Last month marked the close of an exceptional tax year for venture capital trusts (VCTs), with a total of £728m invested. Not only was this 34% higher than last year’s total of £542m – and the sixth yearly increase in succession – it comfortably broke the record for the highest amount raised since income tax relief was set at 30% 12 years ago, and was second only to 2005/06 when income tax relief stood at 40%.
Despite these impressive statistics, the figure left some wondering what might have been. Such was the pace of VCT fundraising in the last quarter of 2017 and the volume of supply on offer that many in the industry sensed this season would see the all-time fundraising record easily eclipsed. Indeed, by November 2017, VCT fundraising was up 100% on the same period in the previous year.
Instead, however, progress seemed to falter, moderating what could have been a truly stand-out year. When it comes to answering what caused this shortfall, two key factors stand out as impacting advisers and upsetting to flow of money into VCTs – the regulatory environment and compliance, suitability and professional indemnity (PI) cover.
Concerns regarding regulatory changes are always a significant driver of investor behaviour. In the 2017/18 tax year, many feared the Treasury’s Patient Capital Review would result in the loss of tax benefits associated with VCTs.
This is likely to have incentivised many investors to bring forward their VCT investments, displacing investment that would have otherwise taken place after November. Positively for the industry, those fears proved ill-founded as, while there were changes to VCT and EIS legislation, many served only to reinforce previous messages while others actually enhanced capacity.
Another major regulatory challenge affecting the industry was the implementation of MiFID II. Many intermediaries had to divert extensive resources into ensuring they were compliant and this has often prompted firms to introduce significant changes to their business models.
One of the issues has been the requirement not only to get one’s own house in order, but to ensure the providers one works with have taken the necessary steps. Many, for example, interpret GDPR as demanding advisers both review their own handling of client data as well as the procedures of providers with whom this data is shared.
The demands faced by advisers in adjusting their business models to comply with MiFID II has naturally reduced their ability to focus on recommending more complex products such as VCTs.
Compliance, suitability and PI cover
Perhaps the greatest impact, however, came from the ever-present concerns about the risks involved in recommending more complex products to clients, the impacts of this on PI and the lack of experience many advisers have when considering writing business in this area. This continues to result in many advisers choosing to steer clear of recommending VCTs, despite the increased recognition of their suitability when considering the needs of many clients.
The FCA requires that advisers file detailed suitability reports, specifying a client’s objectives and personal circumstances and why the product recommended is suitable, as well as any possible disadvantages of the transaction. Furthermore, it must be shown a client has the relevant knowledge and expertise to invest in such products and why the amount selected to invest is appropriate for that client.
In the case of VCTs, the risk/reward profile is sufficiently unique that this suitability analysis must be carried out distinctly from the rest of a client’s portfolio management.
Suitability reports can present a particular challenge to advisers who are not used to recommending such products. Advisers may, for example, be uncertain of which risks should be raised, and how they can be appropriately explained.
Expediting due diligence
While these factors have undoubtedly slowed down investment into VCTs in the last tax year, the good news is that both are temporary – or at least remediable.
The increased popularity of VCTs has meant providers have focused more resources on making the due diligence and suitability report writing process as straightforward as possible. As an example, Foresight’s ‘Adviser Centre’ provides intermediaries with guidance and templates that can help them to expedite the due diligence and demonstrate suitability when recommending VCTs to clients.
This helps ensure the key objectives, risks and considerations are covered in the suitability report, providing some comfort to those unfamiliar with how to document these recommendations appropriately.
On regulation, meanwhile, although it is unlikely the burden will disappear entirely, the unprecedented scale of MiFID II and its impact on the sector is unlikely to be matched in the near future.
Looking ahead, we are confident the growing popularity of VCTs will continue to rise – particularly as advisers become more familiar with the suitability, compliance and due diligence process involved. All things being well, perhaps the 2018/19 tax year can achieve the all-time record the last one narrowly missed.
Hugi Clarke is a director of Foresight Group