Explanatory Memorandum to COM(2011)862 - European Social Entrepreneurship Funds - Main contents
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This page contains a limited version of this dossier in the EU Monitor.
| dossier | COM(2011)862 - European Social Entrepreneurship Funds. |
|---|---|
| source | COM(2011)862  |
| date | 07-12-2011 |
The principal aim of this proposal is to provide support to the market for social businesses by improving the effectiveness of fundraising by investment funds that target these businesses.
Social businesses[1] are an emerging sector in the EU. Social businesses are undertakings whose primary objective is to achieve social impacts, rather than generate profits for shareholders or other stakeholders. In achieving social impacts, social business seeks to build on business techniques – including business finance. While the sector is new, it is characterised by rapid growth. According to the Global Enterprise Monitor 2009 report, between 3% and 7.5% of the workforce in selected EU Member States were employed in various forms of social businesses.
Social businesses are almost exclusively SMEs. The social mission of social businesses correlates with a strong focus on sustainable or inclusive development, and on tackling social challenges across EU societies: this means that investment in social businesses are likely to have a greater positive social impact than investment in SMEs more general. Given some estimates, such as by J. P. Morgan, suggest social investments could grow rapidly to become a market well in excess of EUR 100 billion, underlining the potential of this emerging sector.[2]
Ensuring this sector continues to grow and flourish would therefore be a valuable contribution to meeting the objectives of the Europe 2020 Strategy.
Social businesses derive significant proportions of their funding from grants, whether from foundations, individuals or from the public sector. As businesses, however, their sustainable growth depends on drawing on a wider range of investments and financing sources. In this regard, the EU market for investment funds has begun to play a significant role. A market for investment funds whose main objective is investing in social businesses has taken shape. In order to distinguish such targeted funds from social investment funds more widely, these targeted funds are referred to as social entrepreneurship funds in this proposal. The growth of social entrepreneurship funds reflects the increasing interest of many investors in making investments – typically as part of a wider portfolio – that aim to achieve positive social effects over and above the quest for financial returns.
Evidence on regulatory and market failings shows two problems are limiting the growth of social entrepreneurship funds.
Firstly, regulatory requirements at EU and national levels are not tailored to facilitate the raising of capital by these kinds of funds. Raising capital on a cross border basis is costly and complex due to the fragmentation of national rules that govern 'private placements[3]' abroad. Compliance with a variety of national rules governing the activity of private placements to select investor groups raises the cost of capital for these funds. Also, social entrepreneurship funds are not flourishing across all Member States, but currently are geographically uneven in their distribution.
Following consultations with Member States it is clear such social entrepreneurship funds are in most cases either governed by the general national rules applicable to private placements or, alternatively, by special legal provisions that are introduced for venture capital or private equity. A minority of Member States also has special rules for wider categories of social investment funds that are also open to retail investors. These wider social investment funds do not necessarily target their investments solely towards social businesses. Evidence in the impact assessment shows that the fragmentation of national rules on social entrepreneurship funds and a lack of tailoring of such rules to their needs has led to cost burdens and reduced efficient access to capital markets for such funds. Despite strong investor interest in social investment strategies, these regulatory burdens hinder the creation of efficiently sized social entrepreneurship funds (the average social entrepreneurship fund's assets under management rarely exceed EUR 20 million).
Secondly, potential investors in social entrepreneurship funds are faced with a wide range of different social investment propositions, different levels of information pertaining to social investments, the selection or screening of social undertakings, and approaches to the measurement of their social performance. Funds themselves and their target social businesses can face costs from the existence of overlapping or competing self-regulatory measures with respect to the issues mentioned above. Confidence and trust in the eyes of investors are undermined.
These difficulties hamper efficient flows of capital to social entrepreneurship funds, and thereby the flow of capital to social undertakings themselves, and constitute a barrier to the development of a single investment market in this area.
In these circumstances, the Commission, in the Single Market Act i (SMA), undertook to put in train several measures to ensure EU social businesses can flourish, including by tackling such financing weaknesses. The current proposal on a European framework for social entrepreneurship funds is one initiative that delivers on that commitment; it forms part of the Commission's Social Business Initiative (COM(2011) 682/2), which aims to tackle wider issues in this sector.
The aim of the proposed Regulation is to create a legislative framework tailored to the needs of social undertakings, investors seeking to fund such undertakings, and the specialised investment funds that seek to mediate between the two. It aims to achieve a high level of clarity as to the characteristics that distinguish social entrepreneurship funds from the wider category of alternative investment funds. Only funds that comply with these characteristics shall be eligible to raise funds by virtue of the proposed European framework for social entrepreneurship funds.
The proposed Regulation addresses these problems. It introduces uniform requirements for the managers of collective investment undertakings that operate under the designation 'European Social Entrepreneurship Fund'. It introduces requirements as to the investment portfolio, investment techniques and eligible undertakings that a qualifying social entrepreneurship fund may target. It also introduces uniform rules on which categories of investors a qualifying social entrepreneurship fund may target and on the internal organisation of the managers that market such qualifying funds. As managers of collective investment undertakings that operate under the designation 'European Social Entrepreneurship Fund' will be subject to identical substantive rules across the EU, they will benefit from uniform requirements for registration and an EU wide passport, which will help create a level playing field for all participants in the market for the funding of social entrepreneurs.
The proposed Regulation on European Social Entrepreneurship Funds (EuSEFs) is complementary to the proposed Regulation […] on Venture Capital Funds. Both proposals aim to achieve different goals and both proposals, if adopted, will coexist as autonomous legal acts in mutual independence.
Venture capital funds focus on providing equity finance for SMEs, but typically do not meet the asset-based threshold that defines the passport available for large fund managers under Directive 2011/61/EC (on Alternative Investment Fund Managers). While social businesses are also SMEs, and the funds targeting social business also operate beneath the asset-based thresholds of Directive 2011/61/EC, the range of eligible financing tools proposed in the Regulation on European Social Entrepreneurship Funds go beyond equity finance - the typical instrument for start-up enterprises in the technology sector. Apart from equity finance social undertakings also have recourse to other forms of finance, combining public and private sector financing, debt instruments or small loans. The proposed rules on social entrepreneurship funds therefore provide for a larger range of qualifying investment tools that are available for venture capital funds.
In addition, the transparency issues raised by investments into social businesses are distinct from the general reporting obligations that are provided in the area of venture capital: investments into social entrepreneurship target a form of ‘social return’ or positive social impact. The proposed rules contain special sections that focus on information pertaining to social impacts, their measurement and the strategies employed to foster their achievement.
For these reasons, the preferred choice is that there should be two EU frameworks on venture capital and on social entrepreneurship that would operate autonomously alongside each other.
Further work should be undertaken to ensure that the rights assigned by this Regulation to EuSEF managers and the EuSEFs they manage are not undermined by tax obstacles. Appropriate taxation rules – though independent from this Regulation – are an important compliment to it and aid the development of a fully functional market for EuSEFs within the EU. They could ensure efficient capital flows to EuSEFs and ultimately the qualifying portfolio undertakings in which the funds invest.
2. RESULTS OF CONSULTATIONS WITH THE INTERESTED PARTIES AND IMPACT ASSESSMENTS 2.1. Consultation with interested parties
On 13th July 2011, the Commission services launched a public consultation on possible measures to improve the access of social businesses to finance by means of investment funds, which closed on 14th Sept 2011.[5] Contributions received were 67 in total and can be consulted at the following website:
ec.europa.eu/internal_market/consultations/2011
In addition, regulators and supervisors were also consulted via the European Securities Committee (ESC), including through a questionnaire requesting details on existing national regimes for social investment funds more widely including on social entrepreneurship funds.
This falls within the wider context of the Commission's work and consultation on the Single Market Act, where the role of social businesses and their financing was also identified and explored with stakeholders and participants in that consultation. Following this the Commission launched a stand alone Social Business Initiative which offered further opportunities for discussions with stakeholders including through a workshop in May 2011.
In line with its policy on 'better regulation', the Commission conducted an impact assessment on various policy alternatives.
This analysis identified two key problems: on the one hand, information made available to investors pertaining to social undertakings, the investment policies and screening procedures followed by social entrepreneurship funds and the measurement of social impacts is either insufficient or not presented in a comparable manner. On the other hand, regulatory approaches to the fundraising of organisations specialising in investments in social businesses were not sufficiently tailored to the specific needs of social entrepreneurship funds.
First, market participants lack confidence in the information available, are not readily able to identify those funds that target social businesses, and are not confident in the social impact they can achieve by investing in such funds. The second problem relates to regulatory failings: national systems hat govern fundraising outside the open markets (private placements) are divergent and are not specifically tailored to the need of social entrepreneurship funds and their managers. This means cross-border fundraising is complex, marked by regulatory divergences. In the absence of uniform rules at EU level, social fundraising by social entrepreneurship funds is likely to remain national.
The analysis thereby identifies three key objectives: improving the clarity and comparability of investment funds targeting social businesses; improving tools for assessing and analysing social impacts; and better reflecting the needs of social entrepreneurship funds in the rules applying to such funds across the Union.
A wide range of options were examined against these objectives.
With respect to raising clarity and comparability of social entrepreneurship funds, the impact assessment explores different options for facilitating transparency through self-regulation (codes of conduct), the establishment of an EU label with harmonised and binding measures to enforce compliance. For improving tools for assessing or analysing social impacts, different options were examined, ranging from the establishment of stakeholder fora for discussion to launching further study in how such assessment tools can be harmonised at EU level. In relation to improving cross-border fundraising by such funds and the regulatory environment that governs private placements abroad, options ranged from fostering mutual recognition between national private placement rules, the use of the venture capital rules to also foster fundraising by social entrepreneurship funds, the creation of a bespoke fundraising system for such funds and the creation of a self-standing European fund framework for such funds.
The impact assessment concluded in favour of a standalone framework for defining the funds and the rules applying to them, to facilitate national and cross border fund raising including the development of a European brand of social entrepreneurship funds supported by strong transparency measures.
The impact of options, including benefits and costs for the fund industry, investors, social businesses, society, supervisors and other stakeholders were assessed. The preferred option was retained as offering the strongest potential to tackle the identified problems whilst being proportionate in relation to compliance costs incurred by those who want to benefit from the new framework.
The comments by the Impact Assessment Board expressed in their opinion of 18 November 2011 have been taken into account in the impact assessment report. The wider context for this initiative has been further clarified by showing how the different initiatives by the Commission in the field of social business link together to form a coherent strategy. The analysis of the problems has been further strengthened including a clearer explanation on the reasons why the initiative on venture capital funds will not be able to address the problems for social entrepreneurship funds. The intervention logic and the analysis of the different options, particularly with respect to possible categories of investors have been further clarified. The contents of the measures which are envisaged now and those which might be necessary at a later stage are set out in a clearer fashion. The assessment of impacts has been improved, including an assessment of the inter-dependence of measures in terms of their likely effectiveness. Finally, monitoring and compliance issues have been further clarified.
The proposal is based on Article 114 TFEU as the most appropriate legal base in this field. The proposal aims principally at improving the reliability and legal certainty of marketing activities undertaken by operators using the designation 'European Social Entrepreneurship Fund'. In pursuing this aim, the proposal introduces uniform standards concerning the portfolio composition, eligible investment instruments, and eligible investment targets of collective investment funds that operate under that designation. The proposal also introduces rules on investor categories that are considered as eligible to invest in such investment funds.
A Regulation is considered to be the most appropriate legal instrument to introduce uniform requirements directed to all participants in the market for fundraising for social undertakings - investors, social entrepreneurship funds and the target companies of social entrepreneurship financing. A Regulation is also considered the most appropriate instrument to create uniform rules on who can be a social entrepreneurship fund investor, on who can use the designation 'European Social Entrepreneurship Fund' and on the types of undertakings that can receive funding from such qualifying funds. Finally, a Regulation is considered to be the most appropriate instrument to ensure that all participants are subject to uniform requirements regarding the subscription to 'European Social Entrepreneurship Funds' and the investment strategies pursued and investment tools used by such funds.
Furthermore, the objectives of this Regulation relate to the uniform requirements on transparency in relation to social impacts, including reporting and social performance measurements. For this purpose, uniform requirements to this effect – e.g. details on how the information on social performance is presented – are necessary. If the choice of the precise measures for standardising these requirements was left to the national legislation of Member States, this would incur the risk that these requirements diverge from Member State to Member State. This would create uneven standards in an area which is key for the further development of the market of investment funds targeting social business. Such uneven standards would be detrimental to the aim of ensuring this is a market that investors can trust. Therefore, to boost investors' confidence it is necessary to ensure that fund managers follow the same rules in this key area.
The proposal essentially aims at creating a trusted, safe and legally stable marketing environment for the marketing of 'European Social Entrepreneurship Funds'. The determination of the essential characteristics of such a fund, in terms of its portfolio composition, investment tools, investment targets and eligible investor groups, can not be left to the discretion of the Member States as this would give rise to different and inconsistent application of these defining requirements throughout the EU. Uniform definitions and operating requirements therefore must play a central role in establishing a set of common rules for the European market for these funds and their managers. Furthermore, all collective investment fund managers operating in this market using the designation 'European Social Entrepreneurship Fund' must be subject to the same organisational, conduct of business and transparency requirements.
In respect of the registration and supervision of the managers of 'European Social Entrepreneurship Funds' the proposal aims at striking a balance between the need for effective supervision, the interest of the competent national authorities where such funds are either domiciled or offered to the eligible categories of investors and the coordinating role of ESMA. In order to create a seamless process for supervision, the competent authority in the Member State where the manager of the qualifying 'European Social Entrepreneurship Fund' is domiciled will verify the registration documents submitted by the applicant manager and, after having assessed whether the applicant provides sufficient guarantee of its ability to comply with the requirements of the Regulation, will register the applicant. In supervising the registered manager, the competent authority that has registered the manager will cooperate with the competent authorities in those Member States where the qualifying fund is marketed. ESMA will maintain a central database listing all registered managers that are eligible to use the designation European Social Entrepreneurship Fund.
As regards proportionality, the proposal strikes the appropriate balance between the public interest of promoting the development of more efficient markets for 'European Social Entrepreneurship Funds' and the cost efficiency of the measures proposed. In providing for a simple registration system, the proposal has taken full account of the need to balance safety and reliability associated with the use of the designation 'European Social Entrepreneurship Fund' with the efficient operation of the market and the cost for its various stakeholders.
On 23 September 2009, the Commission adopted proposals for Regulations establishing EBA, EIOPA, and ESMA. In this respect the Commission wishes to recall the Statements in relation to Articles 290 and 291 TFEU it made at the adoption of the Regulations establishing the European Supervisory Authorities according to which: 'As regards the process for the adoption of regulatory standards, the Commission emphasises the unique character of the financial services sector, following from the Lamfalussy structure and explicitly recognised in Declaration 39 to the TFEU. However, the Commission has serious doubts whether the restrictions on its role when adopting delegated acts and implementing measures are in line with Articles 290 and 291 TFEU.'
Article 1 - Scope
Article 1 delineates the scope of the envisaged Regulation. The Article makes clear that the designation 'European Social Entrepreneurship Fund' (EuSEF) shall be reserved to those fund managers that comply with a set of uniform quality criteria that apply to the marketing of their funds across the Union. In this respect, Article 1 underscores the aim to set out a uniform concept of what constitutes a EuSEF. This concept is developed in order to ensure the smooth marketing of such funds across the Union.
Article 2 specifies that this Regulation applies to managers of collective investment undertakings as defined in Article 3(1)(b) of this Regulation that are established in the Union and who are subject to registration with the competent authorities in their home member states in accordance with Article 3 (3) (a) of Directive 2011/61/EC, provided that they manage portfolios of EuSEFs whose assets under management in total do not exceed a threshold of EUR 500 million.
Article 3 contains essential definitions delineating the scope of application for the proposed Regulation. Key concepts, such as the EuSEF itself, the EuSEF manager, the qualifying investment tools and the qualifying investment targets are defined. Essentially, these definitions aim to draw a clear demarcation line between a EuSEF and other funds which may pursue similar investment strategies but which are not targeting social undertakings.
In line with the aim of precisely circumscribing the funds under this Regulation, Article 3, paragraph 1(a) stipulates that a EuSEF shall be a fund that dedicates at least 70 percent of its aggregate capital contributions and uncalled committed capital to investments that are qualifying portfolio undertakings. This implies that e.g. operational expenses to be charged to the EuSEF as may be agreed with investors, must be borne out of the remaining 30 percent of committed capital contributions.
This Regulation takes also the special characteristics of social undertakings into account. Social undertakings have the achievement of positive social impact as their principle objective. Therefore, this Regulation requires that a qualifying portfolio undertaking should have a measurable and positive social impact, uses its profits to achieve its primary objective and that it is managed in an accountable and transparent way. Article 3 also specifies rules and procedures that must be in place to cover the circumstances in which a qualifying portfolio undertaking wishes to distribute some its profits to its owners and shareholders. As explained in the recital, such distributions should not undermine effective achievement of the undertaking's primary objective.
Taking into account the funding needs of such undertakings the eligible investment tools are equally defined. These include equity instruments, debt instruments, investments into other EuSEFs and long and medium term loans.
Article 4 – Use of the designation 'European Social Entrepreneurship Fund'
Article 4 contains the key principle that only funds that comply with the uniform criteria laid down by this Regulation are eligible to use the designation 'European Social Entrepreneurship Fund' to market EuSEFs across the Union.
Article 5 – Portfolio composition
Article 5 contains detailed provision on the portfolio composition that characterises a EuSEF. In this respect, Article 5 contains uniform rules on the investment targets for EuSEF, eligible investment tools, rules on the limits by which a EuSEF manager can increase its exposure. In order to allow EuSEFs a certain degree of flexibility in their investment and liquidity management, other investments are permitted within a maximum threshold not exceeding 30 percent of aggregate capital contributions and uncalled capital investments that does not need to constitute qualifying investments.
Article 6 – Eligible investors
Article 6 contains detailed provisions on the investors eligible to invest in EuSEFs: according to this Article, the EuSEFs may only be marketed to investors recognised as professional investors in Directive 2004/39/EC. Marketing to other investors such as certain high-net worth individuals is only allowed if they commit a minimum ticket of EUR 100 000 to the fund and if certain procedures are followed by the fund manager so that the fund manager is reasonably assured that these other investors are capable of making their own investment decisions and understanding the risks involved.
Article 7 – Rules of conduct
Article 7 contains general principles governing the behaviour of a EuSEF manager, notably in the conduct of its activities and its relationship to investors.
Article 8 – Conflicts of interest
Article 8 contains rules for the handling of conflicts of interest by the EuSEF manager. These rules also require the manager to have the necessary organisational and administrative arrangements in place to ensure a proper handling of conflicts of interest.
Article 9 – Measurement of positive social impacts
Article 9 requires EuSEF managers to have the necessary procedures in place in order to measure and monitor the positive social impacts the qualifying portfolio undertakings are committed to achieve.
Article 10 requires that a EuSEF manager maintains adequate human and technical resources as well as sufficient own funds as are necessary for the proper management of EuSEFs.
Article 11 – Valuation
Article 11 addresses the valuation of the assets of a EuSEF. Rules on this should be laid down in the statutory documents of each EuSEF.
Article 12 contains rules on annual reports EuSEF managers should prepare in relation to the EuSEF they manage. The report shall describe the composition of the portfolio of the fund and the activities of the past year. It shall also contain information regarding the social impact achieved by the investment policy of the fund.
Article 13 contains certain key disclosure requirements that are incumbent on a EuSEF manager in relation to its investors. These requirements contain pre-contractual general disclosure obligations in relation to the investment strategy and the objectives of the EuSEF, information on costs and associated charges, and the risk/reward profile of the investment proposed by the EuSEF. Such requirements also include information about the way the remuneration of the EuSEF manager is calculated. At the same time, these requirements aim to ensure transparency in relation to the specific nature of EuSEFs, particularly as regards the positive social outcome which shall be achieved by the investment policy.
Article 14 – Supervision
Article 14 in order to ensure that the competent authority of the home Member State will be able to supervise compliance of the EuSEF manager with the uniform requirements set out in this Regulation; the EuSEF manager shall inform the competent authority of its intention to market EuSEFs under the designation 'European Social Entrepreneurship Fund.' The manager shall also provide the necessary information including about the arrangements to comply with this Regulation and the funds he intends to market. Once the competent authority is satisfied that the required information is complete and that the arrangements are suitable to comply with the requirements set out in this Regulation, it shall register the EuSEF manager. This registration shall be valid across the entire Union and allows the EuSEF manager to market EuSEFs under the designation 'European Social Entrepreneurship Fund'.
Article 15 – Update of information
Article 15 contains rules on circumstances when information supplied to the competent authority in the home Member State needs to be updated.
Article 16 describes the cross-border notification process between the competent supervisory authorities that is triggered by the registration of the EuSEF manager.
Article 17 – ESMA database
Article 17 entrusts ESMA with the task to maintain a central database listing all EuSEFs that are registered across the Union.
Article 18 – Supervision by competent authority
Article 18 stipulates that the competent authority of the home Member State supervises the requirements of this Regulation.
Article 19 – Supervisory powers
Article 19 specifies a list of supervisory powers that competent authorities shall have at their disposal to ensure compliance with the uniform criteria contained in the Regulation.
Article 20 – Sanctions
Article 20 contains provisions on sanctions to ensure proper enforcement of the requirements of this Regulation.
Article 21 – Breach of key provisions
Article 21 specifies that the breach of key provisions of this Regulation such as on portfolio composition, the eligible investors and the use of the designation 'European Social Entrepreneurship Fund' should be sanctioned by the prohibition of the use of the designation and the removal of the EuSEF manager of the register.
Article 22 – Supervisory cooperation
Article 22 contains rules on the exchange of supervisory information between the competent authorities in the home and host Member States and ESMA.
Article 23 contains provisions on the requisite level of professional secrecy that should apply to all relevant national authorities and to the European Securities and Markets Regulator (ESMA).
Article 24 – Conditions for empowerment
Article 24 sets out the conditions under which the Commission is empowered to adopt delegated acts.
Article 25 contains clauses on the review of the proposed Regulation and possible Commission proposals to modify the latter.
Contents
- BUDGETARY IMPLICATION
- 2. RESULTS OF CONSULTATIONS WITH THE INTERESTED PARTIES AND IMPACT ASSESSMENTS 2.1. Consultation with interested parties
- 2.2. Impact Assessment
- 3. LEGAL ELEMENTS OF THE PROPOSAL 3.1. Legal basis
- 3.2. Subsidiarity and proportionality
- 3.3. Compliance with Articles 290 and 291 TFEU
- 3.4. Presentation of the Proposal
- Article 2 - Scope of application
- Article 3 - Definitions
- Article 10 - Organisational requirements
- Article 12 - Annual reports
- Article 13 - Disclosure to investors
- Article 16 - Cross-border notifications
- Article 23 - Professional secrecy
- Article 25 - Review
There are no budgetary implications.