Professional Investor Funds could fill the UK fund sector gap
The UK has an unfortunate gap in its fund offering compared with many other jurisdictions. It does not have — but in this author's view needs — a closed-ended or hybrid solution for pension funds and other institutional investors to hold UK real estate investments. Ideally, such a fund should be unlisted, tax-transparent and offer tradable units.
Fund managers are limited to alternative fund choices, which have drawbacks:
- Open-ended authorised fund structures — these must comply with regulatory operational requirements that erode returns and maybe inappropriate for holding less liquid assets.
- Offshore alternatives — these face the challenges of (and costs associated with) multiple legal, tax and regulatory regimes, including maintenance of sufficient offshore substance
Review of UK funds regime
February 2022 saw the publication of HM Treasury's policy paper on the review of the UK funds regime, in which it set out responses and a series of next steps.
Publication follows a January 2021 call for input on the UK funds regime, which aimed to identify options that will make the UK a more attractive location to set up, manage and administer funds, and which will support a wider range of more efficient investments better suited to investors' needs.
The policy paper confirms that the government is proposing to take forward further work to explore options for the introduction of a new unauthorised contractual scheme fund structure (known as the professional investor fund (PIF)). The policy paper also explains:
- The government has already taken forward as part of the review:
- a new tax regime for qualifying asset holding companies (QAHCs) in certain fund structures
- facilitating the introduction of the long-term asset fund (LTAF) structure.
- It is not, however, proceeding with proposals relating to unauthorised limited partnerships and unauthorised corporate structures in the short term. These are unlikely to be commercially attractive.
- The responses to the call for input are persuasive that the PIF will strengthen the UK's fund offering. It has the potential to lower the barriers for SME asset managers to launch new products, to increase the number of unauthorised closed-ended investment vehicles domiciled in the UK and to support the government's work to promote investment in longer-term, less liquid assets. The government also notes that professional investors have highlighted the value of the option for an onshore structure.
- The government recognises that reference to the "UK" and "professional" would provide clarity on the fund offering.
- The government and the Financial Conduct Authority (FCA) are not of the view that there is a good case for introducing a light-touch form of authorisation for new unauthorised fund structures.
- It is expected that the tax rules for a PIF will largely replicate the tax rules for co-ownership authorised contractual schemes (CoACS).
The PIF explained
The PIF is supported by the Association of Real Estate Funds (AREF), as well as the UK funds regime working group (UKFRWG), the Alternative Investment Management Association (AIMA), the European Association for Investors in Non-Listed Real Estate Vehicles (INREV) and the Investment Property Forum (IPF). As a conduit for institutional productive capital, the PIF can facilitate the government's goals for "levelling up" the nation (that is, by supporting jobs outside of London).
Real estate, and its funds sector, have much to contribute, for example, by attracting capital and reinvigorating town centres, supporting social and affordable housing and accelerating the UK's green industrial revolution. Other sectors could also utilise the PIF, given it is designed to be unconstrained in terms of eligible asset classes and investment strategies. In addition, the PIF will complement the QAHC and LTAF reforms that the government has already taken forward.
The PIF proposal could be implemented via secondary legislation that amends the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO) and by FCA consultation. There is no need for primary legislation.
The PIF is modelled on existing authorised contractual scheme (ACS) legislation, but is not open-ended. For regulatory purposes, it will be classified as a UK alternative investment fund (AIF) and benefit from the flexibilities of an unregulated collective investment scheme
It is envisaged that the PIF will be formalised by deed, initially made between a PIF's alternative investment fund manager (AIFM) and
depositary. On admission, investors in a PIF will become parties to the PIF deed. The AIFM will make decisions on behalf of the PIF investors about the acquisition, management and disposal of assets, as well as risk management, subject to provisions within the PIF deed, and those decisions will be binding on PIF investors.
Other features include:
- Investor status — the PIF will be restricted to professional institutional investors that commit at least £1 million, while other investors can only gain access through feeder funds that satisfy the professional institutional investor status.
- Registration — the PIF will be established and registered at a registry similar to that which applies in the case of an English limited partnership. This is a solution that means there is no need for prior application to, or approval from, the FCA.
- Segregation — the PIF will operate with protected-cell sub-funds, providing a legally enforceable segregation of the assets and liabilities of each sub-fund. PIF managers will be able to operate a broad range of funds more efficiently. The sub-funds (or cells) are separately managed, charged, accounted for and assessed for tax, but do not have a separate legal personality.
The PIF will adopt the CoACS framework, which is, in effect, tax-transparent, with tax liability applying to investors as follows:
- Income and capital gains — Income will be taxed on the share attributable to each investor, and capital gains will be taxed on each investor disposing its PIF units (but not on gains realised at the PIF portfolio level).
- Stamp duty — Stamp duty is also modelled on the CoACS. For example, in the case of CoACS (and property authorised investment funds (PAIFs)), stamp duty land tax (SDLT) seeding relief will apply to the PIF. This will assist in launching new PIF projects with a similar clawback mechanism as applies for CoACS and PAIFs to limit the scope for tax avoidance. In addition, it is proposed that no transaction tax, including SDLT, will apply on the transfer of units in a PIF to be competitive with equivalent non-UK fund structures.
The government is, helpfully, keen to address this gap in the UK's fund offering, and in particular to improve the prospects for future generations of real estate fund and SME asset managers.
Written by Melville Rodrigues, Head of Real Estate Advisory.
Published on Thomson Reuters Practical Law Financial Services.