London Stock Exchange - Main Market and Specialist Fund Market
Why float, why London?
The alternative investment fund industry has traditionally operated in the private space, but as the industry matures, and the demand for access from a wider investor base increases, achieving economies of scale through the private fund structure can prove difficult for all but the very biggest players. As a private fund manager, how do you increase your profile to a wider, global investor base? How do you demonstrate the public track record and appropriate levels of disclosure and transparency that are part and parcel of an institutional investor's due diligence process? And how do you encourage secondary market liquidity to enable your wider investor base to trade their stakes? One route to accessing economies of scale is for closed-ended funds to seek admission to trading on an 'effective' public capital market.
There are a number of tests that help to define what constitutes an 'effective' capital market. For instance, it should operate at the centre of a cluster of specialist advisers, investors and administrators. It should facilitate access to significant capital pools. It should carry a respected brand, helping to create global profile. And of course, it should offer a robust trading service to facilitate secondary market activity.
London certainly satisfies the 'cluster' test, sitting in a time zone spanning the global business day, with its wealth of specialist advisers, an extensive global banking community and a principles-based regulatory regime. London has quickly become one of the most important locations outside the US for alternative managers and is by far the dominant centre in Europe. Indeed, London's share of global hedge fund assets alone accounts for some 20 per cent of the world total and 90 per cent of European hedge fund managers now make London their home .
Within that environment, the London Stock Exchange passes the remaining tests, offering a choice of markets that open access to Europe's largest capital pool, the instant recognition of the London Stock Exchange's globally trusted brand and a cutting-edge trading system to facilitate liquidity. The Exchange has a long pedigree in the quoted funds arena: closed-ended funds have been admitted to its markets for over 70 years. Currently, the Exchange hosts over 571 funds capitalised at $166 billion .
Choice of markets
No two alternative funds are the same. Each will have differing levels of sophistication, in terms of the investment remit, the fund structure, the method of participation, and the investor audience sought. It is essential to cater for this diversity, which is why the Exchange offers three markets for closed-ended funds: the Main Market, the Specialist Fund Market and AIM. Whilst AIM is the Exchange's international market for smaller growing companies and is suitable for more straightforward funds seeking a broad investment audience, the two principal markets for alternative fund managers are the Main Market and the Specialist Fund Market.
The Main Market
Regulated by the UK's Financial Services Authority (FSA), the Main Market is the Exchange's flagship global market for trading companies and investment entities. The Main Market has EU Regulated Market status, being 'MiFID compliant'. Closed-ended funds must not only meet European standards of disclosure and transparency, enshrined in the Prospectus, Transparency and Market Abuse Directives, but must also qualify for a 'Listing' by complying with Chapter 15 of the FSA's Listing Rules, which sit over and above - or are 'super-equivalent' - to the European framework.
For funds admitted to the Main Market, it is this combination of European law and supplemental Listing Rules that opens up access to the widest possible investor base from sophisticated institutional to a broad range of retail investors.
In particular, listed, Main Market funds benefit from potential inclusion in the FTSE UK Index Series on which tracker and benchmarked funds are built. They also qualify as permitted investments within general retail tax wrappers in the UK such as Individual Savings Accounts (ISAs) and Self-Invested Personal Pension plans (SIPPs). These are a significant part of what is Europe's largest capital pool. For instance, tracker and benchmarked funds comprise over $300 billion of assets, whilst there are over 12 million retail ISA accounts worth $145 billion .
For funds seeking to develop and manage property, a listing on the Main Market is also a pre-requisite for applying to the UK tax authorities for recognition as a 'UK-REIT', conferring various tax benefits.
The Specialist Fund Market
However, not all funds will be seeking to appeal to general retail investors. The more complex funds wishing to create a permanent capital base from experienced, professional investors may require a more flexible market structure. Opened in November 2007 as a peer group market for alternative investment funds and their associated investors, the Specialist Fund Market appeals to hedge funds, private equity funds, emerging country and specialist property funds. The market is also capable of accepting more complex structures, governance models and security types. Limited partnerships, non-voting shares, and funds with concentrated investment policies and bespoke governance arrangements can be accommodated.
As with the Main Market, the Specialist Fund Market is regulated by the FSA, and has EU Regulated Market status. However, unlike the Main Market, funds do not have to comply with the FSA's Listing Rules, which pre-suppose general retail investor participation and are not applicable for funds wishing to appeal only to a more sophisticated, predominantly institutional, investor base.
Importantly, EU Regulated Market status is the baseline requirement for access to European institutional investment mandates without being subject to threshold limits. Specialist Fund Market securities are eligible for inclusion in occupational pension funds, insurance funds and even other mutual funds such as UCITS.
For a closed-ended fund, admission to the Main Market or the Specialist Fund Market requires the production of an EU Prospectus Directive compliant document approved by an EU Competent Authority. In the UK this is the FSA. Key requirements for disclosure in such a prospectus include:
• a detailed description of the investment objective and policy
• details of any investment restrictions which apply
• information on the investment manager and other advisers to the fund
• details of custody, trustee and fiduciary arrangements
• valuation principles and the frequency and method for determining NAV
• details of cross liabilities
• relevant financial information
• a comprehensive and meaningful analysis of the fund's portfolio.
Funds seeking admission to the Main Market must also comply with the FSA Listing Rules, which include the requirement for a minimum of 25% of shares to be in public hands and the appointment of an FSA-approved 'Sponsor' (normally a bank or corporate finance house). The fund must also show that it will invest and manage its assets in a way which is consistent with its objective of spreading investment risk and it must also ensure that the board acts independently of the investment manager.
Any EU Competent Authority can approve a prospectus, which can then be 'passported in' to the UK for admission to either the Main Market or the Specialist Fund Market. However, a fund wishing to be passported in to the Main Market will have to prove that it also complies with the additional Listing Rules. Equally, a prospectus approved in the UK by the FSA can be passported to other European capital markets.
As well as meeting the requirements of the FSA, the Exchange maintains an obligation to maintain a fair, orderly and transparent market. Applicants for either the Main Market or the Specialist Fund Market must therefore also comply with the Exchange's Admission and Disclosure Standards. Given the sophisticated nature of the market, Specialist Fund Market applicants in particular will need to ensure that they can show adequate free float and that securities will be freely transferable and negotiable.
There is no restriction on domicile for funds seeking admission to either the Main Market or Specialist Fund Market, the choice of which will be directed by tax and other considerations. And unlike other jurisdictions and markets (such as the '144a market' in the US), there is also no differentiation for certain types or size of investor. Instead, it is the responsibility of the agency network (e.g. stockbrokers) to assess investor suitability. In the UK, agents are bound by, amongst other things, the FSA's Conduct of Business rules, but local rules will apply in the jurisdiction concerned if that is not the UK.
The timescale for the production and approval of a prospectus can vary, but a minimum of three months should be considered. An FSA-approved Sponsor must be appointed for a Main Market float and they will manage the application process, whereas the lawyer or corporate finance house/broker is more likely to take the lead role in shepherding a Specialist Fund Market application. The provision of financial information is an important consideration for existing funds seeking to float and so the role of the reporting accountant is crucial.
Flotation costs will vary and are a factor of time and complexity of the proposition involved. Whichever market is selected, applicants must be prepared to dedicate time, effort and resource to ensure the process proceeds smoothly and cost effectively. This extends to developing proactive relationships with administrators and ensuring that effective investor and public relations functions are created either internally or in partnership with agencies that specialise in the funds world. Managers seeking to extend investor interest further will need to consider either corporate broking or placement agent involvement in the book-building exercise.
Ongoing obligations for both the Main Market and the Specialist Fund Market also reference European law - chiefly the EU's Market Abuse and Transparency Directives - as applied through the FSA's Disclosure and Transparency Rules. For both markets, new issuers will (amongst other things) need to:
• produce annual and half-yearly reports and interim management statements (with financials to IFRS or equivalent for non-UK applicants)
• identify and disclose inside information, maintaining an Insiders' List of those who may have access to such information
• compile an Annual Information Update which includes or refers to all regulatory information filed or reported to the market.
However, Main Market funds must also abide by 'super-equivalent' disclosure and transparency obligations under the Listing Rules, including requirements to:
• incorporate the UK's Combined Code on Corporate Governance, which covers the composition and operation of the board and sub-committees, and topics such as directors' remuneration, relationships with shareholders, supply of information to the market and accountability and audit measures;
• comply with the Model Code, restricting directors' dealings and buybacks during a close period;
• in certain circumstances seek prior shareholder approval and/or provide notice for certain transactions through the application of pre-emption rights and by observing the FSA's Significant Transactions or 'Class Tests' regime;
• seek shareholder consent for a material change in investment policy;
• comply with the 'related party transaction' rules, applying to transactions and arrangements with those capable of exercising significant influence;
• appoint an FSA-approved Sponsor for certain transactions;
• ensure that the majority of the board of directors (including the Chairman) remain independent of the investment manager;
• ensure that feeder fund investments are consistent with the master fund's investment policy.
Main Market or Specialist Fund Market
The choice between a float on the Main Market or Specialist Fund Market is a subjective and highly individual one. For funds looking to appeal to the widest investor base and content to comply with the additional disclosure and transparency requirements this entails, the Main Market will be the ideal route. However, sophisticated or specialised funds requiring more flexibility in approach when it comes to accommodating particular structural characteristics may find the Specialist Fund Market a more appropriate route.
Despite the dramatic market conditions experienced of late, demographics dictate that the alternative funds industry will continue to be in demand over the long term. There are now nearly 600 million people in the world aged over 60 years - a figure expected to double in the next twenty years . With people living longer, traditional institutional investors such as pension and life funds increasingly have to make their assets work harder for longer. It is likely that investor demand for alternative funds offering the discipline, appropriate disclosures and secondary market potential that the public capital markets bring will also increase. And London, with its collaborative financial community and a choice of appropriate capital markets will continue to play a central role in meeting that demand.
By Andrew Wallace, Senior Manager, Specialist Fund Market