14 October 2016

Venturing further

Venture capital is widely regarded as a catalyst for innovation, investment and economic growth – and, for decades, informed people have argued that Europe needs more of it.

First, the good news. According to Invest Europe figures, 2015 saw an 8% increase in European venture capital fundraising, taking it to its highest level since 2008. No doubt that was, in part, because some early stage and high-growth businesses are clearly booming: the UK’s fast-growing FinTech sector, for example, has benefitted from substantial VC investment and is attracting capital from European and international investors, while GP Bullhound reports that in 2016 Europe (so far) has 47 unicorns – billion-dollar tech companies – which is seven more than last year.

But it is also clear that Europe punches below its weight. European venture capital funding markets continue to lag behind the US, despite similarly sized economies and even after many national and EU-wide attempts to boost them. The European Commission estimated that, if European venture capital markets were as deep as in the US, as much as €90 billion would have been available to finance companies between 2009 and 2014. So what is the Commission doing about it?

One helpful initiative was the (voluntary) European venture capital funds regime (EuVECA), which provides a more proportionate regulatory burden than the AIFMD for smaller scale venture capital fund managers, in return for an EU marketing passport. However, as we reported in November, initial take up was slow, in part due to overly tight eligibility restrictions. While the number of EuVECA registered funds has since more than doubled (to 70 as at 14 July 2016), there is certainly room for improvement.

The Commission recognises this, and its July proposal to amend the EuVECA seeks to extend eligibility to a wider range of fund managers, liberalise criteria for “qualifying investments”, and to make the registration requirements easier and cheaper. An important part of the liberalisation will be to allow investment in unlisted companies with fewer than 500 employees, as well as SMEs listed on growth markets, and to exclude follow-on investments from the investee company qualifying thresholds, allowing EuVECA funds to keep investing in successful, growing companies. It will extend eligibility to managers with more than €500 million under management, and streamline registration requirements to avoid duplication across Member States. Importantly, it will also explicitly prohibit fees charged by competent authorities for cross-border marketing – something that is arguably illegal under the existing rules, but which is widely practiced.

The changes are not yet a done deal, requiring approval from both the Council of Ministers and the Parliament. However, the Council is working on getting agreement quickly and – while the Parliament may take longer, with a first discussion expected in December – it is hoped that these sensible changes will not be controversial, especially as they are a key part of the broader Capital Markets Union initiative which President Juncker has confirmed as a priority. One sticking point might be a (helpful) proposal from the Commission to lay down harmonised minimum capital requirements for EuVECA managers, to address ‘goldplating’ in certain EU Member States, which will likely require a formula to be set out in the actual text.  It will be important that this formula remains proportionate to the risk posed by the failure of a fund manager (which is low).

There may be even better news ahead: the Commission’s public consultation on cross-border distribution of funds, for which the public response deadline was last week, aims (among other things) to improve the passporting regime for smaller funds and to promote best practice for tax treatment across Member States.

However, one conspicuous absence from the EuVECA regime, and any current proposals to improve it, is market access for third country managers: the regime is strictly for EU managers only. Given there are around 25 UK EuVECA managers, its loss will be felt when the UK leaves the EU – unless the British negotiators are able to secure continued access. That would seem to be in the interests of continental European investors, who will not want to lose access to UK venture funds. Unfortunately, whether such an agreement is reached will, of course, depend more on politics than economics.

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