Long-term financing of the European Economy Submission from The Association of Investment Companies (AIC)

Transcription

1 Long-term financing of the European Economy Submission from The Association of Investment Companies (AIC) The Association of Investment Companies (AIC) represents approximately 330 closed-ended investment companies with assets under management of around 90 billion. Investment companies are a type of collective investment fund whose shares are traded on public markets. The AIC s members include UK investment trusts, Venture Capital Trusts (VCTs) and non-eu companies. Investment companies are closed-ended funds. This means that the amount of money which the company raises to invest is fixed at the start by issuing a set number of shares. They generate an investment return for their shareholders by buying and selling shares, property and other assets. An investment manager is employed to build a diversified, managed portfolio. Investment companies are an important part of the UK s investment landscape and have traditionally competed with UCITs funds and other funds through offering lower costs, independent governance, access to shares via a market quotation and access to alternative asset classes. Closed-ended funds facilitate investment in assets over the long-term because investors buy and sell their shares on a market. This process has no impact on the underlying portfolio. In contrast, in open-ended funds (such as UCITS), the manager may need to sell investments in order to meet redemption requests from investors. Closed-ended funds are therefore particularly suitable for less liquid investments, such as unquoted assets (property etc), as the fund manager does not have to be concerned about having to realise investments to raise money to meet redemptions. Having a stable pool of money to invest enables the fund manager to plan ahead. Shareholders in investment companies tend to see them as long-term savings vehicles, with shares often held for extended periods often longer than 15 years. Investment companies themselves tend to be long-term investors. Most investment companies are evergreen. They have no set deadline for selling assets. The proceeds of any realisations are customarily reinvested. The imperative is to focus on investment fundamentals (risk vs. return) and the competing attractions of allocating capital to one or another investment opportunity. Given the timeframe of investment company strategies, they often select investments with a view to how they will provide returns in the long-term. Where stable and growing returns can be achieved without churning the portfolio, this reduces transaction and other costs. Some investment companies are limited-life, where the fund has a set lifespan - usually 7 to 12 years. In these circumstances boards have a responsibility to secure value to a set maturity date. As they move toward the winding-down date investments may be disposed of. However, conducting a planned and agreed investment policy with a set maturity date is not the same as short-termism. Limited life investment companies are an attractive investment opportunity for a variety of retail and institutional investors. 1

2 Long-termism is built into the structure of an investment company. The Companies Act 2006, which governs UK investment companies, sets out the duties of the company s directors. These include having regard for the likely consequences of any decision in the long term. This obligation focuses directors on the long-term prospects of their company. THE SUPPLY OF LONG-TERM FINANCING AND CHARACTERISTICS OF LONG- TERM INVESTMENT 1) Do you agree with the analysis set out above regarding the supply and characteristics of long-term financing? 2) Do you have a view on the most appropriate definition of long-term financing? ENHANCING THE LONG-TERM FINANCING OF THE EUROPEAN ECONOMY 3) Given the evolving nature of the banking sector, going forward, what role do you see for banks in the channelling of financing to long-term investments? 4) How could the role of national and multilateral development banks best support the financing of long-term investment? Is there scope for greater coordination between these banks in the pursuit of EU policy goals? How could financial instruments under the EU budget better support the financing of long-term investment in sustainable growth? 5) Are there other public policy tools and frameworks that can support the financing of long-term investment? VCTs were launched in 1995 as vehicles to encourage private investors to invest in small higher-risk UK unlisted companies which need start-up, early stage or expansion capital. Successful investment in this sector requires a long-term commitment to develop the SME s business model and commercial position. As with other types of investment companies, VCTs tend to attract investors who take a long-term view. Well over 3bn has been raised for investment under the scheme so far. To encourage this investment in what is an inherently risky proposition, investors receive certain income and capital gains tax relief. The tax reliefs received by investors represent State Aid. Research by the AIC has found that the average investment size made by a VCT into SMEs is 2.8m. VCTs are patient investors. The average VCT investment is 2

3 held for around 6 years, though many companies remain in the portfolio of investments for ten years or more. The AIC recommends that the Commission develops the State Aid regime to allow individual Member States to develop similar schemes which can deliver long-term financing solutions for SMEs tailored to their own business landscape. More detail on how this can be achieved is provided in response to question 26. 6) To what extent and how can institutional investors play a greater role in the changing landscape of long-term financing? 7) How can prudential objectives and the desire to support long-term financing best be balanced in the design and implementation of the respective prudential rules for insurers, reinsurers and pension funds, such as IORPs? 8) What are the barriers to creating pooled investment vehicles? Could platforms be developed at the EU level? Investment companies are an important part of the UK s investment landscape. Foreign and Colonial Investment trust was founded in 1868 and remains in operation today. Collective investment funds provide accessibility to a diversified portfolio and fund management expertise for the ordinary investor. The introduction of tax-focussed schemes, such as ISAs and pensions, has stimulated demand and allowed more investors to enjoy these benefits. As a consequence of this, there has been a significant growth in the number and type of collective investment funds over the last 30 years. Whilst market traded closed-ended funds exist in other Member States, they are not regarded as a distinct sector of products in the same way as investment companies are in the UK. This suggests that cultural factors play a significant role. Existing EU rules (namely company law, CARD, the Transparency Directive, the Prospectus Directive and the AIFM Directive) provide the basis for investment companies to develop across Europe. Currently the appetite for such products has not emerged. This is despite a strong regulatory basis for the development of these vehicles in other Member States. 9) What other options and instruments could be considered to enhance the capacity of banks and institutional investors to channel long-term finance? 3

4 10) Are there any cumulative impacts of current and planned prudential reforms on the level and cyclicality of aggregate long-term investment and how significant are they? How could any impact be best addressed? 11) How could capital market financing of long-term investment be improved in Europe? 12) How can capital markets help fill the equity gap in Europe? What should change in the way market-based intermediation operates to ensure that the financing can better flow to long-term investments, better support the financing of long-term investment in economically-, socially- and environmentally-sustainable growth and ensuring adequate protection for investors and consumers? 13) What are the pros and cons of developing a more harmonised framework for covered bonds? What elements could compose this framework? 14) How could the securitisation market in the EU be revived in order to achieve the right balance between financial stability and the need to improve maturity transformation by the financial system? 15) What are the merits of the various models for a specific savings account available within the EU level? Could an EU model be designed? 16) What type of CIT reforms could improve investment conditions by removing distortions between debt and equity? 17) What considerations should be taken into account for setting the right incentives at national level for long-term saving? In particular, how should tax incentives be used to encourage long-term saving in a balanced way? 18) Which types of corporate tax incentives are beneficial? What measures could be used to deal with the risks of arbitrage when exemptions/incentives are granted for specific activities? 4

5 19) Would deeper tax coordination in the EU support the financing of long-term investment? 20) To what extent do you consider that the use of fair value accounting principles has led to short-termism in investor behaviour? What alternatives or other ways to compensate for such effects could be suggested? 21) What kind of incentives could help promote better long-term shareholder engagement? Allowing investors to take an active role in governance, engagement and voting can support efforts to deliver long-term shareholder value and reduce the risk of catastrophic strategic decisions being taken by investment companies. Notwithstanding this, it should also be recognised that other investors may have different investment styles, with less focus on engagement. This is also a valid investment strategy. The AIC does not support measures aimed at incentivising long-term investment or engagement, such as a minimum holding period for shares and securities. Such provisions inappropriately distinguish between investors. This runs contrary to established principles that all investors in the same share class should be treated equally. This would be deeply detrimental to the attractiveness of equity markets, cause unjustified damage to legitimate investment strategies (such as passive investment), and breach the traditional principles upon which equity markets and share ownership operate. The AIC recommends that the focus should be on improving the quality of voluntary engagement. Engagement is most effective when it enables an ongoing relationship between shareholders and boards. This fosters understanding between the parties and builds trust. True shareholder engagement requires more than just attending AGMs or following a tick-box approach to voting. The AIC is concerned about the impact of the increased use of proxy advisors on the quality of the engagement/governance process. Most significantly, third party agencies could remove decisions on governance from the person who makes the buy/sell decision. Ideally the processes of investment and governance should be integrated. Nevertheless, practical considerations are likely to mean that use of agencies is likely to increase. The approach taken by corporate governance agencies can create problems. All too often a mechanistic/tick-box approach is utilised at the expense of a considered judgement. Also, companies under scrutiny are not always properly informed of agency recommendations and do not have the opportunity to discuss them with the agency in advance of a recommendation/vote. ESMA has looked into the operations of the proxy advisor industry and has recommended the industry should develop its own code of conduct. 5

6 Ideally the EU would go further than this. The AIC recommends that the Commission establishes as regulatory framework which would require proxy advisors to manage conflicts of interest and to report on their practices, supported by a code of best practice which would operate on a comply or explain basis. This would be a proportionate approach which mirrors the obligations placed on companies and would tackle potential problems. 22) How can the mandates and incentives given to asset managers be developed to support long-term investment strategies and relationships? The AIC is unconvinced that regulation should seek to influence the investment mandate issued to managers. The priority is to ensure that the mandate is set in accordance with the interests of the beneficial owners. For UK investment companies, for example, this is achieved through various mechanisms. UK company law requires directors to act in a way which promotes the success of the company for the benefit of its shareholders. In discharging this duty, the directors must have regard to, amongst other things, the long-term consequences of their decisions. Listed investment companies have to set investment policies which are agreed by the shareholders. The directors also have to make an annual statement on the continued appointment of any external portfolio manager. The board has to be able to act independently of any external manager. Controls of this nature ensure that asset managers act to deliver the investment mandate and that the mandate reflects shareholder needs. 23) Is there a need to revisit the definition of fiduciary duty in the context of long-term financing? 24) To what extent can increased integration of financial and non-financial information help provide a clearer overview of a company s long-term performance, and contribute to better investment decision-making? The AIC has long been concerned about the length and complexity of annual reports. Too many policymakers and stakeholder groups want a broad range of information to be included in an annual report. This has meant that important information can be obscured by the inclusion of material which is not focussed on informing investors. Relevant and current information risks being lost amongst boilerplate disclosures which are included less to inform shareholders than just in case an omission creates some kind of liability. Whilst the AIC does not oppose the publication of much of the disclosures required to satisfy various lobby groups, it recommends that the quality of financial reporting would be improved if matters such as environmental, social or employee concerns were included in a separate report. There is considerable scope to improve the quality of reporting, reduce the volume of disclosures, increase transparency and reduce the administrative burden placed on reporting entities. 6

7 Separating out broader disclosures would ensure that this information was available for those who want it, but would help focus the annual report on presenting financial information to investors who are, after all, the primary targets of this disclosure. 25) Is there a need to develop specific long-term benchmarks? Some investment companies use benchmarks, primarily for performance measurement purposes. Where our members adopt a benchmark for performance measurement, this is usually a well-known single index published typically by FTSE or MSCI. In some cases it may be a composite index, perhaps constructed by its own management company. There is a strong commercial market for index provision. It is not clear that there is any market failure in this area. The AIC would be concerned about any regulatory requirement to use a benchmark. As detailed in response to Q.24, the AIC is already concerned about the volume of information that companies are required to report. Without first identifying shareholder demand it is hard to support this approach. Investment companies are able to tailor their benchmarks to their investment policies and shareholder needs. Any regulatory proposal risks requiring a common approach which would not reflect accurately the nature of individual companies which would reduce the relevance of this disclosure. 26) What further steps could be envisaged, in terms of EU regulation or other reforms, to facilitate SME access to alternative sources of finance? In the UK, VCTs and their investors benefit from a number of tax incentives. These help attract capital from retail shareholders to an asset class which would otherwise be out of their reach. The tax reliefs received by investors represent State Aid. The investment scope of the VCT scheme is determined by the State Aid Risk Capital Guidelines. Rules on State Aid are an essential part of the operation of the Single Market and are required to minimise potential distortions of competition and trade. However, it is vital that the rules do not go too far and inappropriately prevent SMEs from gaining access to development capital. To deliver this outcome, the AIC recommends that the State Aid Risk Capital Guidelines should be reformed to create a straightforward framework for providing support to SMEs. The rules should not be unnecessarily prescriptive on how these companies are defined or how the funding is provided. For example, the current definition of an SME able to receive State Aid includes a headcount limit. This means that the number of employees a company has may count against whether or not it is an SME and whether it is therefore able to receive state aided investment. This is despite the fact that the number of employees a company has is irrelevant in determining whether or not a company will have a material impact on cross-border trade or if it faces a finance gap. By imposing the headcount condition, the Commission risks denying funding to SMEs which are potentially able to deliver and sustain high levels of employment - 7

8 but are still facing a finance gap. The AIC recommends the headcount limit should be removed from the State Aid Risk Capital Guidelines and/or any successor rules resulting from the current review of the State Aid Risk Capital guidelines. 27) How could securitisation instruments for SMEs be designed? What are the best ways to use securitisation in order to mobilise financial intermediaries' capital for additional lending/investments to SMEs? 28) Would there be merit in creating a fully separate and distinct approach for SME markets? How and by whom could a market be developed for SMEs, including for securitised products specifically designed for SMEs financing needs? 29) Would an EU regulatory framework help or hinder the development of this alternative non-bank sources of finance for SMEs? What reforms could help support their continued growth? The development of the VCT sector in the UK and the positive impact it has had upon funding for SMEs suggests that it is possible for Member States to develop their own alternatives to bank finance which are tailored to national circumstances (and to investors preferences for investing in domestic businesses). However, as other schemes of this nature are likely to also be considered as a form of State Aid, it is important that the State Aid rules allow the maximum amount of commercial flexibility, taking into account the overall envelope of allowable aid. The response to question 26 details the AIC s recommendations for achieving this. 30) In addition to the analysis and potential measures set out in this Green Paper, what else could contribute to the long-term financing of the European economy? To discuss the issues raised in this paper please contact: Guy Rainbird Public Affairs Director guy.rainbird@theaic.co.uk Tel: June