Listed funds - the story continues

United Kingdom

In February this year, our Law-Now article described the UK Listing Authority’s proposals to change the listing rules that apply to listed investment entities on the UK Official List.  These reflected the UKLA’s wish 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.
Since then the changes have continued, driven by conflicting views of how the market should develop.  Below we look at the most recent changes and consider how the market is developing.

Where were we in February 2007?

February 2007 saw us in the middle of the UKLA’s second consultation on investment entities.  It had carried out its first consultation in March 2006, but then surprised almost everyone in October that year when it announced that overseas investment companies would be able to list under a directive minimum regime, with virtually none of the restrictions and other rules that apply to UK listed funds.  This was in response to a number of funds listing under the same directive minimum regime on Euronext Amsterdam, and concerns that the London markets risked being left behind.

The proposals also included several areas of deregulation for UK investment companies, many of which were aimed at permitting a wider range of investment strategies.  These included:

  • removing most investment restrictions so long as the fund’s investment policy has the objective of spreading investment risk - this should permit most hedge fund or private equity type strategies
  • allowing a fund to control entities that it has invested in - crucial for private equity style investment strategies
  • removing all restrictions on investments that property funds could make (for example, on concentration or leverage), so they would only be bound by their investment policies
  • some “feeder funds” (i.e. funds created with the specific policy of investing into another, typically unlisted, fund) would now be permitted, although generally it was thought these relaxations didn’t go far enough to permit a traditional master/feeder hedge fund structure
  • changes to what information has to be regularly disclosed by the fund.

Although all of these changes were welcomed, it was the directive minimum proposal that attracted the most excitement.  BH Macro - feeding Brevan Howard’s global macro fund - was launched in February to take advantage of the new rules, and interest was high.

What has changed since?

While the directive minimum proposal was strongly supported in many parts of the City, opposition to the new proposals became more vocal.  The Association of Investment Companies led a lobbying campaign against the proposal, gaining support from the Consumers Association, MP John McFall, chairman of the Treasury select committee, and investor groups.  John McFall told the UKLA it was opening a “gaping hole” in investor protection, while the AIC suggested that the UKLA had abandoned its consumer protection obligations, pointing out that directive minimum listings disapplied 120 pages of protections applied to traditional investment companies.

In April 2007, the UKLA announced that it would not continue with its proposal to allow funds to take up a directive minimum listing - making it clear that a “very clear majority” of responses to its consultation had opposed the idea of a two-tier system of regulation.

That decision has driven much of what has happened since...

Withdrawal of directive minimum listing for funds

The UKLA has confirmed that overseas funds will not be able to take up a directive minimum listing after March 2008 - although any funds that have listed before then will be able to stay within the old regime.  After that time, any fund (UK or overseas) which wants a full listing in the UK will need to comply with the full investment company rules.

It is clear though that the UKLA does not entirely agree with this position or the consumer protection benefits that are claimed for it - pointing out that “issuers already have other practical options outside the ambit of the listing regime in the form of regulated markets in other EU jurisdictions and the AIM market in the UK” or even new regulated markets in the UK.  They also make clear that they have no power to prevent these shares being sold to UK investors.

Further deregulation of the UK investment company regime

One of the key suggestions was that a separate, directive minimum regime wasn’t necessary because instead the full UK regime should be made more flexible to allow all types of funds to have a full listing.

The UKLA’s June 2007 consultation has confirmed that virtually all of the deregulatory proposals already consulted on will come into force in September 2007, making the regime much more principles-based.  It has also suggested some further deregulatory steps, covering:

  • new rules on regular portfolio disclosures, reducing the amount of information that needs to be disclosed
  • further relaxation of rules on the manager’s experience and board make-up
  • increased flexibility which will permit feeder funds
  • discussion of whether to stop treating investment managers as related parties of the funds they manage

However there remains scepticism about whether these go far enough to satisfy alternative funds - particularly hedge funds - and whether they will accept the burdens of a full listing.

LSE announces its new Specialist Fund Market

In mid-July, the LSE announced that it would launch a new market for large hedge funds, private equity funds, and certain emerging market and specialist property funds seeking admission to a public market in London, with effect from 1 November 2007. 

The market will be a “regulated market” for the EU’s Prospectus Directive and other regulations (like the UK Official List but unlike AIM) but will not require a full listing on the UK Official List.  The requirements for admission to trading will effectively offer once again a “directive minimum” option for investment funds.  For example the listing rules on shareholder approval for transactions and related party transactions, compliance with the Combined Code, independence of the board and changes to investment policy would not apply to any SFM-traded funds.

The LSE states the new market is being launched to meet market demand, and is aimed at professional and institutional investors only.  But despite prominent badging to say it is “not intended as an admission route to a regulated market for investment entities that are intending to make a retail offering”, the AIC has attacked the new market and said that funds should be encouraged to list on the main market instead.  Claiming that retail investors would find their way to the new market regardless of how the LSE described it, the AIC have suggested renaming it the “Unlisted Investment Companies Market” to make clear to investors that they were not gaining the protection of a fully-listed investment trust. 

How the new market will be used is difficult to predict.  Since a prospectus will be needed as part of the admission process onto the SFM, funds will be in a prime position to market shares to retail investors if they choose to do so.  But the LSE may come under pressure from the AIC and others to prevent SFM traded shares from being widely offered to retail investors in practice, and so this may turn out not to be an easy option.

Despite the controversy and uncertainty, the new market is likely to be a welcome addition to the options available for funds.  For more details see the LSE’s website at http://www.londonstockexchange.com/specialistfundmarket or contact us and we will be happy to discuss admission to the new market with you.

Where next?

The market position keeps changing, so it is difficult to know where things will go next.  What is clear though is that the LSE - which was a strong supporter of the UKLA’s previous proposal to allow directive minimum listings - is focused on ensuring it can continue to compete with Euronext Amsterdam and other markets and offer a full range of options to funds looking for a route to market.

Only time will tell whether the Specialist Fund Market will be a success but given AIM’s current popularity, it would be a bold person who would write it off.