Ep. 54 The Long-Short | Getting under the hood of the Edinburgh reforms

Published: 15 February 2023

The Long-Short is a podcast by the Alternative Investment Management Association, focusing on the very latest insights on the alternative investment industry.

Each episode will examine topical areas of interest from across the alternative investment universe with news, views and analysis delivered by AIMA’s global team, as well as a host of industry experts.

The UK government's Edinburgh Reforms are both expansive and represent the strongest expression of divergence from EU financial services regulation by the UK to date. But will they deliver real benefits for the alternative investment industry?

To answer that question and more, AIMA’s Government and Regulatory Affairs team, Adam Jacobs-Dean, Global Head of Markets, Governance and Innovation, and Paul Hale, Global Head of Tax Affairs, join us on The Long-Short this week.

Listen to this episode and subscribe on Spotify

Listen to this episode and subscribe on Apple Podcasts

Listen to this episode and subscribe on Google Podcasts

Listen to this episode and subscribe on Amazon Music

Read the transcript 

Hosts: Tom Kehoe, AIMA

Guests: Paul Hale, AIMA, Adam Jacobs-Dean, AIMA

Interlude: Lorna Barnard, AIMA

Tom Kehoe, AIMA  00:04

Welcome back to The Long-Short, I'm your host Tom Kehoe.

The UK government has long made clear its desire to take advantage of Brexit freedoms and improve the UK financial services regulatory framework. And in the latest step to achieve its ambitions a package of 30 reforms, which at one stage was dubbed ‘Big Bang 2.0’, but subsequently renamed the Edinburgh reforms, were announced by the UK Chancellor of the Exchequer, Jeremy Hunt, last December.

According to Chancellor Hunt, the reforms aim to seize the benefits of Brexit to secure the UK's status as one of the most open, dynamic and competitive financial service hubs in the world. These reforms are both expansive and represent the strongest expression of divergence from EU financial services regulation by the UK to date. They include new secondary objectives for the Financial Conduct Authority, and Prudential Regulation Authority, of supporting medium to long-term economic growth and promoting the UK's international competitiveness as well as amendments to banking regulation and changes aimed at the fund sector.

But will they deliver real benefits for our industry? Joining me today are two of my colleagues from AIMA’s government and regulatory affairs team, Adam Jacobs-Dean the Global Head of Markets, Governance and Innovation at AIMA, and Paul Hale, Global Head of Tax Affairs at AIMA. Gentlemen, you are very welcome to The Long-Short.

Both  01:18

Good to be here.

Tom Kehoe, AIMA  01:19

So, Adam, let's start with you, what more can you tell us about these reforms? Can you briefly explain this to our listeners?

Adam Jacobs-Dean, AIMA  01:26

Absolutely. So, you've already given a bit of a sense of the Edinburgh reforms. But this is, overall, a package of reforms to the UK financial services regulatory framework announced by the government at the end of last year. As you say, there's a huge number of individual pieces of work, 30 different work streams associated with the reforms. Some are more concrete plans for change, some articulate what the government wants to do quite explicitly, and others are more exploratory projects. So, they are intended to look at how the rules might be rewritten, but without necessarily setting a firm commitment to do so.

It's clear that it’s all going to generate a significant pipeline of work, we'll have a consultation process associated with many of the proposals through ultimately to implementation work by the firms that will need to implement the new requirements. Obviously, the context for the reform package is Brexit, the UK is no longer constrained by EU law, and can therefore decide how to rewrite or abandon the rules that it inherited from the EU's regulatory framework. And the government has said that, by publishing the reforms, it will be in a better position to seize the benefits of Brexit. It (the government) talks about its ambition for the UK to be the world's most innovative and competitive financial centre.

I think it is probably worth saying as well up front that I wouldn't describe this as a bonfire of regulation, the UK is still very much focused on having sound regulatory architecture, and there's still a big focus on financial stability. But this is more about making sure that the burden associated with regulation is not excessive. So, as I say, quite a significant package of work and quite a lot of work for us to do in terms of responding to some of the consultations and looking at the implementation of the requirements as they ultimately get formulated.

Tom Kehoe, AIMA  03:27

So, Adam let's then talk about some of these reforms and those response reforms in particular that are aimed at the funds' sector. Which of those will be of greatest interest to alternative investment managers?

Adam Jacobs-Dean, AIMA  03:42

Sure. So, there are a few that I would highlight out of the overall package. What's interesting is that the item that generated probably the most press coverage when it came to the reform package was planned changes to the ring-fencing of banks' trading operations from their retail banking arms. But that's something that's probably quite incidental to most in the hedge fund space. So, there's quite a lot that is maybe getting overlooked.

From my point of view, the things that are far more likely to be of consequence for us would include, firstly, measures that are being advanced as part of the wholesale markets review, so something that was already in train, but the Edinburgh reform package includes new commitments on that front. There's a big focus on quick delivery of a consolidated tape for trade data, something that will be welcome from our point of view, and also work to explore a move to T+1 settlement, which is a new strand of work associated with the wholesale markets review.

Alongside that, changes on the tax front which Paul will be addressing later (in this episode). A planned review of the senior managers and certification regime (SMCR). An interesting question there will be whether there's any sort of rethink of the extension of that regime into the investment management space, given that it really originated as something that was applicable to the banking sector, and I think that's something where there will be interest from industry and whether that could be scaled back.

And then finally, I'd pull out the work that Treasury is currently undertaking on the UK’s short selling framework. And from my perspective, that's probably the most obvious and exciting part of the Edinburgh reforms in terms of how hedge funds are regulated in terms of their UK operations.

Tom Kehoe, AIMA  05:32

So, let's go there for a minute then, Adam, what is the government planning then, when it comes to rules regarding short selling?

Adam Jacobs-Dean, AIMA  05:41

So, they published a call for evidence, it's a pretty wide-ranging look at the way in which the short selling regime operates today. It covers everything from what you have to report to the FCA (Financial Conduct Authority), what you have to disclose publicly to the market, and short selling bans. And there is in the call for evidence, when you look through it, a real focus and acknowledgement of the existing compliance burden associated with the regime and questions about how that could be reduced, but also a definite focus on how the rules affect market functioning and whether they are potentially getting in the way of efficient functioning of UK equity markets.

Tom Kehoe, AIMA  06:24

What changes would we at AIMA like to see regarding some of the short selling proposals?

Adam Jacobs-Dean, AIMA  06:31

So, from our perspective, the top of the list has to be removing the requirement to publicly disclose short positions. So, for those who aren't familiar with the regime, as it operates today, currently, fund managers have to tell the market if they have a short position greater than 0.5% of the issued share capital of a particular company. And this has been a huge disincentive to having short positions of that size, because as soon as you do, your competitors will know what you're doing, and possibly be able to replicate your strategy. And it also means that future dialogue with issuers becomes much more challenging because issuers don't like seeing their stock shorted. But, despite that somebody with a short position today could in future have a long holding. So, it's worth keeping that in mind.

But it's also worth making the point that reluctance to go short on account of the public disclosure rules is also harmful to market functioning because you're essentially removing liquidity from the market. That distorts the price formation process. So, you are depriving the market of key liquidity and key trading interest. So, that would be the area where we are most likely to see change. And we'll be pushing that point very strongly in the response that we make to the Treasury about the call for evidence.

Maybe you could have some sort of issuer-level aggregate short information published by the FCA so that you still have information in the market about what's happening in terms of short activity. But with that kind of approach, you would then avoid the issues you have with individualised named disclosure, which as I say, basically disincentivizes firms from taking short positions.

The other big area where we like to see changes in terms of reporting to the FCA. It's definitely a burdensome reporting regime. And it could be made much less cumbersome without really depriving the regulator of useful information. So, for example, you could allow more time for reporting, and you could adjust the thresholds at which firms have to report to the FCA to reduce the overall number of reports that they're making. You could change the FCA’s reporting portal itself to make it easier for firms to automate their reporting and upload information in bold. So, on that front, there are lots of quick wins that we'd like to see put into practice quickly.

Tom Kehoe, AIMA  09:03

How quickly do you think these changes could materialise?

Adam Jacobs-Dean, AIMA  09:07

I think it very much depends on how ambitious they are in terms of changing the rules. If it's a quite targeted set of changes, it could probably be done within months, I would say. But if they opt for something more radical, then it may might take more time to deliver. So, that's the conundrum I suppose for the industry is how far do we push radical reform that will be slow to deliver, and how much do we focus on getting things done quickly and push for more targeted amendments to the regime as it operates.

Lorna Barnard, AIMA 09:39

AIMA’s Next Generation Manager Forum, now in its 10th year, returns to London on Tuesday the 16th of May. The forum provides a platform for the exchange of ideas and the development of peer networking for senior individuals at alternative asset management businesses managing up to US$500 million in hedge and private credit assets. Throughout the afternoon, speakers will discuss next-generation managers 10 years on, the war for talent, how to acquire and keep it, ESG implementation and non-negotiables, and investor relations, retention and maintenance. Register today to learn more from the stellar speaker lineup and engage and network with colleagues, both old and new. We look forward to welcoming you.

Tom Kehoe, AIMA  10:20

Let's turn to you then, Paul. The reforms, some of them include tax proposals. Are these relevant to the alternative investment management sector?

Paul Hale, AIMA  10:29

Yes, certainly, there are a number of tax measures included in the Edinburgh Reforms. The first which we should look at is a consultation on VAT (Value Added Tax) and fund management. However, this is not the consultation on VAT and fund management that everyone was waiting for, which was promised as part of the UK funds review a couple of years ago, and that would have looked at broader possibilities for change. The current consultation, rather in line with the background to the Edinburgh reforms and Brexit, is seeking to entrench in UK VAT law, the existing VAT treatment for funds and fund management. That, of course, derives from what is currently EU retained law. So, this consultation concentrates on the definition of what is a special investment fund for the purposes of the VAT exemption, and that is really most relevant to UK retail funds. Now, it can go a bit broader than that, but it's of less relevance to most statement members.

Unfortunately, what the consultation doesn't do, which it could have done, would have been to make more certain the boundaries of what fund management is, and that is where the issues really are currently, in terms of working out the exemption.

However, the consultation does have a major issue in it, which is potentially relevant to AIMA members in that it leaves, we think unintentionally, unclear whether the present zero-rating treatment for managing offshore funds will remain. And that is very important to UK managers of, say a Cayman hedge fund, because it means that manager doesn't charge VAT on the management and performance fees but is still able to recover in full the VAT it incurs on its costs. So, it would be a major issue if that treatment were removed.

Now, we understand that it is not intended to make any change to the current position. But it's a point that we have emphasised in our response to the consultation which was submitted at the end of last week.

Tom Kehoe, AIMA  13:05

And Paul, the reforms also address the digital assets sector and I see that there has been a reference to expanding the investment manager exemption to include crypto assets. So, what can you tell our listeners about this?

Paul Hale, AIMA  13:21

Yes, Tom, that's right. The investment manager exemption or ‘IME’ is very important. It permits UK asset managers to carry out transactions on behalf of non-residents without exposing them to UK tax on profits that are realised from those transactions provided that certain conditions are met and the assets in which the transactions are being undertaken, are included on a list of permitted or qualifying investment transactions. And the UK investment management industry has been built on that foundation over the last 30 years.

Now, this list has now been extended to include digital assets and cryptocurrencies, subject to some exceptions. Broadly, the effect of the transaction mustn’t be to replicate something which would otherwise not have been permitted under the IME.

This change is retrospective to the 1st of April 2022, so, it's already there and up and it will be very welcome to those managers who are carrying out transactions for non-residents and non-resident funds in cryptocurrencies and other digital assets. We're very pleased to see this because AIMA has been arguing for this change for several years. Now, so it's good that it's there.

Tom Kehoe, AIMA  15:02

Thank you, Paul. Is there anything else within the reforms that have relevance to tax that's of note?

Paul Hale, AIMA  15:11

The final one I would mention is that there are some changes to the real estate investment trust (REIT regime). That's perhaps of less interest to most AIMA members. But it's worth noting that this is an outcome from the UK funds review, like the qualifying asset holding companies regime, which was introduced a year or so ago, and which is already proving very successful in attracting to the UK asset holding companies that might otherwise have been set up in Ireland or Luxembourg.

And it shows that the government has been willing over the last couple of years to listen to what the alternative investment management sector wants, in terms of things like this and long-term asset funds and removing pension fee caps from pension fund investments. But whether there is currently, in the current position, appetite on the part of the government to go further in terms of innovative products is far from certain. And I think that is one of the limitations, certainly on the tax side, from the Edinburgh reforms.

Tom Kehoe, AIMA  16:41

Thank you, Paul. And turning to Adam, what then are the next steps then regarding these reforms?

Adam Jacobs-Dean, AIMA  16:48

The first thing I would say is, members should feel free to get in touch if they're interested in getting involved. So, we've got a number of working groups on the regulatory front, typically organised thematically, and through those working groups, we are exploring what is in the reform package and developing a position on whether there is something we need to respond to. So, for example, we've got a short selling working group with a very active set of members representative on it. And we're using that group to develop our submission, our response to the Treasury's call for evidence.

We also as well, will be speaking to key policymakers as the rules are elaborated on the short selling front, for example. We've already had very good conversations with the Treasury and the FCA about the direction of the reform work. And it's always valuable from our perspective to be able to involve members in the conversations because we know they have the direct experience of dealing with the compliance burden associated with regulation and the direct perspective on how changing rules could potentially be helped from the point of view of how they approach their business activities.

So if you would like to be involved in any of our working groups, please do feel free to reach out to us and we'll make sure you're on the appropriate groups. I think there will, down the line, be a role for guidance for member firms to assist them in terms of compliance with the new regime. That's something that we place a big emphasis on in terms of our GRA (AIMA’s Government Regulatory Affairs) work. And you've probably seen some of the guidance documents that we've put together on a whole host of different regulatory areas and in this space, as much as anywhere else. I think there will be a need for support for firms once the rules have changed to make sure they're able to navigate them and understand the new requirements and we'll be putting a lot of effort in on that front as well.

Obviously, we will as well continue to monitor for any statements from the government about the direction of travel, or any of what's in the package that might be of interest and keep members up to date. So, do expect to see more from us on this topic over the coming months.

Tom Kehoe, AIMA  18:59

Thank you, Adam. Details as to how to join these various working groups that you mentioned and contact details for yourself and Paul are available in today's show notes.

So, that's all we have time for today then. Many thanks to you both for joining us on The Long-Short and for offering your excellent insights into the Edinburgh reforms and we will keep a close eye on its developments over the coming months. We’ll speak to you again soon.

This podcast is the sole property of the Alternative Investment Management Association (AIMA). This audio production and content are intended as indicative guidance only and are not to be taken or treated as a substitute for specific advice, whether legal advice or otherwise. AIMA permits use or sharing of the content in media or as an educational resource, provided always that proper attribution is made. The rights in the content and production, including copyright and database rights, belong to AIMA.