Listed funds - change for the better?

United Kingdom

Shortly before Christmas, the UK Listing Authority (UKLA) released a further consultation on the listing rules that apply to listed investment entities. This follows on from its original consultation in March 2006 and the UKLA claims that it has tried to take into account "concerns about the relative attractiveness of the UK regime for certain closed-ended investment funds" and the "dynamic, multi-jurisdictional capital market landscape" in which the City operates.

But despite the focus on these concerns, will the proposed changes make any difference to funds in the real world?

What are the proposals

Offshore funds

  • Offshore funds will be able to use a "directive minimum" regime, based on CARD (the EU’s Consolidated Admissions and Reporting Directive), which has very few controls or investor protections built-in. Although this option has in theory been available since July 2005, fund managers have been reluctant to use it without some kind of blessing by the UKLA - which it had refused to give until recently.
  • If a fund takes up this regime, the UKLA will place it in a specific listing category so that investors know that only limited rules apply to it.

UK-based REITs and other property funds

  • Limits on property investments (for example, on concentration or leverage) are to be removed. Instead the fund will only be bound by its investment policy.
  • Existing property companies which aren’t currently treated as property investment companies will be able to transfer into the property investment category. This will mean that the company is no longer required to get shareholder consent for substantial transactions, so long as the transaction is within its published investment policy.
  • For REITs that want to be listed before the new rules are put in place, the UKLA will consider waiving the current investment limits where the REIT meets the requirements of the tax law but would breach the current rules.

UK-based private equity and hedge funds

  • The requirement that a fund must be a passive investor, and the prohibition on a fund having a controlling stake in an entity which it has invested in, are to be abolished. This will allow listed funds to adopt private equity strategies. There will still be some limits, for example on cross-guarantees between different assets owned by the fund, but these are unlikely to conflict with the typical approach taken by private equity investors.
  • Many hedge fund strategies will also be possible, given the removal of most investment restrictions. The UKLA suggests that the only requirement will be that the fund’s investment policy has the objective of spreading investment risk.
  • Listed feeder funds (ie. funds created with the specific policy of investing into another, typically unlisted, fund) will be possible, but only if the listed fund can control the investment policy of the underlying fund and ensure that the underlying fund will comply with the rules about investment policies.

Will the proposals make much difference?

The greatest effect is likely to come from the UKLA’s confirmation that offshore funds can use the directive minimum regime for a London listing. Many private equity and hedge funds already operate from the Channel Islands or other offshore locations for tax and regulatory reasons, and so it will be easy for them to access this regime if they choose.

The change is seen to have been driven by recent listings of funds on the Amsterdam stock exchange, which led to concern that the City was missing out on a new market because of "anachronistic" rules. It seems to have had an immediate impact: January has already seen Brevan Howard, one of London’s biggest hedge fund managers, announcing that it proposes to list a £1bn fund in London under the offshore rules. Others hedge funds are understood to be looking at it as well.

However it’s not clear whether this really marks the beginning of a new trend. Private equity funds such as Permira (through SVG Capital) have had access to money from the public markets for years, and some funds which considered listing last year backed away after looking at the trading performance of other funds, or rejected the idea on the basis that the closer scrutiny and information demanded by the public markets would distract them from their core business of making and realising investments. Only time will show whether this really is a new market.

For property funds, the removal of restrictions on investments will be very useful and make REIT status with a main London listing available to more companies. This will be welcomed but is unlikely to make a major difference to the sector, as in practice the restrictions could be sidestepped by listing on AIM and taking a secondary listing on the Channel Island Stock Exchange (to meet the requirement of being listed on a "recognised stock exchange").

The most significant point may prove to be that the UKLA has given a clear signal that it is serious about ensuring the international competitiveness of the London markets for fund listings. Despite protests from the Association of Investment Companies that allowing offshore funds to use the directive minimum regime could let funds bypass protections which were introduced after the split-capital investment trust crisis, the UKLA has reconfirmed that it intends to allow overseas funds to use the regime - and even suggested that it might be appropriate to consider extending the regime to UK-based funds as well.

The consultation now runs until 28 February, after which there will be a further feedback statement leading on to the changes that are expected to be implemented in the third quarter of 2007. But even that is unlikely to be the end of the process - many issues remain open and further changes in the next few years would not be a great surprise.

Please click here for full details on the consultation.

Please click here to repond to the consultation.