Response to the European Commission s Consultation on a new European regime for Venture Capital

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Rosalind Watts
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1 Response to the European Commission s Consultation on a new European regime for Venture Capital August 10, 2011

2 The German ministry of finance welcomes the initiative undertaken by the European Commission since we share the European Commission s view that fragmented national rules and the lack of a harmonized European regime impede the fundraising and investment by crossborder venture capital. We therefore would like to contribute to the consultation as set out below. Please note that our comments are preliminary and we reserve a new assessment once a concrete legislative act is proposed. Scope of the European regime for venture capital (Box 1, Box 13) In our opinion, the question whether a new European regime for venture capital should be introduced within the AIFMD framework or as a standalone initiative depends, inter alia, on the scope of the new regime. In this respect, we prefer the first option proposed in Box 13. Only those managers should be included in the new regime whose assets under management fall below the threshold specified in the AIFMD. According to the consultation paper this approach would encompass the majority of the venture capital business in Europe. Furthermore, the existing threshold could make it easier to draw a line between venture capital and other private investments because in practice the lines between different stages of investment (expansion phase or restructuring phase?) might be even more blurry in case of funds above the threshold. Moreover, including managers that trespass the threshold would require a more extensive modification of the AIFMD. Since the AIFMD entered into force just recently, we believe that a modification within the AIFMD framework would not be helpful as it would certainly re-open the discussion with respect to the scope of the AIFMD in general. Moreover an extensive modification of the AIFMD at this point in time would necessarily imply an extension of its transposition period. As a consequence, uncertainty for market participants is likely to increase. Thus, in our view a stand-alone initiative would be the adequate tool to build a new framework for venture capital. However, in our opinion, the time line of a stand-alone initiative should also take into account the transposition period of the AIFMD. If the two regulatory frameworks were not applicable at the same time, venture capital funds would first have to comply with the AIFMD for a (short) period and then reorganize their businesses in accordance with the new regime on venture capital funds. In this case, uncertainty and costs for market participants are likely to increase. Investment focus (Box 8, Box 11) Since the objective of the initiative is to address the financing needs of SMEs and to increase the supply of capital, the investment focus should clearly be on these companies. Thus, in our opinion, the definition should reflect that venture capital funds predominantly invest in SMEs. In general, we agree that a definition should draw inspiration from the regulation in 2

3 the U.S. in order to facilitate a globally aligned framework. However, it should be ensured that the investment activities of venture capital funds will not be severely hampered by the criteria imposed as regards possible portfolio companies. Description of activity (Box 9) We agree with the Commission that determining the scope of activity of a venture capital fund is essential in order to foster cross-border venture capital investment within the EU. We agree that the temporary nature of venture capital investment could be used as one criterion to distinguish venture capital from other types of participation in enterprises. We suggest a period of 3 to 15 years as a suitable criterion. However, in order to distinguish venture capital from other private equity investments further criteria should be reflected since the temporary nature of the investment is a characteristic feature not only of venture capital but private equity investments in general. Furthermore, since managers of venture capital funds are generally actively involved in the activities of the portfolio company, we believe that this feature needs to be incorporated within an attractive legal framework for venture capital funds. Description of the venture capital investment strategy (Box 10) In order to distinguish venture capital from private equity we agree that the definition of venture capital should focus on the three phases (seed, start-up and expansion). The definition should exclude buyout transactions. Generally, the objective of improving the financing conditions for SMEs in start-up and expansion phases will only be achieved by introducing a regulatory regime on venture capital if venture capital funds are the main financing resource for these phases in the lives of SMEs. Respective data should be provided. Voluntary registration with a competent authority (Box 2) We agree that registration should be voluntary. Existing structures should not be designed in a way that has an adverse impact on the functioning of the European passport. Besides, the attractiveness of the European venture capital fund should not be alleviated by imposing too strict obligations since there would be an incentive for the exclusive use of the existing national structures. As a consequence, the objective to build a harmonized framework could not be achieved. We support the concept of an extensive passport, including the manager and the funds since we believe that such a passport would surely facilitate cross-border activities of these funds. However, in order to assess the impact of such a new regime the influence of today s diverging tax treatments by the Member States should be analysed. 3

4 In our opinion, registration with the national authority would be the favourable solution. The precise role of ESMA will depend on the final design of the new regulatory framework. Simple notification procedure (Box 3) We agree with the proposed approach of a simple notification procedure. However, this approach should not exclude further close cooperation among the competent authorities. In our opinion, the notification should cover the places where the manager intends to invest in SME as well as the places where it intends to raise funds. Marketing to retail investors (Box 4) We agree that the investments of venture capital funds are typically very risky, particularly early stage or expansion phase investments, and that these funds are therefore no suitable investment products for retail investors. Consequently, venture capital funds marketed under a European passport should only be allowed to be marketed to professional investors. However, we believe that experienced investors, e.g. family offices, business angels and other high net worth individuals who do not meet the criteria of the professional investor definition by MiFID, should be able to invest in venture capital funds. This could be achieved, for example, by introducing a minimum investment commitment. Reporting obligations (Box 5) We agree with the proposed approach by the Commission, i.e. venture capital managers should establish an annual report including the annual financial accounts and a report of the activities of the financial year for each fund, and this report should be made available to investors and competent authorities. The financial information should be audited. Any other specific information requirements will follow industry standards and will be specified in the fund rules or instrument of incorporation of the venture capital fund. Operating conditions for venture capital entities (Box 6) In order to maximize the positive impact of a new cross-border regime we agree that the operating conditions for venture capital should be lighter than the conditions provided for in the AIFMD or the UCITS. However, we believe that certain basic operating conditions should be set out for managers of venture capital funds to ensure that business is carried out fairly, efficiently, and skilfully. Therefore, basic principles could apply, in particular that the managers should act honestly, with due care and diligence, in the best interests of the investors and the integrity of the market, have effectively resources and procedures for proper performance, 4

5 avoid conflicts of interests, and comply with regulatory requirements. The persons effectively conducting the business should have good repute and experience. Legal form (Box 7) We agree on the suggested approach: as a general rule, venture capital funds should be able to adopt the legal forms which are already widely recognised in the different Member States. However, legal forms that may trigger any additional payment liability for investors (Nachschusspflicht) must be excluded. Third country entities (Box 12) We agree that non-european venture capital funds could help to achieve the objective to improve the conditions for SME to access financing specifically at an early stage of their lives and in an expansion phase. However, with respect to the question of an appropriate regime for third country entities, the negotiations of the AIFMD showed that this is a highly disputed issue. It can delay legislative procedures drastically. As mentioned above, the time line of the legislative procedure for a new regime on venture capital should take into account the transposition period of the AIFMD in order to avoid changing regulatory frameworks within a very short period of time. Therefore we suggest not introducing an EU passport for third country venture capital funds in the upcoming legislative proposal but deferring the discussion to a later point in time. Supervision and sanctions (Box 14) We agree that the competent authorities should have adequate supervisory tools corresponding to the obligations to venture capital managers. Sanctions (e. g. fine according to national law) could be provided in order to ensure compliance with the regulatory framework. 5

Comments of the German Insurance Association (GDV*)

Comments of the German Insurance Association (GDV*) on the staff working paper A new European regime for Venture Capital ID Number: 643780268-55 Gesamtverband der Deutschen Versicherungswirtschaft e. V.