Markets in Freefall, Chinese shares and VCT Issues

While the world seems to be collapsing around us – with sharp falls in the price of most commodities including the critical ones of oil and gold – this writer took the time to attend the Annual General Meeting of Downing ONE VCT this morning. Forget also the fact that the Chinese stock market plummeted yesterday. The more I read about the dynamics of that market the more it looks similar to the US market in the 1920s where manipulation was rife, many investors bought on margin and bucket shops exploited unsophisticated retail investors. The interventions by the state to stabilise the market may be to no avail because they have created an unstable and volatile market where investors are borrowing money to buy shares without any real understanding of why they are doing so except that prices are going up.

I may do a longer piece on the problems in the Chinese stock market in the future as it’s passed by a lot of UK investors, but today I wish to talk again on something of more immediate concern to UK investors. This is the impact of the new VCT rules announced in the Budget. The AGM at Downing One VCT enabled me to ask some more questions on this topic, and here is an extract from the report of the meeting which here:

The meeting was opened by Chairman Chris Kay, who just happens to manage the very successful Chrysalis VCT. He introduced the board and representatives from the fund manager including Nick Lewis, Senior Partner, who I have met many times before and who is very knowledgeable on the issues affecting VCTs.

Mr Lewis was then invited to explain the proposed changes to VCT regulations which will affect what they can invest in. See this ShareSoc blog post for a brief summary: www.sharesoc.org/blog/company-news/vcteis-changes-and-rensburg-aim-vct.

Mr Lewis indicated that it might create some difficulties with “buy and build” strategies – for example if a pub chain wished to add another pub and finance it via a VCT investment. The reason for the rule tightening is that the previous regulations were seen as breaching EU imposed rules on state aid limitations. The new rules are likely to be approved in September by Parliament with Royal Assent in October.

I asked how many of the investments made by Downing in the last year or two would have been ruled out by the new regulations. The answer given was less than 50% but other VCTs might be more affected (the Northern ones were mentioned later as they do a lot of MBOs which are made difficult by the new rules and Northern have already suspended their dividend reinvestment scheme, presumably as a consequence).

Asked whether representations had been made on the new rules (i.e. to the Government) and the answer was yes but they had apparently “fallen on deaf ears”. The conclusion was that it might definitely shrink the VCT industry with few fund raisings. This change has been imposed by the EU which prompted Nick to say that this is the result of being run by Eurocrats and you will get your chance to get out next year – so we know which way he might vote on any Brexit referendum.

I asked whether it would rule out most AIM investments, and the Chairman said Yes in summary. But they can do follow-on investments if the VCT invested in the company earlier. However the exact rules were very unclear and opaque. Questions to the Treasury about how they are supposed to be interpreted result in confusing answers. Moreover apparently any breach of the rules (even inadvertent ones such as happened at the Oxford Tech VCTs) might result in the loss of VCT status. This would be a nightmare for VCT managers and VCT investors as the rules are already so complex that they take a lot of effort to adhere to.

Is there an easy way around the new rules? Not obviously was the answer.

It seems likely the demand for new VCT share issues will exceed the supply in future. However that might reinvigorate the “second-hand” VCT market.

So there you have it. I have written to my M.P. on the subject of the rule changes. It makes sensible financial planning by VCT investors and VCT company managers very difficult when the Government keeps changing the rules. VCTs have been very successful in stimulating more investment in SMEs and meeting the UK “equity funding gap” as it is called. They are in danger of being stifled by the EU.

After the problems in the Eurozone over Greece, where the solution settled upon does not really resolve the issue of the country having an unsupportable level of debt, it is certainly undermining my personal support for membership of the EU. In Greece they just gave a bad debtor more rope to hang themselves with. Some write-off of debt will surely have to happen sooner or later, and in the meantime the Greeks will just squirm and try to wheedle their way out of their straitjacket.

One could go on at length on the deficiencies in the EU in terms of democratic representation and their ham fisted approach to many matters (Shareholder Rights and the Prospectus Directive are other examples) and the faults in the Eurozone model but that will have to suffice for the present.

Roger Lawson