Ninth Standing Committee on Delegated Legislation
Wednesday 2 May 2001
[Mr. Bowen Wells in the Chair]
Financial Services Act 1986 (Extension of Scope of Act and Meaning of Collective Investment Scheme) Order 2001
The Economic Secretary to the Treasury (Miss Melanie Johnson): I beg to move,
That the Committee has considered the draft Financial Services Act 1986 (Extension of Scope of Act and Meaning of Collective Investment Scheme) Order 2001 (S.I. 2001, No. 1421).
The order is modest but worthwhile. It extends a degree of consumer protection to investors in limited liability partnerships by amending the Financial Services Act 1986. I hope that the Committee will excuse me if I use the term ``LLP'' as shorthand for limited liability partnership.
Committee members might have hoped that the Financial Services Act 1986 was now entirely a thing of history, given the effort that has gone into the Financial Services and Markets Act 2000. The order shows, however, that there is some life left in the 1986 Act, even in its final days. It might be helpful to explain that LLPs were created under the Limited Liability Partnerships Act 2000. They are corporate bodies without a share capital. The order addresses an issue that stems ultimately from that lack of shares and I shall explain why.
The Limited Liability Partnerships Act came into force on 6 April. That is important for the purpose of the order because it will now be possible to structure LLPs so that management is separated from ownership. Membership of an LLP can, therefore, be bought and sold separately from the underlying business and its assets. Such membership interests will be able to be traded in the same way as shares of a typical company are traded. We have acted to deal with trading in pooled investment interests.
I must emphasise that the emergence of a new investment market is a possibility, not a certainty. However, the Government have become aware that there is interest in such a development, for example, as a result of discussions that firms have had with the Financial Services Authority.
Without this measure, any such investment market would be unregulated because LLPs fall within none of the definitions of investments or investment business contained in schedule 1 of the Financial Services Act 1996. We want to provide a degree of consumer protection to ensure that dealing in the membership of an LLP is regulated under that Act.
The order will extend the 1986 Act's definition of a collective investment scheme to include LLPs. They will become subject to the same requirements of the regulatory regime that apply to existing collective investment scheme structures. In practice, that means that anyone who sets up or winds up a pooled investment LLP will usually need to be authorised under the 1986 Act.
If an LLP is a collective investment scheme, it will need to be authorised itself. As the operator of the scheme, the LLP will control and trade its assets on behalf of the underlying investors, as is the current position with an open-ended investment companyan OEIC.
An advertisement for the issue or sale of an LLP interest will be an investment advertisement and must be issued or approved by an authorised person. However, the issue of an advertisement for new ``partners'' in a purely commercial or professional firm organised by an LLP should not be an investment advertisement.
There are restrictions on the promotion of unregulated collective investment schemes. They largely prohibit promotion to unsophisticated investors and will apply to pooled investment LLPs.
Firms currently engaged in setting up or operating collective investment schemes will be familiar with the requirements. Advisers will be familiar with the boundary questions that will arise in determining whether a firm is a collective investment scheme, because the same tests will be applied.
No additional regulatory costs will be imposed on firms that use the LLP structure as opposed to other existing collective investment scheme structures used to undertake investment business.
One technical point may warrant further explanation. We do not intend to bring every participation in an LLP within the scope of financial services regulation. That is not the purpose of the order. It merely provides that
``limited liability partnerships are capable of being collective investment schemes''.
The order deals with the circumstances where the right to take part in an LLP is packaged and held out as an investment. The process of a partner joining or leaving a working partnership that has chosen to take advantage of the Limited Liability Partnerships Act and is structured as an LLP will be unaffected by the order, because it does only what it says and allows LLPs to be collective investment schemes. It does nothing more, which is why I described the order as modest. It says nothing about the process whereby members join or leave a business. The Limited Liability Partnerships Act 2000 governs those matters.
We expect the costs to firms resulting from the order to be negligible. Indeed, because arrangements for the regulation of LLP rights will be aligned with an already existing regulatory regime for other collective investments, there ought to be efficiency savings for firms, because they can deal with LLP business like other collective investments, rather than requiring special arrangements to be put in place.
The benefits of the order are essentially precautionary. Without this measure we would risk investor difficulty or lossrisks that it is not right to expect investors to run. The sums could be substantial. Of course, we attach real importance to protecting investor confidence in the wider financial systemwhich any widespread problems undermineand the change will contribute to that. The cost to the FSA for implementing the change is also likely to be minimal.
Having already referred to the Financial Services and Markets Act 2000, I should explain that the order applies only to the current 1986 Act. We shall take separate steps to ensure that equivalent protection is in place for the period post N2 on Financial Services and Markets Act implementation.
The order is a modest measure with an important purpose and I commend it to the Committee.
Mr. Howard Flight (Arundel and South Downs): At first blush, I thought that the order was straightforward and made sense. I believed it meant that if an LLP were to be used as a fund or collective investment scheme, it would be regulated as such. That was it. I understood why the 1986 Act was relevantbecause N2 has not happenedand wondered whether the order would have to be renewed on N2 or whether the Financial Services and Markets Act made provision for it to be grandfathered across.
However, it was then drawn to my attention that the drafting might not work. Does it take ``capable of'' formin other words, is it entirely voluntary and who will decide? If that is the correct line, LLPs will not otherwise be regulated, but should be. Alternatively, if it is rather more than ``capable of'', it is inappropriate for the interests of an accounting or soliciting firm structured as an LLP to be regulated as a collective investment scheme. The order is clearly motivated by the Government's understandable concern that LLPs might be used as collective investment schemes when a form of retail organisation is more appropriate.
It might have made more sense to have standard regulation of LLPs as shares in a typical company to meet the stated consumer protection goal and avoid the risk of imposing disincentives on the use of LLPs by professionals or of allowing LLPs to escape regulation completely. The point is that, in future, the interests in a leading law firm as an LLP could conceptually be listed and certainly offered to institutional investors. In such circumstances, under what form of financial regulation will the new entities be regulated?
That touches on the question of the interests to which the Minister referred. It is argued that membership interests in LLPs can be covered by the two potentially relevant paragraphs of schedule 1 to the Financial Services Act 1986 and therefore come within the definition of shares and stocks as well as of units in a collective investment scheme. Shares and stock could cover such interests, although no definition specifically does so. I think that counsel advised that shares and stock should be able to be interpreted as including any equivalent ownership.
Membership of an LLP cannot of itself fall into the definition of a collective investment scheme. Under the order, an LLP cannot be such a scheme unless the LLP's purpose is the investment of funds with the aim of spreading risk and so on. Only if the rights of the participants are represented by shares or securities of the LLP that have redemption or repurchase rights related to a net asset value from the funds of the LLP can they fall into the collective investment category.
LLP arrangements will amount to a collective investment scheme only if they are in relation to property of some kind and the purpose is to enable participants to receive appropriate shares of profit or income from that property. Clearly, most accounting and law firms are not like that. They provide services and could not, I think, be deemed to relate to property. By corollary, if they could be so deemed, it could be argued that most large professional partnerships would already be collective investment schemes, which I believe no one is suggesting. If professional partnerships are outside the collective investment scheme definition, the changes in the order will not make them collective investment schemes as LLPs and they will not be subject to any form of regulation.
What is the full objective? If the order seeks to bring LLPs within the scope of the 1986 Act as collective investment schemes by providing the bodies corporate, which LLPs can be even if they are not open-ended investment companies, it will not achieve its objective. LLPs are used mostly in accountancy and legal practices. They are therefore left completely unregulated. It follows that it may still be possible to trade membership interests of some LLPs without being subject to the FSA regulatory regime. I assume, although it is not clear, that that is the order's intention, but, as I pointed out earlier, it leaves hanging in mid-air what the regulation is to bethere is none in cases in which LLP interests in such service industries in effect become securities that are marketed to institutions and so forth.
I revert to my question: would it not have been more logical for regulatory purposes to treat interest in LLPs in the same way as interest in companies, or to have doubled up and done bothto have them treated as collective investment schemes when that is what they are, but to have them treated for regulatory purposes as companies when they are clearly not collective investment schemes but, in essence, law firms and accounting firms? As such, they would be subject to the investment advertisement and prospectus regime, which would clearly be appropriate if such interests were being placed with institutions.
There is a second risk that, as the order stands, should an LLP be deemed to be subject to FSA regulation, it would have to be FSA authorised. Everyonethe Government, Parliament and Oppositionhas specifically sought not to require accountants and lawyers to be authorised under the financial services regime. It would surely be illogical to create a situation in which the heads of such law firms felt that they needed to be FSA regulated to avoid the risk of being deemed to come under the order. If they did, they should be FSA regulated. Unless that is cleared up, it is a potential disincentive to law and accounting firms using the LLP structure.
There is a potential further problem with the special restrictions on promotion and marketing of collective investment schemes that otherwise do not apply to service providers or even to closed-end investment companies. Clearly, if they were applied to, for example, a law firm business that fell under the collective investment scheme rules because it was placing its interest in some way or other, public offers of interest in LLPs would be a major problema point I have already made.
It is quite complex territory. The objective is simple and understood, but the order seems completely to ignore the fact that there will be LLP interests that will effectively need to behave as securities, and if they fall under the regulatory regime for collective investment schemes, all sorts of unintended problems would be caused for LLPs that would lead them not to be used. If they are not going to be regulated under the retail collective investment schemes regime, how are they to be regulated, when the LLP interests take on the characteristics of securities?