Listing private equity funds

This week’s news that Kohlberg Kravis Roberts (KKR) is seeking to float a $1.5 billion private equity feeder fund on Euronext, the Amsterdam-based stock exchange, is a timely reminder that listed funds have their place in the panoply of vehicles available to promoters. Certainly, publicly quoted funds can raise commercial and tax issues but – for some – their evergreen status (allowing the

The significant benefits of alternative models for private funds hold true, but many funds will continue to find the additional source of capital tempting. Simon Witney, SJ Berwin

proceeds of realisations to be re-invested), and the opportunity to unlock new categories of investor, outweigh those downsides.  KKR is certainly not the first – 3i, Apax, Candover and Permira, to name a few of many, already access the public markets to varying degrees.

But the news is timely because last month the UK’s Financial Services Authority (FSA) published (for consultation) the results of a review of the London Stock Exchange’s (LSE) rules on investment entities, which could encourage more funds to seek a listing on Europe’s most important stock market. 

At the moment there are five separate regimes for funds listing on London’s main market (different rules apply for AIM, the UK’s secondary exchange).  The FSA wants to replace them with a single set of over-arching principles that would govern all “investment entities”, including Venture Capital Trusts, Investment Trusts, property-based investment companies and (from next year) Real Estate Investment Trusts (REITs).  Indeed, in part, the review has been sparked by the introduction of REITs in Britain – it is a requirement of the tax rules that a REIT should be a listed vehicle, and the LSE’s existing rules would have subjected REITs to a number of inappropriate investment restrictions.

The most important proposed change is that managers of listed vehicles would be free to determine for themselves how the fundamental criterion of “spreading investment risk” should be met, rather than being required to follow prescriptive and mechanistic rules on portfolio diversification (for example, the current rule that no more than 20% of a fund can be invested in any single investment will be abolished).  This is consistent with the “principles-based” approach to regulation that the FSA has adopted in recent years, and which ran through its fundamental review of the LSE’s rules last year.  To protect investors, each listed fund will have to maintain a public statement making clear how it will achieve a spread of risk – taking into account asset allocation, risk diversification and gearing – and to report to investors annually on how its strategy is achieving this in practice.

Another key proposal that will be relevant to the venture capital and private equity world is removal of the requirement that a listed fund has to be a “passive” investor.  That rule has created problems for venture funds in the past, and has always looked rather odd.  Its removal would be welcome, although there may still be some push back on the terms of the replacement requirement: that the fund “may provide strategic advice and may have representatives on the boards of companies in which it invests, provided it does not take board control or become actively involved in the day to day management of those businesses”.  For some funds, that would still be unduly restrictive.

A range of interested groups are studying the proposals (which – importantly – will not change the requirements that each type of fund has to satisfy in order to qualify for a particular tax treatment), and will make comments on them before the 30 June deadline set by the FSA.  But (for the most part) the proposals are sensible, and should pave the way for more listed funds on the London market.  Whether that will encourage more private equity managers to list funds or feeder funds remains to be seen:  the significant benefits of alternative models for private funds hold true, but many funds will continue to find the additional source of capital tempting.

Simon Witney is a partner at SJ Berwin, a pan-European law firm with a specialisation in private equity. Further information on the firm is available at www.sjberwin.com.