Melville Rodrigues suggests a fairer basis for SME managers to unleash their entrepreneurial potential
UK fund managers want to boost the UK economy. From affordable housing to national infrastructure and from town-centre regeneration to the green industrial revolution, real estate fund and asset managers can make a significant contribution to economic growth.
Unfortunately, their desire to help is often stymied by regulatory and other barriers. These barriers are a particular problem for small to medium-sized enterprise (SME) managers. While the greater resources of larger managers allow them to operate complex fund structures, comply with burdensome regulatory requirements and gain access to the capital of European Economic Area (EEA) institutional investors, this is much harder for small managers.
There are ways in which these barriers could be removed and, while this would benefit all managers, it would be of particular value to smaller managers. Taking the steps that I will outline would create a level playing field. This, in turn, would increase competition and stimulate growth.
The Reserved Investor Fund
One important first step relates to the Reserved Investor Fund (RIF) that I advocate. The government has helpfully recognised that the RIF unauthorised contractual scheme has “the potential to lower the barriers for SME asset managers to launch new products”. I hope the government, assessing responses to its RIF consultation (which ended this month), will decide to proceed with the legislative introduction of the RIF, and from April 2024.
The RIF will plug a gap in the UK fund offering. Instead of being forced offshore to run closed-ended or hybrid funds (particularly attractive for holding UK real estate investments), managers will be able to use a competitive UK vehicle. In addition, the UK’s Financial Conduct Authority (FCA) will have the scope to further calibrate RIF regulations for SME managers to make them more proportionate – given its ideas about how to improve asset management regulation.
There are two other hurdles that could be lowered for SME managers.
ESG market and regulatory compliance
We need consistent, robust, transparent and quantifiable metrics for reporting. We also need international alignment on regulatory standards. With that in mind, the UK should look to be consistent with the approaches of the Task Force on Climate-related Financial Disclosures (TCFD) and the EU Sustainable Finance Disclosure Regulation (SFDR) reporting and disclosure requirements. However, while ESG-focused regulation is well intentioned, such regulation also has its challenges. For instance, SFDR is difficult to apply to real estate. In particular, some elements of the market are treating the Article 8 and 9 disclosure requirements as labels. There are also differences in the calculation methodologies between the TCFD’s recommendations and the SFDR, as well as inconsistencies with energy performance certificate (EPC) ratings among EEA member states – and between EEA and the UK.
The FCA plans its own Sustainability Disclosure Requirements (SDR) and investment labels with the FCA’s SDR Policy Statement expected by end of Q3 2023. It is reassuring that the FCA has sought “international coherence with other regimes and will continue to consider how to further support compatibility”. Hopefully, the FCA will learn from the SFDR label confusion and will proceed with labels including the “sustainable improvers” (proposed in an FCA consultation paper), which assists all managers (including SMEs) to attract capital for much needed real estate transition strategies.
Large managers generally have the resources to support extensive ESG-specialist teams. These resources enable them to respond to due-diligence questionaries from institutional investors, apply different metric criteria and report on various ESG standards. This is too onerous for SME managers and so are disadvantaged. We need to develop the constructive engagement between industry and the regulators and look to achieve more efficiencies for the spectrum of managers – from SME to large – with ESG real estate due diligence, metrics and reporting.
Greater access to EEA investors
In view of regulatory barriers resulting from Brexit, there is an important and unfortunate fund access problem for many UK firms – especially SME asset managers – in the global map: the EEA. While the UK offers an equivalence system which provides EEA managers with access to UK professional investors, the EU does not offer such a system to UK managers. Since 2020, UK managers have lost their automatic passporting rights into EEA states under the EU Alternative Investment Fund Managers Directive.
The government should build on an expected memorandum of understanding (MoU), which establishes a joint EU-UK Financial Regulatory Forum, and via the forum address this access issue. Last month the European Commission adopted the draft MoU, albeit stating that the MoU “does not deal with the access of UK-based firms to the Single Market – or EU firms’ access to the UK market – nor does it prejudge the adoption of equivalence decisions”.
I construe this statement as a signal that the Commission may review the access issue after the summer 2024 European elections and the UK general election. The next UK government must pursue negotiation with the EU with a view to ensuring that UK managers have improved fund access rights to EEA professional investors. Encouragingly on this front, the EU is also reported to be willing to renegotiate the EU-UK Trade and Cooperation Agreement following the summer 2024 European elections, for instance, to favour SME businesses.
For many years and even prior to 1973 UK joining Europe’s Common Market, the UK funds sector has operated on a pan-European basis – reflecting a gravitational and deep interconnection between the UK and the rest of Europe. However since 2020, UK managers have had to rely on a haphazard patchwork of national private placement regimes. France, Germany, Italy and Spain are effectively ‘out of bounds’ jurisdictions. UK managers are having to incur the substantial costs of establishing and operating fund structures in the EEA in order to continue marketing to EEA investors and managing EEA funds.
This favours large managers that can afford to operate such structures – particularly with the European Commission planning tougher substance requirements for managers operating within the EEA. Our SME managers lose out again. In addition to the problems that restricted access to EEA markets causes for UK firms, it also disadvantages EEA investors in that they are deprived of investment returns and diversification opportunities – for example, EEA pension funds face a greater risk of underperformance.
The review of access arrangements offers a great opportunity both to remove barriers to trade and to reduce the competitive advantage of larger managers.
Let’s look to level up the agenda. Managers of all sizes can play a crucial role in boosting growth. Making it easier for them to do so will benefit the economy as a whole. If removing barriers to trade also creates a level playing field for SME and larger managers can compete, this will also give SME managers a fairer basis on which to unleash their entrepreneurial potential.
