As investors continue to seek enhanced yield from investments in illiquid assets and also look to achieve liquidity, the London listed closed-ended investment fund continues to remain a favourable fund structure, writes Stephanie Coxon of PwC, on behalf of the Guernsey Investment Fund Association.
Why closed-ended listed funds?
The primary advantage of forming a closed-ended investment fund is that it is a pool of permanent capital. Investors have no redemption rights and new share issuances are at the discretion of the fund's directors. Closed-ended investment funds do not face the mismatch that traditional open-ended funds face between the desire to hold illiquid assets, such as debt, infrastructure and real estate, for the long term and the typical investor requirement for shorter term liquidity.
Listing a closed-ended investment fund on the London Stock Exchange (LSE) offers the investment fund access to deep pools of capital, whilst providing investors with liquidity.
Investment funds listing on the premium segment of the LSE comply with the UK's highest standards of regulation and corporate governance. This attracts a broader range of investors through greater transparency and additional protection.
As explained by Darko Hajdukovic, Head of Investment Funds at the London Stock Exchange, the closed-ended structure offers investors access to diverse strategies, including many innovative asset classes.
"Funds with a London listing benefit from a robust and transparent regulatory framework alongside a choice of markets that offer flexibility when it comes to structuring transactions. The combination of this and a knowledgeable group of investors and advisers ensures that a London listing is competitive," says Hajdukovic.
Using Guernsey as a jurisdiction to incorporate a London listed investment fund is a well-trodden path with local service providers having built significant experience and expertise in this sector. As such, Guernsey has paved the way for being the number one jurisdiction for London listed investment funds outside of the UK.
Total listings by jurisdictions outside the UK
Current market trends
The asset management sector is now shouldering a heavier burden to assist with the demographic pensions time bomb and we have seen pension funds and insurance companies seeking to increase their exposure to alternative assets over the past five years in their hunt for higher yields. The majority of London listed funds investing in alternative assets have been set up through Guernsey, given its tax neutral and flexible legal and regulatory regime.
Since Brexit, UK investors' appetite for regular yield has continued, however, the source of this yield has shifted away from the, potentially, higher risk alternative assets (CLOs, P2P platforms etc) to real assets (real estate, infrastructure, renewables), whether they are directly investing or originating debt secured by real assets.
This is also true for UK retail investors who are investing greater amounts in closed-end funds, mainly to get access to illiquid assets. Research completed by Cerulli Associates revealed the value of closed-ended funds in the UK has risen by an average of 16% over the past four years, suggesting that investors are increasingly using these vehicles to invest in physical projects.
"The London listed funds sector remains active, with infrastructure and other yield producing asset classes remaining attractive in the current low (or no) interest rate environment. In our experience, Guernsey remains the non-UK domicile of choice for such London listed funds," says Darren Bacon, Partner at Mourant Ozannes.
Given the uncertainty in the market prior to and following the Brexit vote, there were only five closed-ended fund IPOs in 2016, two of which were domiciled in Guernsey. However, established investment funds investing in real assets out performed other asset sectors by successfully raising further capital during 2016.
2016 capital raising on the LSE
Of the total capital raised, 37% was raised through a Guernsey structure, a few examples are detailed below:
Sapna Shah of the Investment Companies Team at Cenkos Securities believes the flexibility and benefits offered by the closed-ended fund structure has recently enabled a number of specialist fund managers to raise money for new and interesting asset classes, such as social housing, asset backed lending, aircraft leasing and royalty income.
"Key themes from recent new fund launches include strategies that deliver attractive income levels for investors and a large underlying market opportunity, enabling funds to come back to market, raise more capital and grow over time. Investor focus in 2017 is likely to continue with the same themes and investors backing existing funds such that secondary fund raising exceeds primary fund raising," explains Shah.
Nigel Farr, Partner at Herbert Smith Freehills, adds: "It is only in the fairly recent past that structuring for novel alternative assets with particular US tax issues (Healthcare Royalty Trust and BioPharma Credit were both examples of this) has led us to select the UK investment trust for anything other than a straightforward equities portfolio or an entity requiring UK REIT status. Absent such factors, we would continue to follow the long-standing trend of using Guernsey as the domicile of choice for listed closed-ended funds investing in alternative assets.
"One cannot overstate the attractions of a jurisdiction with extensive experience of dealing with this sort of fund to complement the advantages of favourable tax and regulatory conditions and a more flexible corporate law regime than the UK."
The UK equivalent investment fund regime offers a potentially tax neutral structure provided certain onerous conditions are met but the simplicity and certainty offered by a Guernsey incorporation is a huge consideration for many. Ultimately there are still a number of advantages to incorporating a London listed closed-ended investment fund in Guernsey, as mentioned below.
Advantages for listed funds to be incorporated in Guernsey
- Depending on the investor base, it could be more tax efficient to incorporate an income generating closed-ended investment fund offshore;
- High standards of regulation, noting that in 2016 MONEYVAL reported Guernsey as being compliant or largely compliant with 48 out of 49 of the Financial Action Task Force (FATF) recommendations; the highest of any jurisdiction so far assessed;
- No stamp duty payable on the transfer of shares in a Guernsey company;
- The corporate law regime in Guernsey
is similar to the equivalent UK legal regime but also brings extra
flexibility, for example:
- there is no ongoing requirement to meet the onerous conditions of the UK Investment Trust regime. For instance, only a simple solvency test needs to be met before a dividend is declared which can be paid from any account or source;
- the ability for the Company to redeem shares and give investors capital treatment for UK tax purposes and also for the Company to make buybacks directly and not through a market maker; and
- unlike the UK Companies Act 2006, there is no requirement under Guernsey law to pay a dividend by reference to a set of audited or interim accounts. This has proven to be challenging for UK Investment Trusts targeting an income yield in the first year of operation.
- Being outside of the EU helps as UK equivalent funds have experienced long AIFM approval times by the FCA which has held up a number of new funds looking to launch. The national private placement regime is working well and is still the favoured option for marketing into certain jurisdictions amongst UK advisers. Setting up offshore typically means lower ongoing costs compared to the UK, where overheads are naturally higher and additional service providers, such as depositaries, would be required;
- The Guernsey regulator is robust yet pragmatic and is renowned for being approachable and accessible and encourages face-to-face meetings to discuss new ideas;
- Guernsey is politically stable, its government does not have political parties which means the island is not prone to pendulum swings in regime or policy; and
- Guernsey is home to globally recognised administrators, the Big Four accountancy firms have large offices on the island and all of the principal local law firms have specialists with expertise in the London listed investment fund sector;
"Guernsey administrators have considerable expertise in the closed-ended listed fund sector from servicing a diverse range of LSE funds," adds Mariana Enevoldsen, Director of Heritage International Fund Managers.
"These structures continue to be particularly attractive to those wishing to raise a permanent pool of capital for investment in alternative or illiquid asset classes. The market has seen strong demand for secondary listings from investment funds with existing track records and numerous funds have experienced considerable growth over a relatively short period of time by following this route."
The International Stock Exchange (formerly the Channel Islands Securities Exchange) is also headquartered in Guernsey and provides a flexible, quick and cost effective alternative to a full LSE listing, especially where the liquidity of the share trading is less of an issue. Also, The International Stock Exchange helps investment funds where compliance with the close company rules can pose difficulties if the investment fund is not traded on the main market and instead trades on the Specialist Fund Segment of the LSE. Recently there has been an increased demand for real estate investment trusts looking to list on The International Stock Exchange.
With investors looking for exposure to illiquid alternative assets whilst also retaining liquidity, a Guernsey closed ended fund listed on the LSE is definitely a structure to consider.
For more information about Guernsey's finance industry please visit www.guernseyfinance.com.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.