The Economic Secretary to the Treasury (Ian Pearson): I beg to move,

The Chairman: With this it will be convenient to consider the draft Unit Trusts (Electronic Communications) Order 2009.

Ian Pearson: It is a pleasure to serve under your chairmanship, Mrs. Humble. These regulations, and the Unit Trusts (Electronic Communications) Order 2009, make provision for the electronic transfer of ownership to units and shares and UK authorised investment trusts. That should permit major efficiency savings and reductions in error rates.

The Law of Property Act 1925 in England and Wales and the Statute of Frauds Act 1695 in Northern Ireland have the effect of requiring transfers of title to units and shares in UK authorised investment funds to be made in writing. In Scotland, the Requirements of Writing (Scotland) Act 1995 has the same effect for assignments of property made in the form of a gift.

Authorised investment funds are collective investment vehicles authorised by the Financial Services Authority. They can take the form of open-ended investment companies or authorised unit trusts. The two are very similar, with the only significant difference being their legal form and around £468 billion is currently held in these funds.

While paper processes remain a necessary part of some aspects of the investment fund administration process, they also tend to be more expensive and to have higher error rates than purely electronic processes. Indeed, the electronic messaging company SWIFT estimates that across the EU the additional annual costs generated by using manual rather than fully electronic processes could be as high as ƒ,ª1 billion. When the further costs driven by the higher error rates associated with manual processing are taken into account, that figure could rise to between ƒ,ª5 billion and ƒ,ª10 billion. We therefore believe that the requirements that I have described for a paper-based process in the UK impose significant costs on investment fund managers and on their investors. We estimate that making provision for electronic transfer, as we are proposing, could bring annual administrative savings for UK fund managers of between £70 million and £290 million.

None the less, improvements in efficiency must not come at the expense of maintaining reliable systems that protect the interests of investors. We believe that investor protection will continue to be assured for a number of reasons. Electronic systems are already a central and reliable part of the financial services architecture. For example, the Crest system for share and bond trading, which holds around 88 per cent. of UK shares or, at the retail level, secure systems for internet and telephone banking that are now used by more than 17 million people in the UK. We believe that experience so far has shown that properly designed electronic systems can be equally reliable, or more reliable, than paper-based processes and that it is right to extend that provision to the fund management industry.

Mr. Mark Hoban (Fareham) (Con): Will the Minister explain to the Committee how unit trust managers will ensure that reasonable steps are taken to protect the interests of holders of unit trusts or shares in open-ended investment companies? If I have a bank account and I use the internet, there is a relationship between me and the bank—there are statements over a period of time; they know my security details; and checks are in place. If I hold one set of shares, or units in a unit trust, how will the unit trust managers assure themselves that the person sending an e-mail or a message asking for that holding to be sold is me, and not somebody else acting fraudulently?

Ian Pearson: The hon. Gentleman has raised a valid and important point. As he knows, we have consulted extensively on these matters. The FSA is currently issuing the Investment Management Association’s draft guidance on the issue and will not approve it unless it meets the necessary standards. Approving industry guidance allows some flexibility in the precise approach that firms take in meeting their regulatory obligations, while still ensuring proper compliance. So the industry itself will ensure that it takes reasonable steps to check that instructions are genuine and that the people who transact are who they claim to be.

Under the proposed new rules, the fund manager will retain liability for losses incurred when instructions are acted upon that are later shown to be fraudulent. That mirrors the current position for paper-based instructions and acts as a strong incentive for fund managers to ensure that they have adequate security procedures in place and to protect investors in the unlikely event of loss through fraud. I hope that that answers the hon. Gentleman’s points.

Mr. Hoban: No, it does not.

Ian Pearson: Well, it answers at least one of the points, because I stress that there is a strong incentive for fund managers to ensure that the instructions that they receive are valid.

As I have indicated, we will require fund managers to take reasonable steps to confirm the identity of the sender of an electronic instruction. For open-ended investment companies, that requirement is contained in the draft instrument. Detailed rules on the operation of authorised unit trusts are included in the FSA rules, and the new requirement for that type of fund will therefore be imposed by those rules. The IMA has, as I have indicated, produced guidance for firms on meeting the reasonable steps’ criteria, which it has asked the FSA to approve. The guidance lists the types of electronic communication that can be considered secure, as well as precautions that should be taken to verify the identity of investors in particular types of transaction. I hope that that gives the hon. Gentleman the assurances that he seeks.

The proposals have been subject to a full consultation. The responses supported the principle almost unanimously and included helpful feedback, which we have reflected in the proposals before the Committee, to ensure the effectiveness in property law of transactions made under the proposed new rules. In line with the feedback, we do not propose to make it a requirement for fund managers to accept electronic instructions. Investment funds are distributed by a wide variety of means—for instance, independent financial advisers or other intermediaries, or directly by a fund manager or through a platform—and the appropriate means for accepting investor instructions varies accordingly. We therefore want to maintain the flexibility for managers to act only on paper-based instructions, where that is most appropriate. However, we expect electronic transfer to be taken up quickly for wholesale fund business and to be adopted gradually in retail markets.

The reforms will bring substantial efficiency savings for the UK fund management industry, and the safeguards will ensure that investor protection is in no way compromised. I therefore commend the reforms to the Committee.

Mr. Hoban: It is a pleasure to serve under your chairmanship, Mrs. Humble, for what I think is the first time.

We welcome the two statutory instruments under discussion, as they represent modernisation of the rules. I spent part of my formative years as an auditor, where one of my tasks was to audit unit trusts, and there was a clear need for modernisation as the process was very much paper-based, particularly when dealing with the sale and purchase of units. These measures therefore mark a move forward in a sector that requires support through modernisation in trying to reduce its cost base, which will obviously represent good value for investors.

I wish to say a few things about the two statutory instruments. My understanding is that the consultation took place in 2007, and the FSA also consulted on changes to its rule book that would flow from the statutory instruments. The FSA certainly expected the changes to be in place in the second quarter of 2008. Will the Minister explain why it has taken so long for the two statutory instruments to be introduced, given that, as he said, the consultation revealed great support for them? I am surprised that it has taken so long for them to enter the statute book.

I would also like clarification of the Minister’s comments on the status of industry guidance. I intervened and asked him about the reasonable steps that a manager should take to establish the identity of a customer. Proposed new paragraph 4C of the draft statutory instrument on open-ended investment companies states that

The Minister spoke about the industry guidance that has been formulated by the IMA and will be approved by the FSA. Will he confirm that if a manager complies with that guidance, they would be deemed to have satisfied the requirement in the new section? With the FSA moving towards recognising the industry guidance, we must ensure that it is clear from a firm’s perspective that compliance with that guidance will be sufficient to satisfy the rules in the statutory instrument.

My final questions refer to the cost-benefit analysis. The partial regulatory impact assessment produced by the consultation suggested that the cost of introducing electronic communication would be minimal—about £5 million—whereas the benefits would range between £70 million and £290 million. As we are discussing permissive legislation, will it be up to individual managers to determine whether the cost-benefit analysis is such that it is worth accepting electronic communications from unit holders, and that there is no requirement on firms to accept electronic communications, even though the cost-benefit analysis appears to be persuasive? Also, how will firms establish with their customers that they will not accept electronic communications?

Ian Pearson: The hon. Gentleman has raised three points, and I will respond to them in turn. First, he mentioned the delay between the consultation and the current stage. As he is aware, we have a lot on at the moment—there were delays due to constraints on legal resources in drafting legislation, because of the heavy volumes of work caused by market conditions. The delay was also because of the withdrawal of the original draft statutory instruments due to a minor technical error, whereby the date of implementation was omitted, and that has taken slightly longer to deal with.

Secondly, the hon. Gentleman specifically referred to the proposed new paragraph 4C. I understand that if an investment manager fully follows IMA guidance that has been approved by the FSA, the manager will comply with the requirements of the legislation.

Thirdly, the hon. Gentleman mentioned the start-up costs of complying with the statutory instrument, and whether compliance will be compulsory or voluntary. As I outlined in my initial remarks, there is no requirement on firms to move to an electronic-based system. We believe that there are strong advantages in doing so, and we anticipate that the wholesale markets will do so quickly. There is a wide variety of circumstances, and there is no requirement for individual financial advisers or companies to move to electronic systems. They can do so, if they feel that it is in their best financial and commercial interests, and we expect a number of them to do so. That is one of the reasons why the assumptions regarding savings vary—they vary on the take-up rates that we think may be involved.

The regulations have been widely consulted on and strongly supported, and I hope that the Committee will agree to them today.