Withers Worldwide

The attraction of permanent capital

Hedge Fund and private equity fund managers have recently looked to the capital markets for ‘permanent capital’, ie funds which would not be returned to investors.  The more successful hedge fund managers have been able to increase the permanence of their capital by demanding ever longer lock up periods (in excess of 5 years in some cases).  The desire for permanent capital is partly driven by the fact that some of the best returns can be made in times of market turmoil which is when investors would often seek to redeem their investments.  Whilst this can be limited by lock-ups and other limits on redemption, many managers would still prefer to have the flexibility of permanent capital raised through a public listing.

Euronext - one step ahead?

In Europe, Euronext was generally viewed to have stolen a march on the London Stock Exchange (‘LSE’) with regard to listing permanent capital vehicles.  The Financial Services Authority (‘FSA’) which oversees the LSE sought to address this by changing the listing rules in March 2008 to make it easier for funds to list on the ‘main market’.

The LSE, in light of market participants pushing it to maintain a gold standard for fund listings on the main market, set up a new market called the specialist fund market (‘the SFM’) on 1 November 2007, which is designed to compete head on with Euronext as regards funds seeking to list on an EU regulated market with the minimum disclosure and continuing obligations requirements permitted under European law.  This is what the LSE had been seeking to achieve using the secondary listing route for non-UK domiciled investment entities, which closed to new listings in March 2008.

The LSE’s intention in setting up the SFM was to try and stem the tide of permanent capital vehicles electing to list on Euronext rather than the main market.  The LSE also relaxed the rules for funds listing on the main market by deleting or amending rules which were thought to be unnecessarily onerous and unattractive for most funds.  The LSE hoped to retain a greater number of fund listings where funds are looking for a higher regulatory standard.

Following the introduction of the secondary listing route (which is now closed), the LSE did manage to attract the BH Macro Limited Fund (launched by Brevan Howard) to obtain a secondary listing on the main market.  The issue was not, however, fully subscribed and was reduced from a target size of €1.0 – 1.5bn to €770m (pre over-allotment option).  Subsequently, BH Global Limited listed on the main market on 29 May 2008 having raised $1 billion.  Euronext, however, has had more success in attracting listings, as can be seen from the table below:-

Specialist fund market (‘SFM’)

The SFM is still in its infancy.  The first fund to list was the Da Vinci CIS Private Sector Growth Fund, which raised $110m to invest in both non listed equity and equity related securities of companies located in Russia and the Confederation of Independent States.  The Da Vinci listing was followed by Marwyn Value Investors Limited (‘Marwyn’), a feeder fund, and IRF European Finance Investment Ltd (‘IRF’), formed as a special purpose acquisition company.  Both Marwyn and IRF were previously listed on AIM.

In June 2009, two hedge funds were accepted to the SFM: NB Private Equity Partners, a closed-ended private equity fund of funds, which retained its previous listing on Euronext, and Altus Resource Capital Limited, a Guernsey-incorporated closed-ended investment company, which raised £26 million to invest in small cap mining and resource companies.

The SFM was designed to attract funds which do not satisfy the primary listing requirements of the main market.  There are no requirements for risk spreading, no restrictions on control of investments and no portfolio disclosure requirements. Now that the secondary listing route for overseas investment entities has closed, the SFM is the natural destination for funds wishing to list on a regulated market in London without having to comply with the additional main market listing conditions set out in the table below.

The SFM has been designed to accommodate:

• single strategy hedge funds
• multi strategy hedge funds
• funds of hedge funds
• private equity funds
• property investment funds
• infrastructure  funds
• sophisticated legal structures and security types

The LSE would like the SFM to be a market for sophisticated institutional investors and high net worth rather than retail investors.  Funds which join the SFM will not have their securities officially listed and so will not meet the regulatory requirements of certain investors (including ISA and PEP portfolios) or for inclusion in the FTSE UK series of indices.  This does, however, mean that funds on the SFM will not have to comply with the full listing rules requirements (though many of these requirements are market practice in any event, for instance related party transaction disclosures, the need for shareholder approval of material changes to a fund’s investment policy and the requirement to have an independent board).  A fund listing on the SFM will need to produce a prospectus and have it approved by the fund’s competent authority, which will often be the FSA if a fund is incorporated in an offshore jurisdiction such as Cayman or the Channel Islands.  However, there may be merit in considering use of another competent authority (where practicable) whose listing is being sought for a fund vehicle which, as a matter of UK law, could not register a prospectus (ie one which would be considered a ‘collective investment scheme’ for UK purposes, eg a limited partnership).

Comparison of Euronext and LSE listing requirements (for funds)

The table below summarises the different rules applying to fund listings on the various London markets and on Euronext. 

** PD requires disclosure of how risk is spread where a collective investment undertaking may invest in excess of 20% of its gross assets in other collective investment undertakings (open ended and/or closed ended).

*** A feeder fund must ensure that the master fund’s investment policies are consistent with the applicant’s published investment policy and provide for spreading investment risk and that the master fund in fact invests and manages its investments in a way that is consistent with the feeder fund’s published investment policy and spreads investment risk.  A feeder fund should consider withdrawal of funds or other appropriate action if the master fund’s investments are not consistent with the feeder fund’s investment policy.

**** The issuer will need to obtain a Licence from the Dutch regulator as a fund unless the issuer is treated for Dutch purposes as having adequate supervision in its home jurisdiction.  Currently funds incorporated in the United States (only in respect of funds subject to supervision of the Securities & Exchange Commission), Luxembourg, Ireland, Jersey and Guernsey are considered to have adequate supervision.

***** The investment manager is a ‘related party’.

AIM

The AIM market is an exchange regulated market rather than a regulated market, which means that a prospectus does not automatically have to be produced on the admission of a fund to AIM (absent a public offering).  A fund will still, however, have to produce an admission document containing much of the information that you would find in a prospectus. 
AIM rules provide that any ‘investing company’ must raise a minimum of £3 million in cash via an equity fundraising on, or immediately before, admission.  Furthermore, the admission document must include details of the company’s investment strategy, which must include as a minimum:

• the precise business sector(s), geographical area(s) and type of company in which it can invest;
• how long it can exist before making an investment or having to return funds to shareholders;
• whether it will be an active or passive investor;
• how widely it will spread its investments; and
• what expertise its directors have in respect of evaluating its proposed investments and how and by whom any due diligence on those investments will be effected.

Market practice is often, however, to comply with the full prospectus disclosure requirement for closed-ended collective investment undertakings.

Overview

The changes to the listing rules and the creation of the SFM should help to persuade some fund managers to list their funds in London rather than go to Euronext.  After a slow start, a number of funds have listed on the SFM, which is now becoming more familiar to investors.  SFM avoids the need for funds looking to list on AIM to also get a secondary regulated market listing (such as CISX) and, for those who are prepared to pay for the additional expense of FSA approval of the prospectus, this may prove more cost-effective in the medium term.  However, Euronext has built up a real momentum as the location of choice for alternative fund listings and is likely to remain attractive despite the efforts by the LSE and the FSA to reverse the trend.

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