Last Updated February 27, 2019

Law and Practice

Contributed By Travers Smith LLP

Authors



Travers Smith LLP investment funds group comprises four partners and 15 other dedicated fee earners, based in London. The group focuses on funds, investors and intermediaries in the private equity, infrastructure, debt, real estate and listed equities sectors. It has constantly been at the forefront of developing market practice and thought on relevant changes for the investment funds industry, including the European Alternative Investment Funds Managers Directive and, more recently, the potential impact of Brexit. The funds tax group advises on the structuring of investment funds to maximise their tax efficiency for investors and managers. The investment funds group sits alongside the firm’s market-leading private equity M&A practice, one of the largest transactional teams of private equity lawyers in the City. The funds finance practice combines expertise from the firm’s fund formation and finance practices to advise lenders that provide subscription line and other facilities to real estate funds. Travers Smith also advises real estate funds on the borrower side. The investment funds group is best known for private funds and closed-end listed funds.

The UK is regarded as one of the leading global asset management centres, with an investment funds industry covering both traditional and alternative asset classes. Due to having considerable experience and infrastructure, the UK is one of the most prominent jurisdictions for fund formations and has developed a sophisticated market, offering a range of both closed-ended and open-ended types of funds. Within the UK market, alternative investment funds can be, broadly, divided between closed-ended funds that focus on illiquid asset strategies (eg, private equity, real estate and infrastructure funds) and open-ended funds that focus on liquid asset strategies (eg, hedge funds). The common structures will be different between these two categorisations.

Private closed-ended funds, often structured as English limited partnerships, are commonly used for funds that focus on illiquid asset strategies (eg, private equity, venture capital, real estate and infrastructure funds).

Listed closed-ended funds available for sale to the general public are also common and used for both liquid and illiquid asset strategies. The vehicle most often used is an investment trust (ITC). For funds which intend to invest in UK real estate, authorisation as a real estate investment trust (REIT) may be possible provided the relevant conditions are met.

Open-ended vehicles can be either an undertaking for collective investment in transferable securities (UCITS) fund or a non UCITS retail scheme (NURS). One of the key advantages of a UCITS fund is that it can be marketed to investors throughout the EU without the need for additional, local authorisation in each country, known as the UCITS marketing passport. A NURS provides a similar level of investor protection to that of a UCITS and allows the manager more flexibility in terms of the investments the fund can make. However, a NURS does not benefit from the UCITS marketing passport.

The UK provides for a large number of open-ended vehicles which fall within these two categories. These include authorised unit trusts (AUTs), open-ended investment companies (OEICs) and authorised contractual schemes (ACSs). The regulatory regime is substantially the same regardless of the legal form of the fund. Different authorisations apply, depending upon the investments to be made by the OEIC. For example, OEICs which invest in real estate may, provided the relevant conditions are met, be structured as property authorised investment funds (PAIFs), and OEICs which invest in unauthorised funds need authorisations as “FAIFs”, funds of alternative investment funds.

The UK successfully raises capital from investors from all over the world. The strength of the UK market, and the expertise developed by UK advisers and managers, has, in turn, triggered significant outward expansion, with many UK fund managers now implementing their investment strategies on a pan-European or global basis.

Private closed-ended Funds

The statutory framework in the UK requires that an English limited partnership is registered as such. This entails providing an application for registration to the (public) Registrar for Limited Partnerships (held at Companies House), providing certain details including the name of each limited partner and the amount of capital contributed by each limited partner. This will be conclusive evidence that an English limited partnership came into existence on the date of registration. Any changes to these details during the continuance of the English limited partnership must be similarly registered within seven days of the relevant change.

The key document for private closed-ended funds is the limited partnership agreement; this is a freely negotiated contract, with very few provisions prescribed by law, and not available publicly. All parties will heavily negotiate the agreement prior to its execution. Other key fund documentation often used include side letters (providing certain investors with specific terms required for their specific circumstances), the subscription agreement for investors to subscribe for a commitment and be admitted as a partner in the limited partnership and the investment management agreement for the fund to appoint the manager.

Listed closed-ended Funds

An ITC is typically a UK public limited company which has been approved by Her Majesty's Revenue & Customs (HMRC) as an ITC for the purposes of the relevant tax legislation. Investment trusts are subject to special tax rules (discussed below). Similarly, a REIT is typically a UK public limited company which has been approved by HMRC as a REIT for the purposes of the relevant tax legislation. REITs are also subject to special tax rules (discussed below).

A key consideration when setting up an ITC or REIT is that the eligibility conditions (and post-launch, the ongoing requirements) set out in the relevant tax legislation are met in order to gain the tax advantages enjoyed by these vehicles. Tax lawyers should be engaged early in the process to provide advice on the steps necessary for a company to meet these requirements. Offers in respect of ITCs and REITs are subject to the obligation to publish a prospectus under the domestic legislation incorporating the EU Prospectus Directive. The other key document produced will be the investment management agreement for the fund to appoint the manager.

Since January 2018, under the Packaged Retail and Insurance Based Products (PRIIPs) Regulation a short, standardised disclosure document containing key information about the product being offered, a key information document (KID), must also be produced and published for investment products marketed to retail investors in the EEA.

Open-ended Funds

By comparison, open-ended funds are relatively easier and cheaper to set up, notwithstanding the fact that the fund itself requires prior regulatory authorisation. Open-ended funds have their own constitutional documentation, depending upon which type of vehicle is being set up:

  • a trust deed in the case of an AUT;
  • an instrument of incorporation in the case of an OEIC; and
  • a co-ownership or partnership deed in the case of an ACS.

In each case, the documents set out the features, powers and rules governing each authorised fund. For both UCITS and NURS funds, however structured, there are very detailed operational requirements. Day-to-day operations are then detailed in the fund's prospectus.

Private and Listed closed-ended Funds

Closed-ended funds are not required to have a UK manager. While many do, it is also equally common to see UK funds managed by EEA and non-EEA management entities.

Open-ended Funds

The manager of an open-ended fund must be a UK firm authorised by the Financial Conduct Authority (FCA). In the case of UCITS funds, it is also possible for the manager to be an EEA UCITS management company. In the case of a NURS, it is possible for the manager to be an EEA AIFM.

Private closed-ended Funds

The liability of a general partner for the debts and obligations of a partnership is unlimited, whereas the liability of the limited partner is limited to the amount of capital it contributes to that partnership. Also, unless the partnership is a PFLP, there is a restriction on the ability of limited partners to withdraw capital during the life of the partnership. To keep the capital element as small as possible, limited partners will typically split their commitments into a loan element (typically 99.99% of total commitments) and a capital contribution element (typically 0.01% of total commitments).

Listed closed-ended Funds

Under UK companies' legislation, the liability of the shareholders for company debts is limited to the capital originally invested in the fund.

Open-ended Funds

OEICs in the UK can be structured as a single fund or as an umbrella company with multiple sub-funds, each of which would have its own investment aims and objectives. The legal framework in the UK provides for the ring-fencing of the assets and liabilities of each sub-fund.

An AUT can have a single fund or an umbrella fund structure. In the latter case, each sub-fund is constituted under a separate trust and under UK law the assets and liabilities of each sub-fund are ring-fenced.

As can be seen from the previous discussions, there are a variety of different UK fund structures available. As a general point, an important concept in the way that the UK deals with UK investment funds from a tax perspective is that investors should, as far as possible, be put in the same position as if they had invested directly in the underlying assets. This is typically achieved either through tax transparency or by the availability of special tax regimes. A high-level overview of some of the key direct tax features of some of the most common types of fund structure is set out later in this Chapter.

The UK is a popular and commonly used jurisdiction for sponsors from all over the world.

Private closed-ended Funds

Although not required by UK law, the key marketing document that is usually used for a closed-ended private fund is a private placement memorandum (PPM). UK law generally requires that any marketing material, including a PPM, is "clear, fair and not misleading". Depending on the intended recipient, the PPM may also need to be approved by an FCA-authorised person. Under the Alternative Investment Fund Managers Directive (AIFMD), there are also specific requirements to make set disclosures to investors prior to their investment into the fund. These disclosures are usually included in the PPM.

Listed closed-ended Funds

In addition to the AIFMD disclosure requirements, ITCs and REITs must also comply with the disclosure requirements set out in the FCA's listing, prospectus, disclosure guidance and transparency rules.

Under UK companies' legislation, and the FCA's listing, disclosure guidance and transparency rules, UK incorporated ITCs and REITs must also publish annual and half-yearly reports and accounts. The annual report and accounts must be prepared in accordance with applicable accounting standards and must give a true and fair view of the assets, liabilities, financial position and profit and loss of the company. Half-yearly financial reports do not need to be audited, but it is common practice to ask the auditor to cast an eye over them and the audit committee of the fund should certainly review them.

Open-ended Funds

Investors in open-ended funds must have access to an up-to-date prospectus at all times. A key information document must also be prepared and be made available to potential investors under the UCITS Directive (the UCITS KID). The UCITS KID requirements differ from the document that has to be produced under the PRIIPs regulation. For example, the UCITS KID must be provided to all potential investors, not just those in the EEA. Further, it must be provided to both potential retail and professional investors (whereas the PRIIPs KID is required only to be made available to retail investors).

Private closed-ended Funds

The typical structure of a UK private equity or venture capital fund is most commonly an English limited partnership, a form of partnership governed by the Limited Partnerships Act 1907 (LP Act 1907). Under the LP Act 1907, English limited partnerships must have at least one general partner, who is responsible for the management of the limited partnership, and one or more limited partners.

In recognition of the importance of the private closed-ended funds business to the UK finance sector, the government introduced important reforms to the UK limited partnership law applicable to private funds, which took effect in 2017. The reforms introduced the concept of a "private fund limited partnership" (PFLP); an English limited partnership with certain modifications, so as to simplify the regime, making it a more attractive and competitive choice of vehicle. Most private equity and venture capital funds (and related vehicles, for example co-investment vehicles, and feeder funds) will fulfil the relevant PFLP conditions and can therefore choose to be designated as a PFLP (although it is not mandatory to do so).

It is also possible for a private closed-ended fund in the UK to be structured as a unit trust. The English law concept of a trust has no equivalent in some other jurisdictions. It is a structure under which title to the fund's assets are held by a person with legal personality (the trustee) for the benefit of the fund's investors (the beneficiaries). The document constituting the trust (the trust deed) governs the relationship between the trustee and the beneficiaries and, in addition, strict fiduciary duties are owed by the trustee as a matter of law. A trust does not have a separate legal personality; all legal relationships are entered into by or on behalf of the trustee. These vehicles have historically been used for certain real estate fund structures.

It would also be common for a UK-based private fund manager to establish its private closed-ended fund as an offshore vehicle (whether a partnership, a unit trust or a corporate entity). However, for the purposes of the description of closed-ended private funds in this chapter, the focus will be on English limited partnerships.

Listed closed-ended Funds

ITCs and REITs are typically structured as public limited companies under UK companies' legislation and listed on a recognised stock exchange, most commonly the Premium Segment or the Specialist Funds Segment of the Main Market of the London Stock Exchange. As public limited companies, ITCs and REITs will have a board of directors who are responsible for managing its affairs. The board of directors will typically delegate the day-to-day operation of the investment trust. For example, investment management functions are usually delegated to a fund management company, a depositary/custodian will be appointed to be responsible for the safekeeping of the company's assets, a registrar will be responsible for the share register and a broker will advise on the listing of the company's shares. The fund manager, depositary/custodian and broker will usually be authorised and regulated by the FCA.

Open-ended Funds

For an open-ended structure, an OEIC can be used. This is a collective investment scheme structured as a corporate vehicle. Different authorisations apply, depending upon the investments to be made by the OEIC. For example, OEICs which invest in real estate may, provided the relevant conditions are met, be structured as PAIFs. For an open-ended structure, an AUT can also be used. This is a type of unit trust authorised by the FCA, which is constituted by a trust deed made between the trustee and the manager of the fund. The property of the AUT is legally held by the trustee but is managed by the manager. The investors have beneficial ownership of the property of the fund.

In 2013, two new types of tax transparent fund, ACSs, were introduced in the UK. These new types of authorised funds can take the form of a partnership or a co-ownership scheme. In practice, the co-ownership scheme has proved more popular as it is more straightforward to administer. ACSs are only suitable for use by institutional investors. Investment is restricted to either investments of a minimum of GBP1 million or to professional institutional investors. Retail investors could, however, access ACSs through a feeder fund.

Hedge Funds, EuVECAs and ELTIFs

A classic hedge fund structure in the UK would not include the actual hedge fund being domiciled in the UK. This is often because, to set up the fund onshore would lead to tax inefficiencies because the fund would be treated as "trading" rather than "investing" for UK tax purposes. Instead, hedge fund structures will invariably include an offshore company or offshore limited partnership, established in a jurisdiction such as the Cayman Islands. A UK entity would then be appointed as the discretionary investment manager to, or investment adviser of, the hedge fund. For this reason, hedge funds are therefore not discussed in detail in this chapter.

The EU has also enacted the European Venture Capital Funds (EuVECAs) Regulation for certain sub-threshold, venture capital-focused managers, and the European long-term investment funds (ELTIFs) Regulation for funds investing in long-term investments, both of which are directly applicable in the UK. However, to date, there has been little uptake of EuVECAs or ELTIFs in the UK. Again, for this reason, neither EuVECAs nor ELTIFs are therefore discussed in detail in this chapter.

Private and Listed closed-ended Funds

The UK does not directly regulate closed-ended funds themselves. Instead, regulation falls on the manager. Each closed-ended fund vehicle is likely to be an alternative investment fund (AIF). An AIF is defined by the AIFMD as a collective investment undertaking that raises capital from a number of investors, with a view to investing that capital in accordance with a defined investment policy for the benefit of those investors. (ESMA expands on these concepts in its Guidelines on Key Concepts of the AIFMD). Accordingly, the fund manager is likely to require authorisation and permission from the FCA to carry out AIF management in respect of that vehicle.

Some vehicles used in private closed-ended structures may not fall within the definition of an AIF. Examples include staff carried interest vehicles structured as limited partnerships (which are unlikely to be AIFs because of the AIFMD employee participation schemes exclusion) and certain deal-specific co-investment vehicles. These vehicles, if not AIFs, are nonetheless likely to be collective investment schemes (CIS) under FSMA. A CIS is similar to the EU concept of a collective investment undertaking, but is broader. Establishing, operating or winding-up a CIS is a separate regulated activity, requiring authorisation by the FCA.

Historically, ITCs were not regulated entities. Following the adoption of the AIFMD, some investment trust companies may regard themselves as AIF managers (because they are internally managed AIFs) and become authorised under the AIFMD. However, most ITCs have an external manager that is acting as the AIF manager and will not, therefore, be regulated directly.

Open-ended Funds

Both UCITS and NURS funds are regulated funds that require prior authorisation from the FCA. The FCA has a statutory two-month period to review and consider an application for a UCITS and a six month period for a NURS applications. Once authorised, the funds must comply with detailed FCA rules as these vehicles are heavily regulated (in comparison to closed-ended vehicles). In particular, these funds are subject to stringent investment and borrowing restrictions.

Brexit will clearly have an impact on fund managers and fund vehicles operating and/or marketing, in the UK. As, at the time of writing, it is not known whether the UK will exit the EU on the basis of a deal and related transition period or no deal, the exact implications are difficult to ascertain.

Were a transition period to be agreed and put in place, the UK would continue to implement new EU investment funds legislation which takes effect during that time. This means that the UK may potentially be required to implement some very significant measures which are currently being negotiated, including resultant legislation from the upcoming reviews of the AIFMD and the PRIIPs regime, in addition to the new legislation relating to the cross-border distribution of investment funds (frequently referred to as the "Omnibus" package).

Those most affected by a no-deal Brexit would be UK full-scope AIFMs relying upon a managing or marketing passport. As the UK will immediately become a third country in the event of a no-deal Brexit, these AIFMs will no longer be able to rely upon passporting regimes and will instead only be able to market under national private placement regimes (NPPR). Full-scope AIFMs established in other EEA member states would no longer be able to manage a UK AIF or to market to UK investors under the AIFM passport in the event of a no-deal Brexit. To address this, the FCA has proposed a temporary permissions regime. Sub-threshold AIFMs will not be affected to the same extent as full-scope AIFMs; having never had access to the AIFM directive passport, they will continue to market under the NPPR. Similarly, non-EEA AIFMs would also continue to market under NPPR.

Post-Brexit, access to equity capital markets for listed funds will be affected. As the UK will no longer be a Member State, UK companies will not be able to raise capital in the EEA using a prospectus approved by the UKLA and "passported" into Europe. However, it is likely that the UK and EU rules will remain largely aligned, and so it is unlikely that different documentation will be needed, at least in the short term. However, where a prospectus is required, this will need to be approved in an EEA state, as well as in the UK.

Post-Brexit, it will become possible for the UK to deviate from EU-mandated tax legislation. However, there has been no indication that the UK will amend its tax legislation as a result of Brexit in ways which are likely to impact significantly on funds in particular.

As to other upcoming changes, the legislation which governs UK limited partnerships (the principal fund vehicles used for UK domiciled private funds), the Limited Partnerships Act 1907, is currently the subject of reform proposals. The proposals have been put forward in response to concerns that Scottish limited partnerships are being used in illegal activities. The UK government has taken the opportunity to consider how effective controls can be built into the entire lifecycle of limited partnerships. The proposals relate to:

  • stronger registration requirements;
  • a requirement that the limited partnership will need to demonstrate that it maintains an ongoing connection to the UK;
  • a requirement for the filing of an annual confirmation statement, confirming that all information on the Register at Companies House is correct; and
  • giving the Registrar powers to strike-off limited partnerships.

In relation to open-ended funds, the FCA has put forward proposals aimed at ensuring adequate liquidity in open-ended funds investing in illiquid underlying assets. Broadly speaking, a fund will be within scope of the proposed new requirements if it is a NURS which invests, or intends to invest, at least 50% by value of the fund’s property in inherently illiquid assets.

From April 2019, non-residents will be subject to UK tax on the disposal of interests in UK land or UK-land-rich entities. The rules contain specific provisions which explain how this new tax charge will apply in the case of investment funds, but these provisions are highly complex and there remains a degree of uncertainty as to how they will be applied in practice. A summary of these new rules is outside the scope of this chapter, but it should be noted that non-resident investors in UK investment funds (particularly real estate funds) may be subject to this new UK tax charge.

Travers Smith LLP

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+44 20 7295 3000

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david.patient@traverssmith.com www.traverssmith.com
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Authors



Travers Smith LLP investment funds group comprises four partners and 15 other dedicated fee earners, based in London. The group focuses on funds, investors and intermediaries in the private equity, infrastructure, debt, real estate and listed equities sectors. It has constantly been at the forefront of developing market practice and thought on relevant changes for the investment funds industry, including the European Alternative Investment Funds Managers Directive and, more recently, the potential impact of Brexit. The funds tax group advises on the structuring of investment funds to maximise their tax efficiency for investors and managers. The investment funds group sits alongside the firm’s market-leading private equity M&A practice, one of the largest transactional teams of private equity lawyers in the City. The funds finance practice combines expertise from the firm’s fund formation and finance practices to advise lenders that provide subscription line and other facilities to real estate funds. Travers Smith also advises real estate funds on the borrower side. The investment funds group is best known for private funds and closed-end listed funds.

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