Reponse to European Commission Consultation A new European regime for Venture Capital

Transcription

1 Reponse to European Commission Consultation A new European regime for Venture Capital Box 1 VC internal market, policy options a) Do you think that encouraging Member States to a process of mutual recognition of venture capital funds, based on the direct enforcement of the Treaty freedoms, could facilitate the cross-border activity of these funds? If mutual recognition makes it easier for VC funds to approach investors across Europe without regard to local laws (beyond those of their own local regulator), then yes. But this has been tried and results are piecemeal and slow. Further, this still leaves the need for VC managers to check the position in each country regularly. Member states would remain free to impose additional conditions etc., thus denying us the main benefit of a single standard system its simplicity. b) Do you believe that the main impediment preventing cross-border venture capital fundraising and investments is the absence of a passport for activities under the AIFMD thresholds; or the fact that the AIFMD is not tailored to venture capital in general? Both are obstacles. It is hard to say (yet) which is the greater. Very small VCs will be unaffected (but discouraged from growing). Medium sized VCs will be preoccupied with staying below the threshold. Therefore for these sizes, the first bullet above will apply more. Larger VCs will be caught by AIFMD despite its inappropriateness, and hence the second bullet will apply. AIFMD was always wholly inappropriate for VC, damaging both to VC and to the EU as a result. The two stated principal objectives of AIFMD were (i) to address systemic risk and (ii) to protect investors. Neither objective is relevant at all to VC, which poses no systemic risk whatever, and whose investors are all sophisticated institutional investors who receive all the information they ask for, pursuant to detailed negotiated contractual investment agreements. These comments are supported by the EVCA survey of VC investors carried out during the AIFMD gestation period. Investors clearly did not want more regulation. That survey is enclosed for ease of reference. ENC. c) Is a targeted modification of AIFMD rules for venture capital or a standalone initiative in this area the more appropriate tool to increase venture capital activities? Please specify.

2 The best outcome regulators can achieve in this field is to reduce unnecessary regulation and standardise what is left. The only controls should relate to (i) general professional/ethical standards (which in the UK are adequately managed by the FSA) and (ii) fund-raising from nonprofessional investors. Provided that a VC fund approaches only professional investors, those investors are capable of protecting themselves, and no (AIFM-specific) regulation is needed. To achieve this for VC, it is essential to have a standalone initiative, because (as happened with AIFMD) only with a standalone approach with VC s voice not be drowned out by those addressing other agendas. The standalone initiative should disapply AIFMD from those within the scope of the standalone initiative. d) From your experience, could you provide concrete examples where you encounter additional administrative or regulatory hurdles when raising or investing funds cross the EU? It is hard to give concrete examples. We have generally been able to build relationships over a long period prior to fund-raising. When investors hear through the market that we are fund-raising they are able to find us. Nevertheless, a passport would reduce uncertainty about the potential applicability of multiple sets of regulations, so it would be valued. e) Do you believe that an initiative on cross-border operations of venture capital could contribute to eliminating the cross-border tax problems encountered and if so, how? Yes, in the long term if a genuinely pan-european industry emerges, then tax authorities will converge in their treatment. f) How could a possible passport for venture capital operators facilitate targeted tax incentives in favour of cross-border venture capital investments? The key incentive is really just the removal of the disincentive of double taxation. Mutual recognition could assist in preventing this. Box 2 - Voluntary registration a) Do you agree with this approach? If not, what alternative approach would you suggest? Could you then briefly outline the pros and cons of such an alternative? Yes, if set up correctly this is a very good approach. There is really little need to regulate VC managers at all, beyond high level professional/ethical standards and of course the general law as to business conduct etc. For example, in the UK, the FSA imposes obligations as to (i) managing conflicts/personal Account Dealing, (ii) competence of staff, and (iii) disclosure of fees (among many other

3 things). All these matters are handled fully and flexibly in the relevant contracts with investors, and (net of the compliance overhead) do not therefore add significant value. However, everyone gets used to their own regulatory environment and we are content to abide within existing FSA regulation. Hence what is needed is to prevent additional burden at a very difficult time of the industry, and this voluntary registration may be the simplest, lightest-touch way to free VC managers in all parts of the EU from local placement regimes and AIFMD. b) Do you consider such a voluntary regime to have any major cost implications for the key stakeholders? (Investors, competent authorities, venture capital business). Please specify. Not major cost, no. Investors in major states might not know what value to place on a passport issued by the regulator in a small, perhaps CEE state, but at least the relevant VC manager would be able to make contact and the (entirely usual) due diligence process will supersede the passport quite quickly. So investors also should not face any cost. c) Based on your experience, could you provide qualitative and/or quantitative assessment of potential cost savings that the European 'Passport' would bring about? There would be less time spent evaluating where geographically and with which office/individual (within a potential investor organisation) a discussion or an approach is taking place. This is an unreal and sterile exercise (with professional investors). d) What information should the manager provide to the competent authority? A large proportion of European VC (and Private Equity generally) is managed from London, subject to the FSA and English company/partnership law. Though not perfect, it is a matter of simple logic that the least disruptive solution would be to apply the principles used in the UK to the whole industry these principles already apply to a large proportion, and have been well tested and learned. Thus, broadly, from the list in the consultation document, - (i) identification, (ii) domicile, (iii) structure, (iv) resources, (v) identity of the persons conducting the business, (vi) objectives, (vii) investment policy, (viii) geographical area of activity and (ix) identity of significant shareholders, - in the UK we have the obligation to provide: - to the FSA, regarding the manager entity: (i)-(v) and (ix) regarding ownership of the manager. Much of this is on the public record. Items (vii) and (viii) are more relevant to specific funds than managers - to Companies House, under partnership law, regarding each fund entity: (i)-(iii), (v), (vi), and (xi).

4 - to investors, (routinely, under contract): all of (i)-(ix), although as to the manager s resources (i.e. item (iv)), this is not a concern investors have rarely seen the need to evaluate or force any minimum level of regulatory capital. An adequate level of regulation would require only: - As to managers: (i)-(v) and (ix) most countries require all commercial entities to lodge at least this much information at a central registry anyway. The only addition required therefore, is to include a brief summary of (vi) and (vii), mainly to identify that the entity is indeed a VC manager. Item (viii) should be assumed to be nationwide, or (with a passport) Europewide. - As to funds: (i)-(iii), (v), (vi), and under (ix) the identity of shareholders holding over 25%. e) What option would you favour: registration with the national authority or with ESMA? Alternatively, ESMA could hold a European register of venture capital managers and funds with the information provided by national authorities. Would you favour this solution? Surely easier and cheaper to allow national registries to do this as it prevents the need for a separate further registration process. Smaller national registries might delegate to ESMA, but it should not be obligatory. Box 3 - Notification by national authorities to all others a) Do you agree with this approach? If not, what alternative approach would you suggest? It would be simpler to require national authorities to notify ESMA only, who would keep a public database of the simplest kind, listing simply the names and home states of passported entities. Thus any entity could be verified in a simple two step process, with a clickable link, without any duplication (or one step, for states delegating under 2(e) above). Any intention to set up an office or a fund in another member state could perhaps be the subject of positive notification but not simply approaching investors there nor (probably) engaging entities already established there to approach investors on one s behalf. b) What should be the content and timeframe of the notification? Should the notification cover both the places where the manager intends to invest in SMEs and the places where it intends to raise funds? Just ESMA. It really isn t appropriate for regulators, who are there to make business happen smoothly and fairly, to impose burdens intended to enable fact finding about where investment is being raised and where it is being invested.

5 c) Do you consider such a procedure to have any major cost implications for the key stakeholders? (Investors, competent authorities, venture capital business). Please specify. No, if kept simple. For those of us already operating under a regime like the UK FSA regime (and there are many others around Europe that are equally adequate, but the FSA is the most significant by volume), this initiative will do most good if it simply allows us to obtain a passport to all professional investors in Europe, as of right, by virtue of (i) meeting an agreed definition of Venture capital, (ii) being regulated locally. This should be achieved by a simple notification to the FSA (or other body) who would have an obligation to communicate this to the ESMA central record within X days. Box 4 - Restriction on retail investors a) Do you agree with this approach? If not, and in case you believe venture capital should be accessible to retail investors, what kind of measures would you recommend to ensure their protection? Yes. It is clearly right that the passport not apply to retail investors, even if a VC manager has permission under local rules to approach retail customers. Partly because VC is not usually suitable for retail investors, and mainly because the sophistication and expectations of retail investors from country to country are highly variable, much more so than the sophistication and expectation of professional investors. Let s not drag this new initiative down into complexity by worrying about retail investors let that be a separate discussion for some years hence. However, the test of what is retail is important. The passport needs to allow marketing to the FSA definition of "professional investors" rather than the MIFID Version which excludes all HNWIs. There are many wealthy, sophisticated, un-riskaverse, experienced individuals who fully understand the nature of VC investing, and should be allowed and encouraged to invest. But it is frankly impossible for most such individuals to meet the MiFID test; the requirement to meet two of three subtests effectively excludes all those who are not themselves in finance, since the subtest regarding similar investments made in the past year (or is it quarter?) is so onerous that it can never be met (possibly George Soros ). b) What are the restrictions (if any) on participation of retail investors in your country within the fund structures used for venture capital investments? See above. Many firms operate a policy of not dealing with retail investors. Such firms have to evaluate individuals as to their (discretionary investible) wealth, investment experience, and riskappetite. If they meet certain tests, they can be allowed to invest. Individuals of this sort contribute a small share to the total funds

6 managed, but contribute hugely to the VC ecosystem. Having a small investment engages them and enables VC managers and their investee companies to benefit from their expertise. Box 5 Reporting Requirements a) Do you agree with this approach? If not, what alternative approach would you suggest? There is no need for any additional reporting. Investors have considerable power to obtain whatever information they want, when they want it. These requirements are usually negotiated up front. Investors almost invariably seek and receive quarterly unaudited and annual audited statements. b) Do you agree with the need to require an annual report for each fund? No, it is not a useful function of government to hold the hands of sophisticated investors. They get what they want. Any regulatory involvement just causes difficulties, sterile debate and fossilisation. c) Do you agree that the annual report should reflect the annual financial accounts and a report of the activities of the financial year? Not needed. However, to the extent that any additional reporting is mandated, the requirements should be set in such limited terms and without any requirement of format, such that 99% of all VC firms can simply file (for confidential retention) the audited annual reports they already submit to investors, which are detailed and tailored to the needs of those investors. d) Do you agree with the obligation to audit the financial information of the annual report? As with all of the above, since investors always ask for this, there is no need to make it a regulatory requirement. The ascetic Diogenes allegedly said to Alexander the Great, when Alexander asked him whether there was anything he wanted, just stand aside and let the sun reach me. Regulators should leave well alone. e) What reporting requirements/obligations exist within the fund structures used in your country for the purpose of venture capital investments? Would you consider that the proposed information requirements would constitute a significant administrative burden? Please specify. A pointless additional burden, unless reporting obligations were as described in (c) above. f) Do you think that more information requirements should be imposed on venture capital managers? If so, please specify

7 Investors alone decide what information they need, and they have the power to ensure they get it. Box 6 Operating conditions a) Do you think there is a need to specify any operating condition for venture capital entities? If yes, what would you consider as sufficient EU level framework for venture capital managers in this area and what level of compliance cost would this entail? We comply with FSA rules and broadly accept that they apply a suitable level of oversight to our activities. b) Do you think that it should be specified that venture capital entities should comply with rules of conduct when dealing with their investors? If yes, to what extend? Yes. To the extent the FSA already requires it. c) Do you think that it should be specified that venture capital entities should comply with specific organisational requirements? If yes, to what extent? Not as to structure. Yes as to governance, to the extent the FSA already requires it. d) Do you think that it should be specified that the persons effectively conducting the business should have good repute and experience? If yes, to what extent? Yes. To the extent the FSA already requires it. e) Do you think that it should be specified that the significant shareholders should be suitable? If yes, to what extent? Beyond verifying that shareholders are acting legally using legally acquired resources, it is unclear what suitability here means, and how it could be given an objective meaning. There seems to be no need for regulation of this, additional to existing general law. Box 7 Legal form a) Do you agree with this approach? If not, what alternative approach would you suggest? Yes, as a minimum. All structures traditionally used for VC should be allowed, but also variants of them and structures used by other activities. Best would simply be that any enterprise recognised under local law as permissible would be passportable as such without objection on grounds of structure/form.

8 b) Is it convenient to specify in the legislative proposal the legal forms that the venture capital funds might adopt? See above. c) Is there any other aspect relating to the legal form of the venture capital entities that the proposal should take into account? No. Box 8 VC investment sectors a) What, if any, investment criteria determine your existing national fund structures used for purposes of venture capital investments? Tax transparency to prevent double-taxation. Limitation of liability to assets invested. Standardisation, familiarity, flexibility, fairness. b) Do you think it is worth specifying any investment rules for venture capital funds? Yes. How to define VC is critical to the success of this initiative. It is vital that no-one believe or be able to assert that non-vc activities are being smuggled into the safe haven that this initiative could create for legitimate VC, initially for passporting, but perhaps also for AIFMD exemption, tax, state aid rules, and so-on, c) Do you think there is a need to define a compulsory investment percentage of assets that the venture capital fund should invest in SMEs? If yes, what compulsory investment percentage would you propose and how should it be calculated? Probably. A definition of VC is submitted with this submission. 50% seems a good threshold, when applied with other tests. ENC. d) Do you agree with the need to envisage a flexible application of the principle described? Yes. More flexible that in the consultation paper (section 7), which limits to cash like assets. Especially in current difficult times, VC managers are inevitably diversifying into peripheral activities (secondary/ replacement investing, later stage investing, small-cap public stocks, debt instruments, etc). The essential point is that a VC manager should qualify if the bulk of its activities qualify as paradigm VC investment

9 activities, and each fund should be likewise qualify if the bulk of its investments qualify - regardless of what else might be in the mix, in small quantities. Hence there should be no absolute prohibitions. But defining paradigm VC investment is also necessary, and this is attempted in the definition submitted. (NB. Replacement investing is sometimes seen as incapable of benefitting the relevant technology company whose securities are being transacted. This is not at all true because the company cares about who its shareholders are, and replacement transactions usually replace tired, disinterested, sometimes ignorant investors with a fresh, supportive investor which can see the company s potential, will invest further in future as primary capital, and will encourage growth rather than directing management to expedite a trade-sale at any reasonable price. Other shareholders in the same company usually welcome the transaction as one that improves their prospects too, by aligning investors more closely, so raising the chance of an eventual exit in line with their own timescale and vision.) Box 9 Characterisation of VC a) How do your national rules capture (if at all) the definition of venture capital funds? Not well, but it has never in the UK been thought necessary formally to distinguish VC from buyout activities. b) Should the temporary nature of the venture capital investment activity in SMEs constitute a criterion that should be reflected? Subject to comment in 8d) above, this could be done. c) Do you think it should be specified any temporal limit (minimum and maximum) to the participation of the venture capital fund in the capital of the SME (i.e., from at least 2 to 10 years)? This is not desirable, as intentions as to holding periods do not match outcomes. There are various reasons why in specific cases an investment might be held for less than two years, or more than ten. Though not advisable, a requirement on holding period could be included (though the submitted definition doesn t do so) but only as part of a bundle of criteria that need only apply for a proportion of investments made in a fund, so that exceptions can be made as long as the majority of investments conform. d) Are there any other means of finance that venture capital funds provide to SMEs that should be reflected (e.g. loans)?

10 Yes, hence the proposal that as long as a core amount of activity matches the paradigm, other activities be permitted. Commonly investments are made as loans and later converted into equity. Occasionally, loans or guarantees are made which are intended to be repaid. e) Do you think that there is a need to specify that the manager should be actively involved in the development, growth and success of the SME? Or should the passive investment in an SME also be considered by the proposal as venture capital investment? Subject to comment in 8d) above, active involvement should be a factor. f) What other criteria would you consider appropriate to capture the venture capital activity? See definition. Box 10 Limitations on e.g. Stage, Primary vs Secondary, Debt etc. a) To what extent does your national regime capture the above definitions of typical venture capital strategies? Not sure b) Do you agree that the special rules on venture capital should only apply when funds invest in the seed, start-up and expansion stages of SMEs? If not, do you believe that SMEs in a restructuring phase should also benefit from venture capital? What other alternative approaches would you suggest? Subject to comment in 8d) above, yes. Restructuring is not a core part of VC paradigm investing. c) Would you propose other definitions to define the permitted portfolio of venture capital funds? See submitted definition. The key is to make the core of the definition a condition that only a genuine VC manager could meet. It matters less what else might be mixed in. d) Do you agree that venture capital funds do not/should not use leverage? Subject to comment in 8d) above, yes. Box 11 SEC approach a) Do you agree with the list of entities described as not being proper investment targets for venture capital funds?

11 Subject to comment in 8d) above, yes. But the paradigm VC investment should be positively defined. b) If not, what types of companies would you specify as eligible investment targets? N/a c) Do you think that the EU should draw inspiration from the criteria set by the SEC to define the target companies of the venture capital funds? Inspiration, yes. But the definition fails because, for example, a manager who accepts a tiny sum of investment capital for secondary ( replacement ) investment, even into developing technology companies, would fall outside the definition, because a manager must manage only qualifying funds. Or a small amount of replacement will destroy the eligibility of predominantly primary investment. Box 12 Third Countries What could be an appropriate regime for third country venture capital funds? Reciprocity in terms of equal, unrestricted access to (professional investors) in those jurisdictions. This raises a question of where a manager is located if it has EU and non-eu offices. Probably a test based on central management and control would work (and pending establishment of reciprocity, would encourage the importation of management and control into the EU rather than its export). Box 13 Relation to AIFMD a) Do you agree with this approach? Broadly, yes. As to the requirement that only SMEs be the subject of investment, subject to comment in 8d) above. b) Would you support the first (exemption for entities below the AIFMD threshold) or the second option (exemption independently from the threshold)? Would you suggest an alternative approach? Definitely, the latter. First because the threshold has no particular relevance to VC, second (most importantly) because the aim must surely be to expand the VC industry and hence to encourage expansion of individual VC managers, and third because total exemption would greatly alleviate one of the big fears of smaller VC managers, namely that the more bureaucratic (often thereby the larger) investors would begin to require AIFMD as a kitemark stamp of quality even for smaller managers.

12 c) Are there any particular elements from the AIFMD that in your view should also apply to the venture capital managers? In the UK, where FSA regulation already applies, there is nothing of value in AIFMD to any party. It is purely negative in effect, ultimately destructive. Box 14 - Supervision a) Do you agree with this approach? If no, what alternative approach would you suggest? No objections to existing sanctions regimes of the FSA. The competent authority should be the national regulators. b) What supervisory powers should be granted to the competent authorities for the supervision of venture capital funds and managers? As currently held by the FSA. c) What type of sanctions should be envisaged? As currently held by the FSA.