The listed investment funds industry in the UK has been dealing with a period of uncertainty for considerable time. Within the market, shares are trading at discounts to net asset value, there is an increased amount of consolidation and merger activity, and there are growing levels of shareholder activism.

For commercial companies, there has been much focus on the positive changes being made to the UK listing regime.¹ Specifically, the current Listing Rules will be replaced with a new UK Listing Rules sourcebook (UKLR) later this year with the aim of attracting larger numbers of entrants to the UK markets. Whilst this constitutes the most far-reaching reform of the UK listing regime in three decades, for closed-ended investment funds (CEIFs) there was little to be excited about. Indeed, in its May 2023 consultation (CP 23/10), the FCA noted that it expected its approach to CEIFs "would remain largely unchanged".

The recent publication of the FCA's latest consultation paper, Detailed proposals for listing rules reforms (CP 23/31) (the December Consultation Paper), confirms this position, expressly noting that the UKLR will broadly retain the current Listing Rule 15 eligibility and continuing obligations provisions for CEIFs. However, the December Consultation Paper does contain some interesting content for the CEIF industry, as set out below.

Significant and related party transactions

The December Consultation Paper confirms that, for commercial companies, a Class 1 transaction (i.e. a transaction that engages a percentage ratio on any of the class tests which is 25% or more), other than a reverse takeover, will no longer require shareholder approval or related sponsor involvement. This will not be the case for CEIFs, where any Class 1 transactions outside the published investment policy will continue to be subject to prior shareholder approval and an FCA-approved circular.

The FCA justifies the different approach for CEIFs because CEIFs already benefit from an important exemption from the significant transaction regime, namely where the transaction is within the scope of the investment policy of the CEIF. The FCA's view is that this properly reflects the different nature of a CEIF and the purpose of its investment policy – a material change to a CEIF's investment policy requires shareholder approval and therefore maintaining shareholder approval for a significant transaction outside a CEIF's investment policy is consistent with this approach.

By contrast, and in a welcome move, the FCA is ready to improve the way the new listing regime deals with related party transactions (RPTs) for CEIFs.

The investment manager of a CEIF is a related party but, unlike with significant transactions, there has been no express exemption from the RPT requirements in respect of transactions with the investment manager which are in scope of the investment policy of the CEIF. This has been a source of frustration for the industry, in particular for funds with alternative strategies which are reliant on sourcing assets from their investment manager. While UKLA Technical Note 406.1 has sought to explain how these transactions may instead fall into an "ordinary course of business" exemption, that is applied on a case-by-case basis and can be difficult to navigate with the FCA.

Under the proposed new regime, for commercial companies, the current requirement for shareholder approval of an RPT where a percentage ratio on any of the class tests is 5% or more will fall away. A sponsor's fair and reasonable opinion, and board approval, are all that will be required.

For CEIFs, the FCA proposes to draw a distinction between RPTs which fall within and outside the scope of a CEIF's published investment policy. RPTs outside the scope of the investment policy will continue to be subject to the requirements of the current RPT regime (i.e. a sponsor's fair and reasonable opinion and prior shareholder approval with an FCA-approved circular where the relevant percentage ratios are exceeded). However, RPTs which are within the scope of the investment policy will only require a sponsor's fair and reasonable opinion, even where a percentage ratio is 5% or more.

This is a positive development. It is also logical as it confirms the prominence for CEIFs of their published investment policy, and ensures consistency between the significant transactions and RPT regimes.

Note that this change to RPTs is not expected to change the way in which CEIFs and their managers need to evaluate management fee amendments, which are currently classifiable as RPTs. We anticipate that the current treatment of management fees, as outlined in UKLA Technical Note 404.1 and UKLA Technical Note 403.2, will continue, with the possible requirement for shareholder approval if the benefit to the investment manager of any change is uncapped or unquantifiable.

Timetable and the draft CEIF rules

Note that, unlike for commercial companies, the new regime for CEIFs is not yet reflected in detailed draft rules. The devil may of course be in the detail!

The proposed rules for CEIFs to be contained in the UKLR will be published during the first quarter of 2024. We know that UKLR 11 will be the UKLR's chapter dedicated to CEIFs, replacing the current Chapter 15 of the Listing Rules, but UKLR 11 is currently empty.

The FCA is working to an accelerated reform timetable and expects the new regime to go live early in the second half of 2024. The current consultation period will close on 22 March 2024, but we anticipate a further consultation period once the rules relating to CEIFs are published. The FCA aims to publish its policy position and the final UKLR at the start of the second half of 2024, with two weeks between publication of the final rules and implementation.

Additional points to note for CEIFs

Board independence

In order to enable new applicants to have a wide pool of experienced directors from whom to choose, the UKLR will clarify that, notwithstanding an appointment to the board of more than one CEIF that has engaged the same independent alternative investment fund manager (AIFM), a director can be considered independent where the AIFM is independent of the CEIF's investment manager.

This expressly acknowledges the growing number of CEIFs (and investment managers launching new CEIFs) which choose to outsource the AIFM role to an independent third party, and is a welcome development.

C Shares

Where a new class of shares is issued by a CEIF that is ultimately intended to convert into an existing class of shares (C Shares), under UKLR such C Shares will be listed in one of two categories based on the voting rights attaching to the C Shares. If the C Shares carry voting rights prior to conversion, they will be listed in the CEIFs category (being the equivalent to the current Chapter 15 of the Listing Rules). If the C Shares do not carry voting rights, they will be listed in a new "non-equity and non-voting equity shares" category which will be based on the continuing obligations contained in Chapter 14 of the Listing Rules.

Implementation arrangements

As part of the implementation of the new regime, the FCA will map existing issuers' current listings to the appropriate new categories once the new regime goes live. This means that existing CEIFs will be automatically mapped to the new CEIFs category.

The FCA is proposing to apply the new transactions requirements and related sponsor services with immediate effect from the day on which the UKLR takes effect.

There will be transitional arrangements for in-flight listing applications and mid-flight transactions.

1. See https://www.dentons.com/en/insights/articles/2024/january/4/the-uk-listing-regime-the-fcas-detailed-proposals-for-reform for more information on the changes affecting commercial companies.↩