-level commitment to create a framework for agreeing, via an MoU by March 2021, how the EU and UK will communicate and work together on financial services regulation going forward. Both parties have also committed to discussing “how to move forward” with equivalence determinations between the EU and UK, whilst stressing the unilateral and autonomous decision-making processes of each side. We remain in discussion with HMT on the potential implications of this agreement for our industry.
The Alternative Investment Fund Managers Directive (AIFMD) and the Markets in Financial Instruments Directive (MiFID) are core regulatory regimes which govern and regulate Europe’s private equity and venture capital industry. The new trade deal between the UK and EU will impact firms under these regulatory regimes.
The BVCA, in discussion with members, has identified the following as the key short term technical needs of the industry:
The BVCA has also been in discussions with HRMC regarding firms’ Brexit planning and we have published a detailed summary of those discussions for our members. HMRC have also produced a separate document summarising the outcome of meetings involving HMRC, HMT and a number of representative bodies representing the financial services industry (including the BVCA). This document contains a fuller discussion of the points identified in the BVCA example as well as other issues, not all of which may be immediately relevant to BVCA members.
We recommend that members contemplating a business restructuring (whether or not in response to EU Exit) review the BVCA example then refer to the broader HMRC document, and obtain appropriate professional advice where required.
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.
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.
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.
Tax implications of Brexit structuring: The BVCA has been in discussions with HRMC regarding firms’ Brexit planning, which have looked into whether firms establishing new managers in Luxembourg will be transferring substantial value out of the UK. We have explained that firms who want to continue to use, or need to use, the AIFMD marketing passport are establishing or have established a new AIFM in an EU jurisdiction. In the context of closed ended funds, HMRC agrees that if no high value fee generating functions or contracts are transferred to the new EU AIFM from the UK, then it seems unlikely that there will be an exit tax charge, but each firm must perform its own fact-based analysis. Members may be asked for evidence of their own position by HMRC and are expected to retain this. The summary of discussions with HMRC is available here.
HMRC have also produced a separate
document summarising the outcome of meetings involving HMRC, HMT and a number of representative bodies representing the financial services industry (including the BVCA). This document contains a fuller discussion of the points identified in the BVCA example as well as other issues, not all of which may be immediately relevant to BVCA members. We recommend that members contemplating a business restructuring (whether or not in response to EU Exit) review the BVCA example then refer to the broader HMRC document, and obtain appropriate professional advice where required.
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
+44 (0)20 7492 0400