UK response to European Commission consultation on a new European regime for Venture Capital

Transcription

1 UK response to European Commission consultation on a new European regime for Venture Capital The UK welcomes the Commission s consideration of measures to improve access to venture capital by EU small and medium-sized enterprises (SMEs) with high growth potential. A vibrant venture capital market is an important part of supporting the growth of innovative SMEs. Evidence 1 shows that venture-funded businesses grow faster than other businesses. Over a five-year period to 2006/7, businesses funded by venture capital increased their UK employment by 6% and sales growth by 12%, compared to a national rise in employment of 1% p.a. and 5% p.a. rise for FTSE Mid-250 companies 2. The UK Government has a number of policies in place to encourage venture capital activity. Enterprise Capital Funds (ECFs) combine Government and private money and invest in innovative smaller businesses, for example; the UK Government has committed to continue ECFs with a further 200 million over the next four years. The Enterprise Investment Scheme (EIS) and Venture Capital Trusts (VCT) tax regimes also encourage individuals to invest in this sector. Currently, the schemes allow up to 2 million annual investment in qualifying companies with up to 50 employees, with an annual limit of 500,000 per investor. Since introduction in the 1990 s, the schemes have supported over 11.5 billion of equity investment. In March s Budget, the UK Government announced that, subject to State Aid, we would seek to increase the annual investment limit in a single company to 10 million, widen the eligibility to include companies employing up to 250 employees, and double the investor limits under EIS to 1 million. These proposals will incentivise investors to invest increased amounts into a wider range of enterprises in the UK, helping to meet the equity gap identified in the Rowlands Review 3 of between 2 million and 10 million. And we have welcomed the establishment by a number of major banks of a new Business Growth Fund, which will invest 2 million to 10 million in established businesses that are looking to grow to the next stage. The banks had committed to provide 1.5 billion for this fund, but agreed to increase this to 2.5 billion as part of the Project Merlin agreement in February Like others, however, the UK market has slowed and we should consider improvements to the wider EU venture capital market that will scale up EU venture capital and attract more investment to EU funds and innovative SMEs. 1 BVCA Private Equity and Venture Capital Performance Measurement Survey (2008). See 09.pdf 2 BVCA Private Equity and Venture Capital Performance Measurement Survey (2008). See 09.pdf 3 The Provision of Growth Capital to UK Small and Medium Sized Enterprises, The Stationery Office, Project Merlin - Banks statement (2011). See 1

2 Interventions to improve access to venture capital for EU SMEs should target a clear and identifiable market failure, drawing upon an evidence base which assesses barriers to investment. Evidence 5 of a market failure in the provision of equity finance to SMEs by venture capital markets has pointed toward an equity gap in investments up to a value of 10 million. We would be interested in seeing further evidence that suggests that national fragmentation of venture capital markets in Europe is an issue that is preventing access to venture capital funding for SMEs. Discussions with industry indicate that the extent to which addressing cross border venture capital activities can help reduce the equity gap, raising funds across borders is where the barriers exist rather than investing across borders. Focus should therefore be on the difficulty in finding adequate deal flow in the smaller markets and we consider that measures such as improving fundraising across the EU, targeted at encouraging and attracting further investment into venture capital funds would be a positive step towards developing an internal venture capital market in the EU. Assessment of options More detailed cost benefit analysis of the various policy options proposed in the consultation paper is necessary in order to inform the approach taken and ensure clear and identifiable market failures are targeted. Given the uncertainties around the evidence on barriers, there could be significant risks with measures, such as regulation or legislation, and any measures in this area will require a robust evidence base. We consider that the proposal should focus specifically on venture capital, ensuring that appropriate measures are targeted at early stage investments. A standalone initiative would be more appropriate, as AIFMD has only recently been adopted and has yet to be implemented. In order to encourage venture capital and ensure burdens are not added to the industry, we consider that a new initiative should be implemented on a voluntary and flexible basis, as an over-prescriptive solution could distort rather than improve market operation. The following of best practice should be encouraged and the initiative should be permissive of existing working regimes in member states rather than creating something new or seeking to extend something less established. There are a number of other measures which also provide important contributions to improving cross-border access to venture capital within the EU by SMEs with high growth potential and these measures should also be considered and taken into account when developing this initiative. For example, we encourage the Commission in the review of MiFID to consider an exemption from the three criteria in the final 5 The Revisiting the Equity Gap Report (2009). See 2

3 paragraph of Section II.I of Annex B of MiFID for members of a Business Angel network. Further detail is included in the response to Box 4. Evidence of Market failure Compared with the US, the development of the venture capital industry across Europe has been held back by historical low returns and performance. Although comparisons with the US market present some difficulties, evidence shows that on average Europe invests four times less in venture capital than the US: US United Kingdom Scandinavia Ireland Spain Benelux France Europe Switzerland Germany Portugal CEE Austria Poland Italy Greece 0.091% 0.090% 0.083% 0.066% 0.057% 0.055% 0.053% 0.047% 0.042% 0.041% 0.020% 0.019% 0.014% 0.014% 0.012% 0.202% Source: PEREP/Dow Jones venture source Total private equity investment in Europe in 2009 reached billion, of which venture capital investment accounted for 3.82 billion. This represents a drop of almost 30 billion (total equity) and 2.66 billion (venture capital) on 2008 levels. Dow Jones Venture Source highlighted 2009 as the worst year for venture investment into European companies since it started tracking in 2000, over 40% down on In addition, like elsewhere in Europe, over recent years the UK venture capital industry has seen a period of decline, including with regards to early stage investment. For example, EVCA data shows that total venture capital investment in the UK dropped by 744 million or 49% from 2008 to 2009, with seed and early-stage venture capital investment down 187 million or 32%. This has been attributed to some extent to the economic crisis. Equity gap Evidence shows that the key market failure faced by SMEs seeking equity finance is linked to the existence of an equity gap. Research suggests this is a particular problem in the range 3

4 of 250,000 to 2 million 6 in the UK, but below and above this range problems with accessing finance are also now being identified, particularly the growth capital gap of investment between 2 million and 10 million identified by the 2009 Rowlands Review 7. Below 2 million is below the minimum size of investment that most private sector funds are willing to consider, and where investment is normally required at the seed, or start-up, stage of a business. The gap here is due to asymmetric information between the investor and business on the likely viability and profitability of the business. Fund managers experience difficulties in assessing the quality of SME proposals and associated likely returns leading to transaction costs which do not vary for the size of investment, such as due diligence costs. The result is a structural gap in the market where investors and risk capital fund managers focus on fewer, larger investments in more established (lower risk) businesses, leaving viable businesses with growth potential not being able to obtain equity finance. Over time funds have been starved of new finances by disillusioned investors (particularly institutional investors). The Rowlands Review of growth capital in 2009 found evidence of a second equity gap (or growth capital gap ) of around 2 million to 10 million. One anecdotal point raised during this review was the lack of UK firms ability to follow their investments in the same way that the larger US houses do. This is reinforced by a recent study by Josh Lerner, which finds that over , US funds invested in follow-up rounds in twice as many of their portfolio companies as in the UK and continental Europe. 8 Cross border fund raising and investment Discussions with industry indicate that raising funds across borders is more challenging than investing across borders. We are not aware of particular regulatory barriers that exist which restrict the ability of a fund to invest in different countries. Venture capital investments across borders are likely to incur higher transaction and due diligence costs, which will make the international venture capital market less efficient at selecting high growth potential businesses to invest in. Fragmentation of the EU market is therefore also one of the potential, although perhaps secondary, obstacles to achieving scale and depth in EU venture capital. The diversity of operating environments for venture capital across EU member states might also make it more difficult and costly for venture capital funds to reach a wider range of SMEs and spread their portfolio risk. 6 The Revisiting the Equity Gap Report (2009). See 7 The Provision of Growth Capital to UK Small and Medium Sized Enterprises, The Stationery Office, Josh Lerner et al. Atlantic Drift: Venture Capital performance in the UK and the US, NESTA,

5 However, discussions with the industry indicate that one of the main barriers to crossborder investments is the need for local cultural and market knowledge, as well as the difficulty of monitoring investments. These appear to be greater barriers to cross-border investments than the potential tax and regulatory obstacles, which are referred to in the consultation paper. The UK does not consider taxation to be a significant barrier to the cross-border operation of venture capital. As with all fiscal provisions intended to provide support to specific sectors, any specific schemes for support through tax schemes for venture capital in Member States are already subject to State Aid controls under the Community Guidelines On State Aid To Promote Risk Capital Investments In Small And Medium-Sized Enterprises ( SARC ) and the Commission notice on the application of the State aid rules to measures relating to direct business taxation. We would require further evidence that the types of issues raised in the consultation (e.g. double taxation) cannot be adequately addressed through such controls or through existing mechanisms such as the network of double tax conventions and the mutual agreement process between Member States. It would therefore be inappropriate for an initiative on cross-border operations of venture capital to include tax provisions, as the taxation of this type of vehicle should remain a matter for Member States. If any EU initiatives on the taxation of venture capital were to be brought forward, they should be subject to a tax legal base, with any decisions made by unanimity at ECOFIN. In addition, any public intervention in support of venture capital funds should be justified by evidence of market failure and in respect of EU State Aids rules. Although there may be benefits in addressing fragmentation, more benefit is perhaps to be gained by focusing on the difficulty in finding adequate deal flow in the smaller markets and facilitating fundraising across the EU. Our analysis of market failure with regard to the provision of equity finance to SMEs by venture capital markets points toward the equity gap rather than cross-border venture capital activities. However, there is a case for supporting improvements to the wider EU venture capital market that will scale up EU venture capital and attract more investment to venture capital funds and innovative SMEs. We therefore consider the introduction of measures to improve the ability of venture capital funds to raise funds across the EU in order to encourage and attract investment to be a positive step towards developing an internal venture capital market in the EU. The UK Government is supportive of action to improve the venture capital market for sustainable, long-term EU growth, where decisions will be fully consistent with principles of competition, open markets and smart regulation. We would be interested in seeing evidence that suggests that national fragmentation of venture capital markets in Europe is preventing access to venture capital funding for 5

6 SMEs, especially given other substantial factors that inhibit the growth of the venture capital market. 6

7 As far as we have been able to, we have provided answers to the specific questions raised in our response below. 1. Venture capital and SME Box 1 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? Further assessment of the mutual recognition of national frameworks for venture capital is necessary and it is important to establish what the appetite is for firms to invest crossborder despite the existence of barriers, as discussions with industry suggest that proposals should be targeted at facilitating fundraising across the EU rather than the ability of the fund to invest across the EU. The UK would not support compulsory mutual recognition of entities for tax purposes. There is currently no precedent for the recognition of an entity s tax status by another Member State to take priority over domestic law other than on a case-by-case basis through the mutual agreement procedures in double tax conventions. To oblige one Member State to adopt the tax treatment of another Member State, regardless of its own legislation and practice, raises tax sovereignty issues. 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? As outlined above, our evidence of a market failure with regard to the provision of equity finance to SMEs by venture markets points toward the equity gap rather than crossborder venture capital activities. Administrative or regulatory hurdles to cross-border investment by venture capital managers are secondary to the difficulty in finding adequate deal flow in the smaller markets, the costs of operating cross border and the cultural and language differences. It is unclear whether addressing fragmented markets will affect the volume of cross border investment by any significant amount. We therefore consider that measures, such as improving fundraising across the EU, targeted at encouraging and attracting investment into venture capital funds would be a positive step towards developing an internal venture capital market in the EU. 7

8 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. A vibrant venture capital market is an important part of supporting the growth of innovative SMEs. As set out above, measures should focus on addressing identified market failures for venture capital. This should be treated as a distinct issue, and we consider that the initiative should focus specifically on venture capital, ensuring that appropriate measures are targeted at early stage investments. A standalone initiative would be more appropriate, as AIFMD has a broader scope and has only recently been adopted and has yet to be implemented. d) From your experience, could you provide concrete examples where you encounter additional administrative or regulatory hurdles when raising or investing funds across the EU? As discussed above, we are not aware of particular regulatory barriers that exist which restrict the ability of a fund to invest in different countries. However, discussions with industry indicate that raising funds across borders is more challenging than investing across borders, where administrative and costs burdens, such a legal advice, can arise in order to comply with differing private placement regimes in Member States. 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? The UK does not consider taxation to be a significant barrier to the cross-border operation of venture capital. As with all fiscal provisions intended to provide support to specific sectors, any specific schemes for support through tax schemes for venture capital in Member States are already subject to State Aid controls under the Community Guidelines On State Aid To Promote Risk Capital Investments In Small And Medium-Sized Enterprises ( SARC ) and the Commission notice on the application of the State aid rules to measures relating to direct business taxation. We would require further evidence that the types of issues raised in the consultation (e.g. double taxation) cannot be adequately addressed through such controls or through existing mechanisms such as the network of double tax conventions and the mutual agreement process between Member States. It would therefore be inappropriate for an initiative on cross-border operations of venture capital to include tax provisions, as the taxation of this type of vehicle should remain a matter for Member States. We are aware that there have been some issues relating to cross-border venture capital investment and Permanent Establishments. The UK recognises that there is a need to improve the definition and model tax convention commentary relating to permanent establishment to improve certainty, and welcomes forthcoming OECD work in this area. The UK has recently (2009) amended the rules for its Enterprise Investment Scheme and Venture 8

9 Capital Trusts that the qualifying company only has to have a permanent establishment in the UK, ensuring that UK investors are able to invest in qualifying companies that have more of their activities in other EU member states. We do not believe that an EU initiative on cross-border operation of venture capital should be used as a vehicle to address these issues. f) How could a possible passport for venture capital operators facilitate targeted tax incentives in favour of cross-border venture capital investments? The UK does not believe that a possible passport for venture capital operators should be linked to targeted tax incentives, which should remain a matter for national governments. It is important that Member States retain the flexibility to define and target their tax incentives in the way that is most appropriate to their economic circumstances and domestic priorities, while also supporting the effective functioning of the single market. 2. Elements of a European legislative framework for venture capital 1) Voluntary registration with a competent authority. Box 2 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? In order to encourage venture capital and ensure burdens are not added to the industry, we agree that a new initiative should be implemented on a voluntary and flexible basis, as an over-prescriptive solution could distort rather than improve market operation. Venture capital funds should not have to comply with the regime if they do not wish to take advantage of the passport. The following of best practice should be encouraged and the initiative should be permissive of existing working regimes in member states rather than creating something new or seeking to extend something less established. 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. Costs will depend on the level of requirements that are introduced against the benefits from improved fundraising across the EU. c) Based on your experience, could you provide qualitative and/or quantitative assessment of potential cost savings that the European 'Passport' would bring about? d) What information should the manager provide to the competent authority? 9

10 While one of the main objectives of the AIFMD is to increase transparency vis a vis competent authorities the objective of the proposed EU regime in relation to venture capital is to increase access of SMEs to venture capital finance and as a result the information that such managers should provide to competent authorities should be limited to a geographic and sector analysis of funds invested. The information should be provided no more frequently than annually. 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? We would support registration with the national competent authority as this is where the relationship with many of these firms currently exists. 2) Simple notification procedure. Box 3 a) Do you agree with this approach? If not, what alternative approach would you suggest? A simple notification procedure would appear to be the most appropriate way to implement this aspect of the proposed framework. Care should be taken not to over engineer the process which could result in increased costs. 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? We would propose that the notification should only cover places where the manager intends to raise funds as managers should retain maximum flexibility as to where they invest. The timeframe should be consistent with passport arrangements under existing legislation. 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. Provided that the procedure is not over engineered we do not believe it would lead to major cost implications for the key stakeholders. 3) Restriction for retail investors. Box 4 10

11 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? We are supportive of the principle that the initiative should not be accessible to retail investors. However, it is important that this is captured in a way that is consistent with market practice in the venture capital space and does not limit participation from key investors. The consultation paper proposes that the European passport system would only be offered to professional investors as defined by MiFID. The definition does not align with existing practice in the venture capital industry and if the passport system would only be offered to these investors this would significantly limit its impact on increasing fundraising across the EU. The UK response to the Commission Services consultation on the Review of MiFID 9 sets out the unintended consequences of the current professional client requirements on Business Angels. This is also applicable to other investors in venture capital including high net worth individuals. This is because a business angel investor, for example, despite the fact he or she may be a high net worth individual with considerable understanding of the risks involved in investing seed capital, is unlikely to fulfil the requirements in Annex II.I of MiFID to be treated as professionals on request. The criterion requiring investments of 10 per quarter over the previous 4 quarters is particularly problematic. Business angels invest more irregularly than this, and it can also be a barrier for new/ prospective business angels. As set out in the UK response to MiFID, we encourage the Commission in the review of MiFID to consider an exemption from the three criteria in the final paragraph of Section II.I of Annex B of MiFID for members of a Business Angel network. Alternatively, the Commission might consider changing the regularity of investments in unlisted firms required in the quantitative test to the following: The client has carried out one or more investments in an SME (of an average of 100,000 or more) within the last two years, or has an existing portfolio of two or more SME investments (of an average of 100,000 or more). b) What are the restrictions (if any) on participation of retail investors in your country within the fund structures used for venture capital investments? It is crucial that the initiative is permissive of existing working regimes in member states. For example, in the UK we have tax-based venture capital schemes which aim to improve small

12 higher risk trading companies ability to secure longer-term financial support in the form of equity investments. These schemes are available to retail investors as they are listed on regulated markets and are crucial in promoting venture investment. 4) Reporting obligations. Box 5 a) Do you agree with this approach? If not, what alternative approach would you suggest? b) Do you agree with the need to require an annual report for each fund? c) Do you agree that the annual report should reflect the annual financial accounts and a report of the activities of the financial year? d) Do you agree with the obligation to audit the financial information of the annual report? 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. f) Do you think that more information requirements should be imposed on venture capital managers? If so, please specify Please see response to box 6 below. 5) Operating conditions for venture capital entities Box 6 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? 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? Do you think that it should be specified that venture capital entities should comply with specific organisational requirements? If yes, to what extent? 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? 12

13 Do you think that it should be specified that the significant shareholders should be suitable? If yes, to what extent? The UK currently regulates its venture capital funds through the Financial Services Authority. As mentioned above, a new initiative should be implemented on a voluntary and flexible basis. While there are certain elements where it would be appropriate to adopt a tailored regime an over-prescriptive solution could distort rather than improve market operation. We want to encourage the following of best practice rather than creating something new or seeking to extend something less established. As with the use of other branch and services passports it is important to ensure an appropriate balance of home and host responsibilities. 6) Legal form of the venture capital funds. Box 7 a) Do you agree with this approach? If not, what alternative approach would you suggest? b) Is it convenient to specify in the legislative proposal the legal forms that the venture capital funds might adopt? c) Is there any other aspect relating to the legal form of the venture capital entities that the proposal should take into account? We are supportive of this approach as any intervention should be permissive and inclusive of existing models. How venture capital funds establish themselves is a commercial decision and we would want to ensure that this flexibility is maintained. In the UK tax transparent limited partnership models are often used by venture capital funds and are recognised internationally, for example by the USA. We do not consider that a European specific legal form should be adopted as this could risk deterring overseas investors if a new unfamiliar model is adopted. 7) Investment focus on SMEs Box 8 a) What, if any, investment criteria determine your existing national fund structures used for purposes of venture capital investments? b) Do you think it is worth specifying any investment rules for venture capital funds? If yes: 13

14 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? d) Do you agree with the need to envisage a flexible application of the principle described? The UK Government supports the principle that the investment focus of venture capital funds within this regime should be SMEs, in particular early stage investments in SMEs. It is important to ensure flexible application in this approach and further analysis is necessary in order to ensure the regime is targeted effectively and does not inhibit facilitating venture capital. The UK Government has a number of equity funds which are overseen by our SME Finance body Capital for Enterprise Limited (CfEL) 10. The aim of the funds are to increase the availability of growth capital for SMEs affected by the equity gap, by: Encouraging an increased flow of private capital into the equity gap, by adjusting the risk-reward profile for private investors making such investment; and Lowering the barriers to entry for entrepreneurial risk capital managers by reducing the amount of private capital needed to establish a viable venture fund. Providing gearing for the benefit of private investors to increase their potential return on profitable funds. Government-backed national venture capital funds in the UK currently require that investments must focus on companies that: Meet the EU definition of an SME; Whose equity or other securities are not, at the time of investment, listed on a recognised stock exchange (such as a the London Stock Exchange) or otherwise quoted on a non-recognised exchange (such as the Alternative Investment Market (AIM), Off Exchange (OFEX) or any other market on which prices are quoted publicly). 8) Determination of the scope of the activities of venture capital funds. 1. Description of the activity. Box 9 a) How do your national rules capture (if at all) the definition of venture capital funds?

15 b) Should the temporary nature of the venture capital investment activity in SMEs constitute a criterion that should be reflected? 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)? d) Are there any other means of finance that venture capital funds provide to SMEs that should be reflected (e.g. loans)? 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? The UK has specific schemes, including Venture Capital Trusts (VCTs) and Enterprise Investment Scheme (EIS) that provide income tax and capital gains tax relief as well as coinvestment for investors in small higher risk companies. These schemes aim to incentivise investment in the equity gap for SMEs in line with state aid requirements. However, the UK does not provide a definition of venture capital funds for tax purposes. The UK would be very cautious of any pan-eu definition of venture capital for tax purposes particularly as the UK s experience has shown that it is very difficult to draw an effective distinction between venture capital and the wider set of private equity. It would be very difficult to establish such a definition without creating the risk that treatments intended to encourage capital investment in start up businesses could be applied to multi billion Euro leveraged buy outs of multinational businesses. It is important that the regime is targeted effectively and does not inhibit facilitating venture capital. f) What other criteria would you consider appropriate to capture the venture capital activity? It is important to take a holistic approach to improving access to finance for SMEs and join up thinking across institutional boundaries and initiatives. Funding options, such as early stage investment by business angels which are an important part of the venture capital industry, could be facilitated more easily by MiFID. The UK response to the Commission Services consultation on the Review of MiFID 11 sets out the unintended consequences of the current professional client requirements on Business Angels. This is also applicable to other investors in venture capital including high net worth individuals. Further detail is set out in the response to box

16 2. Description of the venture capital investment strategy. Box 10 a) To what extent does your national regime capture the above definitions of typical venture capital strategies? 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? c) Would you propose other definitions to define the permitted portfolio of venture capital funds? d) Do you agree that venture capital funds do not/should not use leverage? Please see the response to Box 8. Box Definition by exclusion of certain types of investments. a) Do you agree with the list of entities described as not being proper investment targets for venture capital funds? b) If not, what types of companies would you specify as eligible investment targets? 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? The UK Government is clear that equity is an important source of finance for investment and growth, at all stages of the business life cycle, although it is particularly important for earlystage higher risk businesses that offer the best potential for higher returns. To foster growth, the UK Government is focussed on supporting the development of a sustainable funding escalator with flexible solutions for start-ups through to established, growing businesses. Evidence shows that there is a missing market or equity gap in the supply of equity finance at each of these key points. As a result, part of the UK Government s strategy is to improve access to public markets for SMEs. Primary multilateral trading facilities (MTFs) (such as AIM and PLUS-quoted) in particular can act as an important link between smaller companies and the main markets. Venture capital is an important feature for these primary MTF markets. Venture capital funds commit financing to these companies, use primary MTF markets as an exit route (or 16

17 partial exit route), and these companies continue to rely on venture capital for secondary rounds of fundraising. This also provides an important source of liquidity to these markets. In the UK, tax-advantaged venture capital schemes such as Venture Capital Trusts (VCTs) operate to incentivise investment in small companies, including those quoted on AIM and PLUS-quoted. In line with this, we believe that it is important that companies which are quoted on those primary MTFs, are not excluded as investment targets for venture capital funds, under the passporting scheme. Smaller companies are quoted on these markets in the UK and these (and other equivalent growth markets across member states) should be able to benefit from this regime. To not allow venture capital funds to invest in companies quoted on primary MTFs would be inconsistent with the approach taken in the UK. This could also have the adverse consequences of affecting fund raising for small companies on these markets. The proposal to exclude SMEs that are publicly traded would therefore restrict the full benefits of the passporting regime envisaged. However, to prevent abuse of the passport scheme, we agree that excluding investment in companies listed on EU regulated markets (main markets) would be a reasonable measure. 9) Third country entities. Box 12 What could be an appropriate regime for third country venture capital funds? The UK is supportive of the principle that the proposal should provide for an open venture capital market. Encouraging third country investment in EU venture capital funds will scale up EU venture capital and attract more investment to EU funds and innovative SMEs. 10) Impact on other pieces of EU legislation. Box 13 a) Do you agree with this approach? 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? c) Are there any particular elements from the AIFMD that in your view should also apply to the venture capital managers? 17

18 We would support the second option (exemption independently from the AIFMD threshold). This should be treated as a distinct issue, focusing specifically on venture capital and ensuring that appropriate measures are targeted at early stage investments. A standalone initiative would be more appropriate, as AIFMD has a broader scope and has only recently been adopted and has yet to be implemented. In addition, venture capital funds are unlikely to pose systemic risk and as a result their regulation should reflect this and the fact that, with minor exceptions which are caught under other regimes, they are not offered to retail investors. 11) Supervision and sanctions. Box 14 a) Do you agree with this approach? If no, what alternative approach would you suggest? b) What supervisory powers should be granted to the competent authorities for the supervision of venture capital funds and managers? c) What type of sanctions should be envisaged? The UK agrees with the principles that the obligations in the proposal on venture capital managers should be appropriate and proportionate. We agree that it is important that Competent Authorities have sufficient tools for enforcement and deterrents. The UK would encourage the Commission to explore and develop a harmonised framework of basic principles to promote coherence of EU action. Such a framework would be more effective than seeking to harmonise sanctions by way of a little by little approach as part of the MiFID and MAD reviews. 18