HL Deb 31 October 1996 vol 575 cc511-20

7.31 p.m.

The Minister of State, Department of Social Security (Lord Mackay of Ardbrecknish) rose to move, That the draft regulations laid before the House on 17th July be approved [28th Report from the Joint Committee—Session 1995–96].

The noble Lord said: My Lords, these regulations are being introduced under the European Communities Act 1972 to provide for the establishment in Great Britain of a new type of body corporate falling within the scope of an EU directive. Separate regulations will be introduced to enable the formation of open-ended investment companies in Northern Ireland.

The EU directive in this case is the 1985 directive co-ordinating the provisions relating to undertakings for collective investment in transferable securities, usually known as the UCITS directive. It may assist noble Lords if I explain briefly its purpose and effect. It is a single market directive for schemes (known as collective investment schemes) in which investors' money is pooled and invested in a way which spreads risk. Although the directive provides that schemes may take the form of open-ended investment companies, the only UK-based schemes able to take advantage of the marketing passport so far have been authorised unit trust schemes. This is because there is currently no provision in UK law for open-ended investment companies.

Much business has been lost to Luxembourg and Dublin because of difficulties of marketing unit trusts offshore. One of the main reasons for the regulations before us this evening is to enable British investment companies to catch up with their offshore competitors by enabling them to compete on a level playing field with the rest of Europe.

There has been a long and thorough period of consultation about these regulations for open-ended investment companies. I hope that your Lordships will forgive me if I refer to them from now on by the rather inelegant title of OEICs—not in the usual meaning of "oiks" but with a different meaning. It may not be particularly elegant but it is a good deal easier to say than repeating the long handled version every time I—and all of us—have to mention them this evening.

The Treasury first consulted with policy proposals in 1994 and followed this with further consultations about draft regulations in 1995. The investment fund industry has responded most constructively with comments and the Government are most grateful for its thorough and careful consideration of the issues. A number of adjustments to the original proposals have been made to reflect messages from those consultations. I will mention some of those in the course of my speech today.

The regulations for OEICs establish the main elements of a separate corporate code for the new type of investment company. These regulations are the first part of a package of measures to allow the formation of OEICs in Great Britain. OEICs will not be formed under the Companies Acts because the Government do not consider this traditional route to be appropriate for what will be regulated collective investment schemes. However, a number of familiar concepts of company law are contained in the OEICs code, blended together with other features from unit trusts.

Like the authorised unit trust, the OEIC will be authorised and regulated by the Securities and Investments Board (or SIB for short) under powers granted to it in the European Communities Act regulations. These powers are similar to those in the Financial Services Act 1986 under which SIB regulates unit trusts. SIB regulations for OEICs will be the second part of the package of measures I have mentioned and will supplement the ECA regulations to complete the code of OEICs. A near final draft of SIB's regulations was published for consultation on 22nd October.

The third part of the package will be tax regulations to be introduced shortly by the Inland Revenue. The tax regime for OEICs will be broadly similar to that for authorised unit trusts. The tax regulations will also provide some relief from stamp duty and stamp duty reserve tax for authorised unit trusts which convert to OEICs. In addition, the Government have already announced that the next Finance Bill will introduce relief from stamp duty for other mergers of authorised unit trusts for a period of some two years.

So what is an open-ended investment company? It is in fact exactly what its full title suggests. It is a type of company whose business is investment in securities such as shares of other companies. It will issue shares to its investors and its capital may go up or down as shares are issued or cancelled. Hence the "open-ended" in the title.

The assets of an OEIC—the shares which its owns—will be held by a depositary which must be authorised under the FSA. The depositary plays a key role, similar to that of the unit trust trustee, and must be legally independent of the directors of the OEIC. That independence requirement is an important feature of investor protection and reflects a clear message from virtually the whole of the investment fund industry during the consultations.

I turn briefly to the corporate structure of the OEIC which has been the subject of some debate. Each OEIC will have a board which may consist of a sole authorised corporate director or a number of directors. Promoters of OEICs will therefore have a choice. This important element of flexibility was introduced following consultation. The Government believe that an OEIC with a sole corporate director can be effective, just like the unit trust with its fund manager. At the same time, many OEICs and indeed many investors may see advantages in a board with a number of directors, some of whom might be non-executives. Where a board has more than one director, SIB regulations will require one to be an authorised corporate director.

I have mentioned the element of flexibility in the regulations. This is balanced by the robust framework of protection for investors within which OEICs must operate. All the activities of the OEIC will be supervised by the regulators and the OEIC itself and its key players must be authorised under the FSA. It is unfortunately the case that no system of regulation can entirely rule out the possibility of fraud or mismanagement, but it is important to set high standards of protection for investors. That is what the Government propose for OEICs, as is already the case for authorised unit trusts.

I hope that my remarks have given your Lordships an indication of the main features of the OEIC. It will be a modern, flexible and transparent investment product, and it will be regulated.

Investors in this country will find a new product which is simple to understand, with key features disclosed more clearly than ever before. And they will have an opportunity to widen their ownership of shares without the burden of managing a diverse portfolio. Its corporate form will make it attractive to overseas investors too.

Promoters will benefit from the additional flexibility which is possible when backed by full and clear disclosure. Costs generally are likely to be more or less neutral when compared with unit trusts and there may be some economies of scale from using an umbrella structure.

The Government have been careful throughout to maintain a balance between flexibility and a high standard of protection for investors. These regulations for OEICs introduce a new and forward-looking stimulus to collective investment schemes in this country, and I believe that they will enhance the City of London's reputation as a centre for excellence in financial services. I commend them to your Lordships. I beg to move.

Moved, That the draft regulations laid before the House on 17th July be approved [28th Report from the Joint Committee—Session 1995–96].—(Lord Mackay of Ardbrecknish.)

7.40 p.m.

Lord Eatwell

My Lords, I am grateful to the noble Lord, Lord Mackay of Ardbrecknish, for introducing this complex piece of legislation so clearly. As I am going to make some critical remarks, I should make clear at the beginning that the Labour Party is supportive of the introduction of open-ended investment companies as a flexible investment vehicle which will not only increase investment choice but also enable the British investment industry to compete more effectively with other investment centres in the European economic area, notably Dublin and Luxembourg.

While I welcome the intention to introduce open-ended investment companies, I am not content with the manner in which the legislation is presented to Parliament, nor indeed with some of the content of the regulations in the order. I am also disturbed to hear this evening that we have only part of the legislation with respect to open-ended companies before us. A package of SIB measures has just been published and we are asked this evening to approve a regulation which has fiscal implications when the Inland Revenue regulations have not yet been published. That is not the right way to proceed.

Before moving on to detail, let me reflect for a moment on the environment in which the legislation is being introduced; namely, at a time when we are all acutely aware of the problems that are being encountered in the unit trust business of Morgan Grenfell. Those problems raised serious questions about the conduct and regulation of collective investment institutions. Noble Lords will be aware that if it were not the case that the financial strength of Deutschebank stood behind Morgan Grenfell and that Deutschebank has been prepared to cover potential losses in the Morgan Grenfell business, then the individual purchasers of trust units would have suffered substantial losses.

In those circumstances, before we have all the facts of the Morgan Grenfell case before us, it seems unwise—to say the least—to introduce an entirely new form of retail product by means of an order. While it is true that there has been extensive consultation on this matter, that consultation took place prior to the Morgan Grenfell case and could not have taken that case into account.

The Association of Unit Trusts & Investment Funds, in a briefing prepared for this debate, argued that the problems at Morgan Grenfell, seem to have related more to controls and the application of regulations rather than to the product regulations themselves". That may be so; we do not know as yet. But, if it is so, it raises serious questions in relation to some of the regulations in this order as they apply to open-ended investment companies. For example, can the Minister explain why, oddly, in these regulations—Regulation 10(4)—the company must have at least one director? The Minister referred to this point. Why only one?

I accept that in the case of there being only one director Regulation 10(6) states that the director must be a body corporate. Can the Minister explain why the usual Companies Act condition that there should be at least two directors does not apply in this case? The Minister referred in his remarks to the blending of unit trust and company legislation. Surely in this regard the blend has turned distinctly sour. It is an illegitimate extrapolation of trust law.

As I said, under the Companies Act there must be at least two directors of a company. The reason for that requirement is to protect the shareholders against impropriety. Surely in the circumstances of an open-ended investment company the same requirement should apply. It is worth noting that under the Financial Services Act—Clause 77—a unit trust scheme must have a manager and a trustee, who shall be different persons. Why are the conditions in this regulation so different? Why is a similar statement to that in unit trust law not made here?

Furthermore, given that the Morgan Grenfell case raised serious questions of controls within financial companies, why is there no requirement that there should be non-executive directors? The legislation seems to be going in exactly the opposite direction from that which has become customary in Britain in recent years, when there has been an emphasis on the need for more non-executive directors to play a vital monitoring role. Is it not even more the case that there should be non-executive directors in a retail financial business where the care of public savings is involved?

In continuing the theme of responsible control, I should like to ask the Minister some questions in relation to the role of the depositary. Regulation 10(8)(d) states that the depositary must be an authorised person; but it nowhere defines who is an authorised person. Can the Minister tell us? More importantly, Regulation 5(2)(b) states that nothing shall prevent the depositary from, entrusting to a third party all or some of the assets in its safekeeping; or … authorising the third party to entrust all or some of those assets to other specified persons". Are those third parties or even fourth parties authorised persons in terms of the regulation? If so, why does it not say so? Is the Minister content that by permitting these depositary chains, the consumer is being adequately protected by the regulations? Will the widows and orphans investing in these schemes know who is the depositary who is holding their assets? Will SIB know as the third and fourth elements in the chain are passed on?

Finally, I turn to that part of the regulation which is at one and the same time innovative and, I believe, most disturbing. The Minister did not mention it in his introduction. It was the dog that did not bark. I have given the Minister notice of my worries on this point. I refer to Regulation 42, which permits the introduction of bearer shares; that is, shares, the ownership of which is defined purely by their being in the possession of the bearer and of whose ownership, as Schedule 4, Clause 1(2) makes clear, no record is kept in the share register.

I am aware that bearer shares are common in many European countries and are not unknown in this country, particularly in some pre-war legislation. But their use was discontinued in this country, not least because they were a potent means of tax evasion. Introducing them into the heart of the financial services industry is contrary to the entire thrust of British companies and financial legislation for the past 50 years. It introduces a clear and present danger to the integrity both of financial institutions involved and of the fiscal system. The Minster should reflect on some of the dangers.

The ability to issue bearer shares means that the situation can arise in which no one will know who owns the company in which they are investing and will have no means of finding out. A major proportion of the shares might be owned by Mr. Nick Leeson or by an investor of the integrity of Mr. Robert Maxwell so far as anybody would know. Is the Minister content with that? Equally, it is not clear from the regulations how the company law with respect to mergers and takeovers will apply in a situation where the actual holders of shares are not on the register. If no one knows who owns the shares, how can the usual conditions of proportions and holdings in takeover regulation possibly operate? Will the Minister explain how that is to be done?

On a technical matter, in Regulation 42 it is stated that a company may issue bearer shares, evidenced by a share certificate, or by any other documentary evidence of title for which provision is made in the instrument of incorporation". Will the Minister explain what is meant by that? What do the Government have in mind? Will the Minister also tell the House what steps have been taken by the Inland Revenue to ensure that bearer shares do not become a means of tax evasion? As I said earlier, it was for that reason that their use in Britain was discontinued. Why are the Government willing to introduce that well-known evasion device now?

The introduction of bearer shares into British financial institutions, particularly retail financial institutions, is a grave step. It is entirely inappropriate that this remarkable change to British financial custom and practice should be introduced in an order. This House has had no opportunity to discuss the full implications of the innovation in Committee or to introduce amendments. I ask the Minister seriously to consider whether he should proceed this evening with an order containing Regulation 42.

This is an extraordinary statutory instrument. It contains 75 clauses or regulations and eight associated schedules. The Minister told us this evening that there are two more batches of legislation to come. This is not merely amending or developing financial legislation which has been considered in detail on previous occasions—the Minister and I have dealt with such orders on many occasions; orders which amend trivial or limited parts of financial legislation—this is something completely different.

This order introduces into British financial law an entirely new sort of investment vehicle making substantial innovations in the form in which collective investment companies are organised in this country. More seriously, it introduces bearer shares into British financial practice, from which they had been banished. In other words, this is a Bill masquerading as an order and it is entirely improper that it should be introduced in this manner. I am particularly disturbed, given our support for the overall form of open-ended investment institutions, that the Government have decided to proceed in this way. I would once again ask the Minister to consider whether this important legislation should proceed this evening in this form.

7.50 p.m.

Lord Alexander of Weedon

My Lords, I rise to give a welcome to these regulations and I hope very much that my noble friend the Minister will say this evening that the regulations will go ahead. I speak in two capacities and therefore probably disclose two interests: first, in my capacity as chairman of NatWest, which has an interest as a financial institution and will potentially be able to market OEICs, and, secondly, as deputy chairman of the Securities and Investments Board. I should like to say just a few words in both capacities.

Speaking as a banker, I greatly welcome the new opportunity which the introduction of OEICs and these regulations will provide to our financial services industry. Investment management is at the moment an area of competitive advantage for the United Kingdom. We need to capitalise on City expertise. Perhaps I may give our own position purely by way of example. In the NatWest group we have a unit trust management company operating trust funds under management. In the shape of Coutts, we also have one of the small number of authorised unit trust trustees acting as a custodian for trusts. With these companies at the moment we can manage, market and protect only unit trusts and it may well be we will wish to develop new vehicles of the kind envisaged in the regulations. If we do decide to go ahead, that will be because of the additional flexibility, simplicity and competitiveness which these new vehicles will offer if the regulations are approved. I say that by way of example because I know that other investment houses will be considering exactly the same opportunity. I very much welcome the fact that the noble Lord, Lord Eatwell, has indicated that the Labour Party is supportive of the principle of open-ended investment companies.

Perhaps I may be permitted to add a few words in my other capacity as a regulator. The Securities and Investments Board has been working closely with the Treasury on open-ended investment companies for some three years now; indeed, during the whole period of my association with the SIB. We are fully satisfied that the project should go ahead as presently designed. We have taken a great deal of care to ensure an equivalent level of investor protection to that available to investors in unit trusts. We have sought to provide a flexible vehicle for the benefit of the industry and investors alike, simplifying the new product wherever possible.

One example of this simplicity may suffice. These new vehicles will be priced on a single pricing basis with the preliminary charge shown separately. This should make for much greater transparency for those buying and selling the shares and should enable some worthwhile economies in the administration of the investment vehicle.

I shall obviously leave my noble friend the Minister to respond on the issue of bearer shares but my understanding is that bearer shares are very popular in continental Europe. It was felt that without them United Kingdom competitors for that marketplace would be at a disadvantage. Their use in many European states is well-established, but we do not in practice expect them to be used much in the domestic market. I also understand that concerns about potential money laundering were carefully addressed during consultation, but there was a consciousness of the protection provided by the money laundering regulations which are in place.

So, wearing my two hats, I think it is important that the United Kingdom should take advantage of the opportunity to expand our own stable of collective investment vehicles to include the corporate vehicle that has been so successful in Luxembourg, Dublin and the Channel Islands. And although there was an invitation from the noble Lord, Lord Eatwell, to say, "OEICs, OEICs, go away, come again another day", I hope very much that that will not be acceded to. I agree with him that every Member of your Lordships' House will be well aware of the problems that have recently come to light in the Morgan Grenfell case.

Obviously it will come as no surprise that industry and regulators are both giving intensive thoughts to the lessons to be learnt from the case. The SIB, for instance, is urgently reviewing the limits on investment in unlisted securities, on the valuation of unlisted securities and the relevant responsibilities of the manager and trustee, including obligations to report to the regulator. Our preliminary conclusion—I underline the word "preliminary"—is that no major changes are required to the product regulations for unit trusts. But if some changes are to be made in the areas I have mentioned, I understand that those amendments would be carried over to SIB's regulations for OEICs at more or less the same time. Any additional protection needed for unit trusts generally can be extended to OEICs. So I hope we will not postpone the envisaged arrival of the new vehicle which has an important future in the United Kingdom. I believe that these regulations provide us with a solid start. If improvements can be made later, we should all welcome that. But there is no need to wait for that to happen.

As has been indicated from both sides of the House, the City thrives on innovation. I believe it will suffer if we withhold or postpone tonight our approval to this welcome new vehicle, however difficult we find it to come to terms with the name.

7.56 p.m.

Lord Mackay of Ardbrecknish

My Lords, I am grateful to my friend Lord Alexander and to the noble Lord, Lord Eatwell, for their welcome of the regulations and of the advent of the OEIC, despite its name. I am particularly grateful to my noble friend Lord Alexander, who, with his wide background of knowledge in the City and as a regulator, was able, I hope, to allay some of the fears of the noble Lord, Lord Eatwell.

Perhaps I may take one at a time the four main points which the noble Lord raised with me. He asked me about Morgan Grenfell and suggested that we should hold our hand until we had discovered a little more about what had led up to that and whether there were any lessons to be learnt. I am sure the noble Lord will understand, as will the House, that, while IMRO's investigations continue, it is impossible for me to say anything of the details of those problems. But what I can say is that, as a result of IMRO's monitoring of unit trusts run by other fund management firms, this was an isolated incident. The recent problems are unusual and perhaps even unique and they have undoubtedly caused other firms offering unit trusts to the public to consider carefully whether their own internal controls and management procedures are adequate. As we have just heard, SIB is considering whether there might be value in adjusting its regulation in certain technical areas. But, conscious of the costs and dangers of over-regulation, SIB is planning to consult about a number of possible minor changes to its unit trust regulations. Against that background we feel that we can be comfortable with using unit trusts as the model for investor protection standards for the OEIC.

Yesterday there was a thoughtful speech by the chairman of SIB outlining a programme of work on the responsibilities of senior managers of investment firms in order to underline their role in delivering proper compliance with the regulations. I am sure your Lordships would be interested in reading what the chairman of SIB said. SIB will report early next year.

Your Lordships will also notice, and the Government welcome, the AUTIF's recent proposals for voluntary self-restraint on the holding of pre-listed securities, as mentioned by my noble friend Lord Alexander. That is a good sign. It shows us that the fund management industry is moving to reassure investors who may find it worrying that all of a collective investment scheme can be invested in securities which are expected to list within a year. I hope that AUTIF members will respond positively.

The noble Lord, Lord Eatwell, was concerned about the timetable. I assure him that the regulations do not come into force until 6th January, by which time SIB regulations which are now out will have been fully examined through consultation, and also the tax regulations, which I have mentioned will be available. The tax regulations are subject to negative resolution. So without being too hopeful that the noble Lord will respond, he will always have the opportunity to discuss them if he wishes when they come before us.

The noble Lord asked me why only one director and not two. I am sure that the noble Lord appreciates that OEICs may have non-executive directors if they wish. They may have more than one director, but it is not mandatory. If there is to be a sole director then that director has to be a corporate director. He must be an authorised person and he will be responsible for all aspects of the management of the company. If there is more than one director then SIB' s regulations will require all OEICs to have one corporate director and that must be an authorised person. The SIB regulations set out the responsibilities of that authorised corporate director. Some of these are the responsibilities of the authorised corporate director alone. In such cases the other directors are required to exercise reasonable care to satisfy themselves that the ACD undertakes those functions in a competent manner. In other areas SIB regulations require the ACD to act with the agreement of the board. The activities for which the ACD alone is responsible include investment decisions, pricing and ensuring compliance with ECA regulations, which impose obligations on the company. I hope that explains the position.

The noble Lord asked me what were the responsibilities and duties of an OEIC depositary. The SIB regulations set out the details. The assets of the OEIC must be entrusted to the depository, which is in fact a UCITS term for safekeeping. The depositary will be responsible for ensuring that the OEIC complies with SIB regulations on pricing, investment and borrowing powers and income allocation. The depositary also has a duty of oversight over the authorised corporate director to ensure compliance with the regulations which relate to the protection of the investors. The depositary of an OEIC will count as an investment business and a depositary will have to be authorised under the Financial Services Act. When the ECA regulations are made, and before they come into force on 6th January, the Treasury will lay an order extending the scope of the Financial Services Act to add the activity of the depositary of an OEIC to those activities which require authorisation.

I am grateful to the noble Lord, Lord Eatwell, for giving me notice that he would ask about bearer shares. Bearer shares are very popular in continental Europe. It was felt that, without them, UK competitors would be at a disadvantage. Their use in many European states is well established and is in fact the norm more often than not.

Unit trusts may issue bearer units in the United Kingdom now and the Government wish to allow parity between OEICs and unit trusts where possible. In practice, bearer units are very rarely used and we do not expect bearer shares in OEICs to be much used in the domestic market either.

During the consultation there were indeed concerns about potential tax evasion, as raised by the noble Lord, Lord Eatwell. Payment of interest distributions without deduction of tax is already permitted for authorised unit trusts provided investors can be clearly identified as satisfying the relevant residence requirements. The same rules will apply to investors in OEICs.

I do not believe that it is actually a question of who owns the OEICs because the bearer shareholders will be people who will be other shareholders, the same as any other person who decides to take out shares in an OEIC. I therefore do not believe that the danger is as considerable as the noble Lord, Lord Eatwell, suggested.

He asked how bearer shareholders are to be found in the event of a takeover or merger. I am sure that people who become bearer shareholders know that they have to keep an eye on advertisements and so on addressed to bearer shareholders. That is how they pick up that information currently.

On a more general point, the noble Lord, Lord Eatwell, drew our attention quite rightly to the fact that this is a considerable body of regulation. In choosing the secondary legislation route we were especially conscious of the need for full consultation about the proposals. There were two rounds of very detailed public consultation in 1994 and 1995. That gave the investment industry an opportunity to comment on every aspect of the proposed regulations. We listened carefully to the views expressed and we made certain adjustments to the proposed structure in the light of advice from the industry.

I hope that I have answered the main points raised by the noble Lord. I commend the regulations to the House.

On Question, Motion agreed to.

House adjourned at six minutes past eight o'clock.