Listed Investment Funds - Why List?
Following the surge of interest in 2006, the potential for listed investment funds, structured on the right model, remains strong. The stock exchange listing provides solutions to long-term commercial needs of both investment managers and investors.
For the investment manager, a listed investment vehicle provides the ultimate "lock-up" period for committed capital (it is by definition, permanent). For the investor it provides the liquidity normally associated with an open-ended vehicle, such liquidity being provided by trading units in the fund in the secondary market, rather than by regular redemption opportunities provided by the vehicle itself.
Listing provides an additional benefit for certain institutional investors. Listed equities commonly carry a lower risk-weighting than unlisted securities and thus certain institutional investors may be less restricted by regulatory, capital adequacy or internal investment allocation requirements from investing. Listing may imply additional regulatory oversight both on admission and on an ongoing basis. The listed investment fund may therefore facilitate investment by institutional investors who could otherwise be restricted from doing so.
In addition to facilitating investment by such institutional placees, listing also presents the possibility of private equity / alternative investment type returns to the wider market.
Listings to date
A number of listed investment funds successfully launched during 2006 including the KKR Private Equity Investors $5 billion fund, Goldman Sachs Dynamic Opportunities Limited, Dexion Alpha Strategies Limited, Apollo’s AP Alternative Assets US$1.5 billion fund, Partners Global Opportunities Fund, Cheyne Capital’s Queens Walk Fund, Cazenove Absolute Equity Limited, and other similar vehicles.
The experience to date shows that both investment managers and investors have appetite for listed investment vehicles and that structures are developing to address investor preferences. One of the first permanent capital vehicles was Dexion Absolute Limited which was launched in 2002 and is now worth + US$1 billion.
Challenges and Solutions
The principal challenge that has emerged from the structures to date is the risk of the price at which units in the fund trade dropping below the launch offer price in the short term. Examples of this have now however generally traded up over the medium term. Certain factors can be identified as being associated with this risk including how start up costs (including underwriting fees) are dealt with and an absence of immediate yield on portfolio investments.
One of the principal factors associated with successful launches appears to be the inclusion of short-term yield on investment. This may imply certain consequences in relation to the investment management of the vehicle such as pipeline deals, acquisition of a pre-existing, performing portfolio and a diversified investment policy (including income yield).
A declared dividend policy may also assist a successful launch. Legal techniques such as a court-approved reduction of capital bracketed around the launch date may assist in creating a distributable reserve from which to source such a dividend policy. Credit facilities can be used to supplement portfolio income generation to finance such a dividend policy in the immediate post-launch period.
One of the key drivers in structuring investment funds is the need for tax efficiency at the fund level, so as not to result in a structure where investment returns effectively suffer double taxation at both fund and investor levels. Investors also require the certainty of limited liability.
The use of offshore master/feeder structures may also enable effective pooling at the fund level by both tax-exempt and non-exempt investors.
Offshore vehicles meeting these criteria are Jersey and Guernsey closed-ended limited companies and the Guernsey limited partnership. Both provide investors with limited liability and, provided they are appropriately managed and controlled, with tax efficiency. Other key advantages of Jersey and Guernsey listed investment vehicles are that they also do not suffer from restrictions on investment policy, on eligible investor populations or on distribution policy.
Further, the separate legal personality of the Jersey or Guernsey company and the ability of the Guernsey limited partnership to elect for separate legal personality enables both vehicles to invest in underlying investment holding English limited partnerships, without requiring registration of the ultimate investors in the fund at the English Limited Partnership level.
Offshore regulatory and legal advantages
The use of a closed-ended Jersey or Guernsey company or Guernsey limited partnership as the listed fund vehicle may entail significant regulatory and legal advantages. Jersey or Guernsey companies offer greater flexibility to investors as the Island’s companies law utilises many of the same concepts as English company law (and will therefore be familiar to investors) but applies these in a less burdensome fashion.
In particular, Jersey or Guernsey companies may be incorporated with no par value shares which can be redeemed or purchased by the fund company (subject to the terms of issue of the shares and the company’s articles) out of its stated capital account (the equivalent of a combined share and share premium account) without reliance on distributable reserves, enabling a streamlined and cost effective procedure to effectively return capital to investors when commercially appropriate.
The criteria for the payment of dividends by Jersey companies, a key area for an investment fund’s dividend policy, are proposed to be amended in 2007 to provide that dividends may be paid on the satisfaction of a cash-flow solvency test only. This would remove the current requirement (modelled on the English law position) to pay dividends out of distributable profits / reserves only.
The position in Guernsey remains similar to that in England, with dividends being payable from profits available for the purpose. However, it is a well established practice in Guernsey that profits may include unrealised capital gains, provided that unrealised losses are also taken into account.
Pending that reform to Jersey law, a court-approved reduction of capital, bracketed around the fund’s admission to listing is accepted practice in both Jersey and Guernsey. This enables the creation of a distributable reserve from which to source the fund’s dividend policy in the initial, post-launch period, to help mitigate any time-lag on investment returns.
The Jersey Court recently provided guidance in respect of this technique, confirming the acceptability of a conditional shareholder resolution passed pre-IPO. In relation to incoming investors, a full description of the amount and purposes of the proposed reduction must be set out in the prospectus. Shareholders are to be treated equitably, the proposed reduction must be properly explained in accessible language and that the reduction is to have a discernible purpose. The same procedure is followed in Guernsey.
In relation to creditors, the Jersey or Guernsey Court is likely to dispense with the requirement to hold creditors meetings if the application can show that all creditors of the Fund have consented to the proposed reduction. This should prove manageable immediately post-launch when the creditor population is likely to be limited to finance creditors, professional advisors and stakeholders in the fund.
Abolition of financial assistance prohibition
The flexibility of Jersey’s companies law is proposed to be further enhanced by the abolition of the prohibition on financial assistance during 2007. Unlike the position under English law, post-2006 amendment, where financial assistance continues to be prohibited if provided by a public company (or a subsidiary of a public company), the proposed abolition of the prohibition in Jersey is intended to extend to both private and public companies. This will entail significant transaction management advantages for Jersey public companies, which will include all listed Jersey corporate funds.
Under Guernsey companies law a Guernsey company is not prohibited from giving financial assistance, so long as it is permitted to do so by its memorandum and articles and will satisfy a statutory solvency test immediately after the financial assistance is given. Similar to the proposed changes under Jersey law, this flexibility provides significant transaction management advantages to Guernsey companies.
Share transfers of Jersey or Guernsey companies and transfers of Guernsey limited partnership interests are not subject to stamp duty provided the share/partnership register is maintained offshore. Jersey and Guernsey companies and Guernsey limited partnerships are required by law to maintain their share/partnership register in their respective Islands.
Expedited Regulatory Treatment
Expedited regulatory approval is available from the Jersey Financial Services Commission ("JFSC") in relation to listed, closed-ended, Jersey corporate funds meeting the criteria of the JFSC’s Listed Funds Guide (January 2007). The principal eligibility criteria relate the investment manager/adviser and the inclusion of certain prescribed information in the offer document in connection with the listing. The investment manager/adviser will be approved if regulated for this purpose in an OECD member state and otherwise if sufficient track record and experience can be demonstrated to JFSC. Where the eligibility criteria are met, JFSC will aim to issue regulatory permits within three working days of application.
Guernsey also provides a fast-track regulatory process in relation to closed-ended funds. Regulatory consents in respect of "qualifying investor funds" or "registered" funds may also be obtained from the Guernsey Financial Services Commission ("GFSC") within three working days of filing. Similarly to the Jersey approvals process, the GFSC’s policy is based on a self certification process, due diligence by the fund’s Guernsey administrator, the track record of the fund’s principal persons and certain offer document content requirements.
Ease of Offshore Management and Control
Consideration of management and control questions, following recent English case law, highlights the practical advantages of establishing listed investment funds in Jersey and Guernsey, in addition to the legal and regulatory aspects noted above. The experienced fund administration capability in the respective Islands provides appropriately qualified, experienced directors who are often pre-approved by the JFSC and GFSC as a result of their previous experience. Language, time zone and ease of access from the UK (in terms of duration and frequency of transport links) are also significantly advantageous in this respect.
To date both AIM and Euronext Amsterdam’s Eurolist appear to be frequent choices in relation to listing investment funds. Euronext’s listing requirements are based on the minimum standards of the EU Prospectus Directive, which are considered less onerous than those applied by the London Stock Exchange in relation to primary listings.
The Netherlands’ Financial Markets Authority ("FMA") does not require an additional licence to be obtained from it in order to list Jersey or Guernsey regulated funds on Euronext. This entails expedited access to listing for Jersey and Guernsey investment funds and results from the approval of the FMA of the respective Islands’ funds regulators.
Both Jersey and Guernsey investment vehicles have a successful track record of listings on AIM.
The UK Financial Services Authority has also recently confirmed that non-UK companies (for example Jersey or Guernsey companies) can obtain a secondary listing on the London Stock Exchange without requiring a primary listing elsewhere. Secondary listings are required to meet the Prospectus Directive’s requirements and not the comprehensive requirements of a primary listing.
Commercial drivers suggest that the listed investment fund is likely to prove a structure of permanent interest to both investment managers and investors. This interest is anticipated to grow as track records and deal modelling in the sector develops.
Jersey and Guernsey’s respective legal, regulatory and fund administration infrastructures has made them the jurisdictions of choice for listed investment funds on both the limited partnership and corporate models.
The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.