Investment Funds 2023 Comparisons

Private Funds

The typical structure of a UK private equity or venture capital fund is most commonly an English limited partnership, which is 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 (GP), who is responsible for the management of the limited partnership, and one or more limited partners. Thus, investors in such funds are limited partners in the partnership. One of the fundamental attractions in the UK of a limited partnership structure for private closed-ended funds is that the limited partnership is a flexible vehicle in terms of internal governance and control.

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, such as 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 scheme. 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 is 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 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 most commonly been used for certain UK real estate fund structures.

In November 2021, rules came into effect for a new UK fund structure: the Long-Term Assets Fund (LTAF). The LTAF is a UK-authorised fund that is designed to be focused on long-term, illiquid assets and is particularly targeted at increasing defined contribution pension scheme investment into alternative assets.

The LTAF is an authorised fund so can be structured as an open-ended investment company (investment company with variable capital – ICVC), unit trust or contractual scheme. There is an increasing expectation that the LTAF will play a significant role in attracting long-term capital to the market (for further details on the LTAF, see 4.1 Recent Developments and Proposals for Reform).

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 Funds

The vehicles used most often are ITCs and REITs. These 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, although certain other stock exchanges both in and outside of the UK are possible.

As public limited companies, ITCs and REITs will have a board of directors who are responsible for managing their 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 Financial Conduct Authority (FCA).

Private Funds

The statutory framework in the UK requires an English limited partnership to be 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 is not available publicly. All parties will heavily negotiate the agreement prior to its execution.

Other frequently used key fund documentation includes 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 Funds

An ITC is typically a UK public limited company that has been approved by His Majesty's Revenue & Customs (HMRC) as an ITC for the purposes of the relevant tax legislation. ITCs are subject to special tax rules (discussed below). Similarly, a REIT is typically a UK public limited company that 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). Since April 2022, it has been possible to have an unlisted REIT where, broadly, it is at least 70% owned by institutional investors. This makes the REIT a potentially attractive private fund vehicle for the right investor base.

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 need to be met in order to gain the tax advantages enjoyed by such 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 deriving from the EU Prospectus Regulation. Where a prospectus is required, this will need to be approved in an EEA member state for use in the EEA, in addition to being approved by the FCA for use in the UK. The other key document produced will be the investment management agreement for the fund to appoint the manager.

Private 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 Funds

In respect of ITCs and REITs, under UK companies legislation the liability of the shareholders for company debts is limited to the capital originally invested in the fund.

Private 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 UK AIFM Regime, 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 Funds

In addition to the UK AIFM Regime 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 must also publish annual and semi-annual 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. The semi-annual 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.

Under the UK's Packaged Retail and Insurance Based Products (PRIIPs) Regime, derived from the EU PRIIPs Regulation, a short, standardised disclosure document containing the 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 UK. If an investment product will also be marketed to retail investors in the EU, a separate KID prepared in accordance with the EU PRIIPs Regulation must also be produced and published. Since 1 January 2023, changes to both the UK and EU regimes have led to divergence between the two regimes (see 4.1 Recent Developments and Proposals for Reform).

Private Funds

Investors typically seen investing in private closed-ended funds in the current market include pension funds, sovereign wealth funds, endowments, insurance companies, fund of funds and high net worth individuals.

Listed Funds

Closed-ended listed funds can be marketed broadly and attract both institutional and individual investors.

Private Funds

Limited liability partnerships (LLPs) tend be the most commonly used legal entity for the management entities of private equity and venture capital funds, who are attracted by some of the benefits of the LLP structure, such as flexibility, and the fact they are transparent for direct tax purposes and can benefit from national insurance contribution savings.

Listed Funds

The legal structure used for the management entity of listed alternative funds will depend upon the jurisdiction in which the manager is based. The most common structure seen is a corporate vehicle.

Other than general marketing/financial promotion rules in the UK, there are no restrictions under UK legislation on the type of parties that can invest in a fund. However, in practice, REITs seek to prevent certain corporate investors from holding interests of 10% or more due to the adverse tax consequences that would otherwise arise.

A closed-ended fund in the UK will almost certainly be an AIF for the purposes of the AIFMD and for the purposes of the UK AIFM Regime, which defines an AIF as any investment fund that is not subject to the UK UCITS regime. As such, the AIF's manager will be an AIFM for the purposes of both regimes and will need to be authorised to carry out AIF management in respect of that vehicle. Any person who carries on the activity of managing an AIF in the UK without being duly authorised, and in the absence of an exclusion, commits an offence. In addition, if they have entered into an agreement with another person (eg, an investor) in the course of that activity, this agreement is unenforceable against that other party, who is entitled to receive their money back, and to compensation for any loss.

An ITC or REIT could be self-managed or managed by an external manager. The board of an externally managed ITC/REIT will generally consist of non-executive directors, the majority of whom must be independent of the investment manager. In many cases, ITCs and REITs will now have no manager representative on the board, due to the unpopularity of such arrangement with investors.

The AIFMD sets out various provisions relating to service providers, such as depositaries and valuers. UK legislation does not restrict the use of non-UK service providers to provide these services.

However, one restriction does apply in the UK in respect of external valuers: UK legislation prohibits an external valuer from delegating valuation to a third party.

Under the AIFMD, the depositary of an EEA AIF must be established in the home member state of that AIF. Therefore, post-Brexit EU AIFs are no longer able to use UK banks as depositories, and UK AIFs are no longer able to use EU banks as depositaries.

EEA AIFMs are no longer able to exercise management passport rights available under the AIFMD to manage a fund in the UK. Authorisation will be required from the FCA to manage a UK AIF. As a temporary measure, EEA AIFMs were able to seek authorisation in the UK to use the FCA's temporary permissions regime (TPR) to continue to access the UK market but the FCA's window for notification by those wanting to use the TPR has now closed.

Generally, a fund delegates investment management, and it is usual to see delegation to either an FCA-regulated investment management firm or an investment manager domiciled outside of the UK. Any firm applying for authorisation or registration by the FCA must have its head office in the UK. Although the FCA will judge each application on a case-by-case basis, the key issue in identifying the head office of a firm is the location of its central management and control.

The AIFMD permits the delegation of portfolio management activities by an EEA AIFM to non-EU managers, subject to a number of strict conditions. As the UK is now a third country for these purposes, delegation or sub-adviser arrangements between an EEA AIFM and UK managers may need to be updated to satisfy those requirements. AIFMs may also need regulatory approval for the delegation.

In respect of closed-ended funds, three types of licence are available to an AIFM that has its registered office in the UK:

• authorisation under the Financial Services and Markets Act (FSMA) as a full-scope UK AIFM;
• authorisation under the FSMA as a small authorised UK AIFM; and
• registration as a small registered UK AIFM.

The type of licence that is applicable to the manager will depend on the total amount of assets it has under management and the nature of the AIFs managed.

The UK has not introduced equivalent legislation to that set out in the EU's Directive and Regulation on the cross-border distribution of collective investment undertakings. Although there is no formal concept of pre-marketing, any invitation or inducement to engage in investment activity will constitute a financial promotion for the purposes of the UK domestic regime. Any activity that would involve pre-marketing will therefore involve the issuance of a financial promotion in the UK and will accordingly be restricted by the UK's financial promotion regime.

A number of useful exemptions to the restrictions on making a financial promotion are available under the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (the FPO). The primary exemptions are:

• the “Investment Professionals” exemption, which permits financial promotions to be made to, inter alia, firms authorised by the FCA and any person whose ordinary activities involve carrying out the activity to which the communication relates; and
• the “High net worth companies” exemption, which permits marketing to certain categories of high net worth institutions.

Between them, these exemptions generally allow financial promotions to be made to the institutional markets.

The activity of marketing or promoting securities or other investments is not in itself a regulated activity requiring any form of licence in the UK. However, there are circumstances where someone whose main aim is to make promotions either for their own purposes or on behalf of others (or to help others to make promotions) may, in conjunction with the marketing or promotion, be engaged in regulated activities. In this regard, the most likely regulated activities under the Regulated Activities Order are those of “arranging deals in investments” or “advising on investments”. A firm will require authorisation, with specific permission for the relevant activity, to the extent that it is deemed to carry on such activities in the UK.

In practice, marketing activities in relation to a fund will also often involve the regulated activities of making arrangements with a view to another person buying or subscribing for interests in the fund. In view of this, fund marketing activities in the UK are generally conducted only by authorised persons. Any person conducting marketing activities in relation to a fund should consider whether authorisation is required and, if it is authorised, whether it has the appropriate permissions from the FCA to undertake these activities.

The promotion of an interest in an unregulated collective investment scheme (such as a limited partnership interest) is restricted in the UK. It cannot be promoted to the general public and, even for a private placement, there are broad restrictions on its promotion to different categories of recipients. The persons to which a limited partnership interest can be promoted include:

• investment professional organisations;
• high net worth organisations; and
• in limited circumstances, some certified high net worth individuals and sophisticated individuals.

In the UK, the FCA permits the marketing of a private fund to a wider group of recipients than the category of “professional investors” referred to in the AIFMD, provided the financial promotion rules referred to above are complied with throughout the entire marketing process.

Since 1 January 2021, full-scope UK and EEA AIFMs are no longer able to use the AIFMD marketing passport to market into the UK and will need to rely on the UK national private placement regime (NPPR) instead. This will only be possible if the UK and the EU member state in question have entered into a regulatory co-operation agreement.

Under the UK's NPPR, the following requirements need to be satisfied:

• an AIFM needs to submit a notification using the FCA's online system, Connect; and
• appropriate pre-investment disclosures need to be made in accordance with the provisions of UK AIFMD.

There is a fee for AIFMs making a notification. Marketing can commence once the FCA has received the notification.

Non-UK AIFMs marketing in the UK under the NPPR must report transparency information to the FCA using the Gabriel system.

The two main investor categories in relation to the distribution of funds in the UK are “professional investors” and “retail investors”. A “professional investor” is one who is considered to be a “professional client” (ie, a “per se professional client” or an “elective professional client”, in each case within the meaning of MiFID).

An investor will be a “per se professional client” if it fulfils one of a number of objective criteria listed in MiFID. Such entities include regulated financial entities, large undertakings, governments and public bodies, and investors whose main activity is to invest in financial instruments.

Any investor that does not satisfy any of the “per se” criteria in MiFID will be categorised as a “retail client”, unless it can be treated as an “elective professional client”. To be able to do this, the manager must assess the expertise, experience and knowledge of the investor and whether this makes them capable of making their own investment decisions and understanding the risks involved (the “qualitative test”). The investor must further pass the “quantitative test”, meaning that they have satisfied two out of the three following requirements:

• having carried out transactions of a significant size on the relevant market at an average frequency of ten per quarter over the previous four quarters;
• having a financial instrument portfolio exceeding EUR500,000; and
• working or having worked in the financial sector for at least one year in a professional position.

An investor satisfying the relevant qualitative and quantitative tests and wishing to opt-up must be given a clear written warning of the protections and investor compensation rights they may lose, and they must state in writing that they are aware of the consequences of losing these protections and wish to be treated as a “professional client”.

Private closed-ended funds tend to only be marketed to non-retail investors. Listed closed-ended funds are available to both professional and retail investors.

The FCA is regarded as being co-operative, and regularly publishes guidance on relevant regulatory matters.

An OEIC can be used for an open-ended retail fund, which is a collective investment scheme structured as a corporate vehicle. Different authorisations apply, depending upon the investments to be made. For example, OEICs that invest in real estate may be structured as PAIFs, provided the relevant conditions are met. 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 managed by the manager. The investors have beneficial ownership of the property of the fund. Many PAIFs have an AUT as a feeder vehicle to enable corporate investors wishing to hold 10% or more indirectly to invest without infringing regulatory requirements.

In 2013, two new types of tax transparent funds (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, particularly from a tax perspective. However, ACSs are only suitable for use by institutional investors, with investment restricted either to investments of a minimum of GBP1 million or to professional institutional investors.

Compared to AIFs (which fall within the scope of the UK AIFM Regime), retail funds structured as open-ended funds can be 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, as follows:

• 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 detailed in the fund's prospectus.

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 the assets and liabilities of each sub-fund are ring-fenced under UK law.

Certain pre-investment disclosures must be made to investors. Under UK regulation, every manager is required to provide comprehensive information to help investors make a balanced and informed decision about any retail fund prior to investing. In most cases, this information is contained within the prospectus. Investors in open-ended funds must have access to an up-to-date prospectus at all times.

In addition, a KID must be prepared and made available to potential investors under the UCITS Directive (the UCITS KID). The UCITS KID requirements differ from those for 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; it must also be provided to both potential retail and professional investors, whereas the PRIIPs KID is only required to be made available to retail investors.

Open-ended funds, particularly OEICs, are popular with individual investors, insurance companies and pension funds. ACSs are increasingly popular for institutional investments and pension funds.

The new open-ended fund vehicle introduced in the UK in 2021 – the LTAF (see 2.1.1 Fund Structures) – is primarily aimed at defined contribution pension schemes but is also available to retail clients if they are sophisticated investors or certified high net worth individuals. The FCA published a consultation in 2022 in relation to broader retail access (see 4.1 Recent Developments and Proposals for Reform).

The legal structure used for the management entity of retail funds varies and will depend upon a number of factors, such as tax considerations. The most common structure used is a corporate vehicle.

Other than general marketing/financial promotion rules in the UK, there are generally no restrictions under UK legislation on the type of parties that can invest in a retail fund. However, PAIFs cannot have a corporate investor with an interest of 10% or more (but see 3.1.1 Fund Structures in relation to the use of feeder vehicles to address this issue).

The manager of an open-ended authorised fund must be authorised by the FCA. It should be noted that, since 1 January 2021, EEA UCITS funds fall within the definition of an AIF for the purposes of the UK AIFM Regime, as AIFs are defined as any investment fund that is not subject to the UK UCITS regime.

Each open-ended fund must have a depositary. In the UK, this is a regulated activity for which the depositary must hold the appropriate FCA permissions.

The UK’s authorised fund governance regime goes further than is required under the UCITS Directive in that it places a number of additional responsibilities upon depositaries and requires them to be independent (so as to avoid and manage any potential conflicts of interest).

Depositaries in the UK are also required to undertake a wide variety of oversight activities, and are subject to extensive conduct of business rules and other regulatory requirements.

It is no longer possible for EEA-authorised UCITS managers to provide management services to a UK domiciled fund by exercising management passport rights available under the UCITS Directive. Instead, FCA authorisation to manage a UK AIF will be required.

As with depositaries, managers are required to be independent.

Investment funds that are structured as collective investment schemes must be authorised or recognised by the FCA in order to be promoted to retail investors in the UK. Authorised funds must be established in the UK and take one of the following legal forms:

• ACS;
• AUT; or
• ICVC.

A fund must also be classified, based on a marketing strategy, as either a UCITS, NURS, QIS or LTAF. The application must include the requisite application form, certain relevant supporting documents and information, and an application fee. Application processing times depend upon whether the application relates to a NURS or QIS (six months, although the FCA aims to process such applications within two months), a UK UCITS (two months) or an LTAF (six months).

The pre-marketing of retail funds is subject to the financial promotion regime (see 2.3.5 Rules Concerning Pre-marketing of Alternative Funds), which requires financial promotions to be approved by an authorised firm.

The marketing of a UK retail fund can only be undertaken in EU member states once the required documents have been filed with the FCA. The required documentation varies according to the type of fund vehicle, but is in most cases the fund's prospectus and KID. A notification letter must also be filed. The FCA then has ten working days in which to process the notification.

NURS funds fall within the UK AIFMD Regime and can therefore be marketed to the general public in the UK. NURS funds cannot be marketed to investors living in EU countries, unless the fund is approved by the regulators in each country and complies with the terms for regulated funds in each country.

Although QISs also fall within the UK AIFMD Regime, they may only be marketed to experienced investors who meet certain qualifying conditions.

Funds established in countries other than the UK must be recognised by the FCA under Section 272 of the FSMA, or must be entered into the temporary marketing permissions regime.

Some open-ended funds are available for distribution to retail investors.

A “retail investor” is defined as any investor that does not meet the necessary criteria in MiFID, unless it can be treated as an “elective professional client” (see 2.3.10 Investor Protection Rules).

In practice, many retail funds are available for purchase by the general public via investment platforms and retail supermarkets.

EEA AIFMs are no longer able to exercise marketing passport rights available under the EU AIFMD. As a temporary measure, EEA AIFMs were able to seek authorisation in the UK to use the FCA's TPR to continue to access the UK market but the deadline by which firms and fund managers had to notify the FCA that they want to use the TPR has now passed.

A new regime for non-UK retail funds, the Overseas Funds Regime, has been introduced in the UK but is not yet in force.

Before a retail fund is made available to retail investors, a KID will need to be drawn up (in English) in the UK in accordance with the UK PRIIPs Regulation (see 3.1.4 Disclosure requirements). The UK PRIIPs Regulation requires the KID to be updated regularly, and updated when the review indicates that changes need to be made.

The FCA is introducing a new consumer duty, which is intended to provide a higher level of consumer protection in retail financial markets and which will include ongoing requirements in respect of the firm-consumer relationship (see 4.1 Recent Developments and Proposals for Reform).

In the UK, there are both legal and regulatory requirements for retail funds to produce periodic reports every six months. Managers must prepare and publish annual and semi-annual reports, and make them available upon request and free of charge.

In the UK, the FCA has the power to require a manager and/or depositary to compensate an authorised fund in the event of a finding against the manager and/or depositary. It also has the power to fine those entities and to fine or ban individuals in those companies.

In addition, authorised fund management is covered by the Financial Ombudsman Service and the Financial Services Compensation Scheme, which each deal with investor complaints and can require managers to compensate investors in certain circumstances.

See 2.3.11 Approach of the Regulator.