10% limit on crossholdings proposed in response to split-cap problems
Closed-end funds will be prevented from putting more than 10% of their assets in other closed-end funds under plans put forward by the FSA as part of its response to problems suffered by split-capital trusts.
Consultation paper CP164, released last week, proposed a number of measures designed to increase the information and protection available to investment trust investors.
The paper stated the new safeguards will address weaknesses in the design of split-capital trusts that were exposed by bearish market conditions.
They include a 10% limit on an investment company's gross assets that can be invested in other investment companies whose investment policies allow cross investing.
The paper also proposes that full details of all investments over 0.5% of the portfolio are released monthly. For investment trusts of investment trusts, managers will be required to provide full details of any funds within the portfolio which also have holdings in other trusts.
Prospectuses for trusts under the FSA's proposals, will also have to include detailed descriptions of key risks to the trust.
FSA managing director Michael Foot said: 'The proposals should ensure clearer warnings about key risks. They propose a limit on one key risk: the extent of crossholdings. These proposals underpin the rights of shareholders.'
The FSA may also stop employees of the investment manager from sitting on the board of the trust, in order to increase the independence of the company from its investment manager.
All material changes to the investment policy will require prior shareholder approval, while the board will be required to explain every year why the continued appointment of the investment manager is in the interests of shareholders.
Close Wins analyst Charles Cade said most of the proposals are a sensible response to events in the split capital market, albeit after the horse has bolted.
'There will be considerable attention focused on the proposal that employees of the management group will no longer be able to sit on the board of their own investment companies. It had become standard industry practice to allow one in-house director,' he said.
'Whether or not this change improves corporate governance is debatable, but it is by no means unworkable and could help to improve the tarnished image of the sector.'
The FSA is trying to prevent the recurrence of systemic risk through a network of cross-holdings, rather than banning funds of funds, Cade noted. To achieve this, we would suggest that no more than 10% of assets can be invested in funds which themselves have more than 10% of assets invested in other funds.'
He said the monthly disclosure proposal also seems extreme and introduces a considerable administrative burden with little or no benefit to most shareholders, although he noted it will likely be welcomed by arbitrageurs looking to exploit short-term price discrepancies.
'It will also be close to unworkable for many private equity companies ' are they expected to have to revalue the portfolio on a monthly basis?' he said. 'There is an argument that holdings in other investment companies over 0.5% should be disclosed monthly, but there is no need to show that 1% of assets is now invested in Vodafone instead of Shell.'
The FSA is taking comments on the consultation paper until 14 April.
Copies of the paper are available on www.fsa.gov.uk.
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