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FSA confirms ending of London secondary listing route for alternative funds

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The Financial Services Authority has confirmed that alternative investment funds will no longer be able to take advantage of a secondary listing regime under Chapter 14 of the UK’s listing

The Financial Services Authority has confirmed that alternative investment funds will no longer be able to take advantage of a secondary listing regime under Chapter 14 of the UK’s listing rules once a new unified regime for the listing of investment entities is in place early next year.

A surge of so-called directive-minimum listings under Chapter 14 has bolstered the London Stock Exchange’s position as a market for listed hedge funds, funds of hedge funds and private equity vehicles, business for which its main competitor is Euronext Amsterdam.

However, the FSA is perceived to have bowed to pressure from market players such as the domestic investment trust industry, which argue that foreign-domiciled funds should not be permitted to enjoy the lighter-touch regime offered by the minimum standards set out by the European Union’s Consolidated Admissions and Reporting Directive, while domestic funds must meet the higher requirements of the ‘super-equivalent’ regime under Chapter 15 of the listing rules.

Investment companies listed under Chapter 14 of the listing rules are not required to comply with the diversification limits on investment portfolios, board independence rules or the limits on cross-holdings set out in Chapter 15.

Following consultation with members of the industry, the FSA is now proposing to bring in a unified regime for investment vehicles in the first quarter of next year. In the meantime some changes to the existing Chapter 15 rules prompted by the consultation exercise will be implemented under an interim region starting in September.

Once the unified regime comes into force, alternative funds will no longer be able to opt for the directive-minimum regulatory regime when they list in London, but it will still be available in Amsterdam. Existing funds that have already listed in London under Chapter 14 will not have to switch to the new rules.

Some London lawyers believe that the FSA’s decision to bar access to the lighter-touch regime is likely to prompt some alternative fund sponsors to opt for the Amsterdam exchange instead. ‘I think it’s a bit of a shame that they’ve ditched that route,’ says Gray Smith, a London-based partner with international law firm Ogier. ‘The regulations seemed to be working pretty well. I thought this would be quite a decent competitor to Euronext and something we could have marketed.

‘I understand the reasons for wanting a single regime. The reputation of the regulator is paramount, and after the split caps and other scandals there’s a certain nervousness. However, I didn’t see a problem with the secondary listing route as it stood. It was a good response to everything that was happening in the listing market, and the funds that have been using this route are all big companies. It’s a very different proposition from AIM.’

Inevitably, Smith believes, the change will leave London somewhat on the back foot for the listing of alternative funds. ‘The argument will probably be that the biggest companies will still come to London, but some very big permanent capital vehicles have already gone to Euronext. The whole nature of the hedge fund industry is that while it’s perfectly happy to be regulated, it doesn’t actually seek extra regulation, so if there’s a perfectly good stock exchange that may be more accessible, they are more likely to go down that route.’

The FSA’s latest consultation paper as part of the Investment Entities Listing Review puts flesh on its previous paper issued in April, which announced an about-turn on the future of the listing rules. Previous the regulator had envisaged making the directive-minimum regime, which had been opened up a few months earlier to foreign funds that did not have a primary listing elsewhere, a permanent option for alternative funds seeking a London listing.

The FSA says its goal is to create a modern, flexible unitary regime, with changes to the current Chapter 15 rules that will for example give issuers more flexibility in the way that they spread the investment risk in their funds. These changes will take place from September.

‘This is an important reform, and part of ensuring the UK continues to be Europe’s recognised centre of financial innovation,’ says Hector Sants, the FSA’s managing director in charge of wholesale and institutional business.

‘Respondents to our second consultation agreed with our basic objective – making UK-listed markets more attractive to a wider range of investment strategies while maintaining appropriate standards of investor protection. We now plan to pursue this goal through a single regime, based on the high standards of our existing super equivalent regime, modified through further deregulation.

‘Underpinning our proposed unitary regime is the key principle that shareholders of investment entities can look to an independent board to represent their interests, particularly in relation to overseeing any external fund manager. The amendments are intended to ensure the detail in the rulebook delivers on the principle without undue additional prescription.’

The changes that are proposed to take effect next year are designed to remove some of the constraints that led many fund sponsors to prefer the less onerous Chapter 14 route. For example, board independence rules will stipulate that a simple majority of independent directors plus an independent chairman will be sufficient for a board to be considered independent of its manager. Currently an investment manager is limited to one representative on a board.

The new unified rules will also make it easier for feeder funds to list, provided that they can still demonstrate a spread of investment risk. Quarterly portfolio disclosure will no longer be required, with the existing FSA disclosure and transparency rules sufficing instead, along with a new overriding requirement to disclose on a quarterly basis details of significant holdings representing 10 per cent or more by value of an issuer’s overall portfolio.

The FSA also proposes to remove the requirement that, as a condition for listing, a listed investment fund must have sufficient investment management experience, and will offer a new exemption to the related party rules designed to facilitate co-investment by listed investment funds alongside other funds managed by the same manager. The consultation exercise will solicit views on whether the listing rules should deem an investment manager a related party.

The measures to be introduced to the Chapter 15 regime in September are intended to implement immediately changes on which the FSA sees a broad consensus of support, without waiting until 2008. These include permitting a flexible, more principles-based approach to investment strategies, allow firms to follow a wider range of strategies to spread their investment risk including long/short strategies used by hedge funds and the taking of controlling stakes.

The transitional regime will remove prescriptive additional rules for property funds, thus making UK real estate investment trusts structured as closed-ended funds subject to the same investment restrictions and governance requirements as other funds, and the removal of most super-equivalent rules for regulated open-ended funds. The FSA says this group, which includes most exchange-traded funds, are already subject to detailed authorisation requirements, so the imposition of extra listing rules is unnecessary.

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