Amendments to listing rules published in the FSA's Consultation Paper 06/21 would allow closed-ended funds to control companies in which they invest.
The paper’s general aims are to bring more flexibility into the listings regime to give investment vehicles more leeway in using or adopting different investment styles and strategies, including approaches used by hedge funds, but still retain sufficient transparency to make the regime palatable for investors.
Initial thoughts were laid out by the regulator in CP06/4 published earlier this year as part of the general move towards principles-based regulation.
As a result of feedback to the earlier paper, the FSA has now amended some of its key proposals. This includes those relating to closed-ended funds, such as private equity funds.
These amendments include removing the prohibition on closed-ended funds from controlling companies in which they invest, enabling such vehicles to take on a broader range of investment strategies; ensuring greater clarity in the sorts of information published by closed-ended companies relevant to their investment strategies; and ensuring any listed investment company provides sufficient information to assess associated investment risk.
The FSA says market developments since CP06/4 was published along with the discussions held during the initial consultation period have led it to believe it can allow closed-ended investment vehicles to control the companies in which they invest.
This is possible as long as the spread of investment risk is understood and can form the distinction “between a fund with a controlling stake and a conglomerate” more suited for a so-called Chapter 6 listing rather than a Chapter 15 listing, which would apply to a closed-ended vehicle.
“We also think that a number of other factors also serve to distinguish a fund that takes controlling positions from a conglomerate:
- investment funds which take controlling stakes in businesses in which they invest nonetheless invest in distinct, stand-alone businesses;
- investment funds which take controlling stakes in businesses do not have common treasury functions with the companies they invest in; and
- investment funds which take controlling stakes do not use that control to make the businesses they invest in give guarantees or other security over their assets in order to finance the operations of other businesses in which the fund has a controlling interest.”
As a result of the decision to allow closed-ended funds to control the businesses in which they invest the FSA says it will give them “greater freedom to pursue their investment objective and is consistent with a basic objective of this review: permitting listed closed-ended funds to pursue a wider range of investment strategies.”
To ensure the risks to investors are held in check despite the greater freedom of investment strategies being permitted, the FSA is proposing a two-pronged approach.
Firstly, any funds investment policy would have to address investment risk by setting maximum permitted [risk] exposures. Secondly, it would have to address gearing risk by setting out maximum permitted gearing.
By quantifying such risk openly the funds would meet requirements under the new listings regime.
Also, as a result of the new focus on greater transparency in communicating with investors, the funds would have to draft more precise investment policies.
“An investment entity is required to seek shareholder approval for material changes in the investment policy under the current rules and all changes under the new rules. We expect that when existing listed issuers subject to Chapter 15 publish their investment policy under the new rules for the first time, they will respond to the new investment policy provision by examining previously published statements in the area, reviewing their current investment practices, and reformulating and publishing their investment policy in the greater detail required.”
The push for transparency has not, however, been fully extended to immediate market notification of changes in risk profiles. The FSA says this original proposal in CP06/4 has been watered down after consultation suggested publication of non-price sensitive information could have a “disproportionate” impact.
This does not mean the FSA agrees investors should have to wait until interims or year-end publication for information which may reveal something about changes in risk levels.
Therefore, it now proposes to retain a quarterly reporting requirement, adding such reports should include reference to weightings of each position disclosed relative to the rest of the portfolio, to disclose derivatives positions, to disclose cross-holdings and gearing.
The FSA says it also wants to impose particular amendments for closed ended property funds, which make up the UK real estate investment trust market.
Because such investment vehicles will be investing their funds in line with clearly stated investment policies, which must be published and adhered to at all times, the FSA says it wants to remove any requirements they meet transaction rules affecting the buying and selling of property as applied to property companies.
“We therefore propose to remove this additional requirement and instead rely on the investment policy as the key control.”
Finally, the FSA says it wants to introduce a new name for a particular type of closed-ended funds which are listed in the UK under UCITS rules.
The so-called “listed open-ended funds” would contrast with closed ended investment funds in that they would not be listed under Chapter 15 rules. This is because overseas recognised schemes are subject to the full UCITS regime, meaning subjecting them to Chapter 15 rules would be simply to duplicate regulation.
If you have any comments you would like to add to this story or would like to speak to its author about a similar subject, telephone Jonathan Boyd on 020 7484 9769 or email [email protected].IFAonline
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