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A new chapter for UK Exchange Traded Funds

  • United Kingdom
  • Capital market law
  • Financial services and markets regulation
  • Investment funds and asset management

26-02-2021

FCA publishes revised rules for a more proportionate listing regime

While the Financial Times reports trading in Exchange Traded Funds (“ETFs”) is surging across European stock exchanges, the UK ETF market has never really taken off, so the recent publication by the Financial Conduct Authority (“FCA”) of more proportionate Listing Rules for open-ended investment companies (“OEICs”) could be a welcome change.

The FCA began reviewing the effectiveness of UK primary markets in 2017, when it published its Discussion Paper DP17/2 “Review of the Effectiveness of Primary Markets: The UK Primary Markets Landscape”. A question which arose from DP17/2 was whether the requirement for OEICs to take a premium listing on UK markets was unnecessary and excessive. The responses to DP17/2 indicated limited rationale for premium listing of OEICs and that standard listing would be more appropriate for these investment companies. Accordingly, the FCA committed to producing a revised set of listing rules disapplying or amending requirements that were disproportionate, not relevant or inoperable for OEICs because they did not take into account unique features of the OEIC model. The proposal was set out in Consultation Paper CP20/5 “Open-ended Investment Companies – Proposals for a more proportionate Listing regime” and mentioned in the FCA’s 2019/2020 Business Plan.

On 28 January 2021, the FCA published FCA 2021/3 Listing Rules (Open-ended Investment Companies) Instrument 2021 setting out a new standard listing regime for OEICs, which will come into force on 4 January 2022.

What is the current regime under Chapter 16 of the Listing Rules?

Currently OEICs must comply with the premium listing requirements in Chapter 16 of the Listing Rules (“LR16”) in order to list on a public stock exchange in the UK. In addition, OEICs are subject to certain of the ongoing obligations for all premium listed companies set out in Chapter 9 of the Listing Rules (“LR9”).

In order to operate a listed OEIC (which is the form most European ETFs take) the first step is to prepare FCA-approved listing particulars relating to the issuer and its securities. These particulars are similar yet additional to a standard fund prospectus, creating duplication of work from the outset.

The premium listing obligations that apply under LR16 and LR9 include:

  • the investment company must at all times exercise operational control over its main business activity. This requirement is potentially inoperable for an OEIC since its main activity involves investing into other businesses over which it does not have operational control
  • the related parties rules place significant transparency and governance requirements on issuers to prevent any related party transactions causing detriment to shareholders. These rules place an additional layer of regulation on top of the conflicts of interests requirements already applicable to investment managers of FCA authorised OEICs
  • LR16 is subject to additional obligations in relation to share issuance transactions set out primarily in LR9.5. These rules address shareholder concerns about dilution resulting from further share issuances. While these rules are relevant to commercial companies and closed-ended funds, they impose unnecessary burdens on OEICs for which such concerns are not relevant due to their variable share capital
  • under LR16, shareholder approval is required for various transactions or corporate actions, including related party transactions and further share issuances. This requirement poses particular issues for OEICs, since voting at general meetings is an uncommon and inefficient way for shareholders to interact with issuers
  • LR9.8 requires premium listed companies to meet a number of disclosure requirements, including by disclosing names of major shareholders, which can be quite difficult for OEICs given their variable share capital
  • issuers with a premium listing, including OEICs, must state how they have applied the Principles of the UK Corporate Governance Code (the “Code”). The Code has not been designed for OEICs, which are already required to follow prescriptive rules in applicable funds regulation, and therefore contains provisions that are not appropriate or relevant to OEICs, including for example rules on the composition of the board

Why are these changes necessary?

Many of the premium listing requirements in LR16 are incompatible with the OEIC model and the UK financial services regulatory landscape. The FCA’s finding in CP20/5 was that the rules needed to be revised to disapply or amend existing requirements that were (i) disproportionate because they prescribed obligations already present in the fund regimes under which OEICs are authorised or (ii) irrelevant or inoperable for OEICs because they did not take account of the features of an OEIC’s business model or structure.

Historically, the main reason for having a listing under the premium listing regime was the belief that the enhanced transparency and credibility of a premium listed company would appeal to investors. When applied to OEICs, however, these additional safeguards and disclosure requirements do not add any appreciable value for investors, given the rigorous regulation to which FCA authorised OEICs are already subject. Over time, both the FCA and the wider funds industry have come to realise that a premium listing is not necessary to boost investor confidence and credibility in relation to OEICs. This can be contrasted with the position in relation to closed-ended funds.  Funds admitted to trading on the Specialist Fund Segment (“SFS”) of the main market of the London Stock Exchange typically “opt-up” to comply with the majority of the premium listing requirements to improve their marketability with investors. Such funds aren’t, of course, directly regulated by the FCA and therefore their position is quite different to that of OEICs. The FCA has found that the main source of investor confidence in OEIC ETFs is fund regulation and not additional Listing Rule requirements.  

The difficulties and costs of the premium listing regime have acted as barriers to the establishment of ETFs in the UK. In CP20/5 the FCA noted that there were only eleven OEICs listed under the premium listing regime. More recently, HM Treasury (“HMT”) commented in their “Review of the UK funds regime: A call for input” that very few ETFs have ever been located in the UK and that firms have consistently chosen to set up their ETFs in other jurisdictions. See our client briefing “HM Treasury’s Review of the UK funds regime: a call for input”.

Traditional active managers across Europe face increasing competition from ETF providers, as ETFs continue to grow in popularity. On-exchange ETF volumes in Europe rose 46 per cent in 2020, mirroring trends already seen in the US, where the ETF market is highly developed. As investors become more comfortable with trading on-exchange, they are starting to see the benefits of ETFs, which can include lower fees and greater diversification. With the UK still behind the curve on this, as noted by the FCA and HMT, demand is likely outweighing the supply of UK established ETFs. The relaxation of the listing regime will create a much better environment for asset managers to launch innovative products and take advantage of the growing demand for ETFs. Should firms seize the opportunities presented by these new rules, the UK’s reputation as a desirable jurisdiction for the establishment of ETFs could skyrocket and allow the UK to catch up to what is already happening across global markets.

A standard listing regime for OEICs is therefore intended to assist the establishment of ETFs in the UK. A key driver for this long-awaited change is the hope that the new rules will play to the strengths of the UK’s legal and regulatory systems and enhance the UK’s attractiveness for funds sold in high-growth international markets. This is in line with the current direction of the UK funds industry and HMT’s objective of making the UK “a more attractive location to set up, manage and administer funds, which will support a wider range of more efficient investments better suited to investors’ needs”.

Stamp tax treatment of UK ETFs

Stamp tax issues were historically a major driver for forming ETFs outside the UK, generally in Ireland, even when they were to be listed on the London Stock Exchange.  This was because their purchase on CREST gave rise to stamp duty reserve tax (SDRT) at 0.5% in the same was as for purchases of regular UK equities.  In fact the government removed the SDRT liability on the transfer of and agreement to purchase UK-incorporated ETFs in 2014 but by then it had become the norm to incorporate them in Ireland.

What will the new Listing Rule chapter look like?

CP20/5 proposed OEICs should be listed in the standard listing segment of a stock exchange and the final rules published on 28 January 2021 are largely identical to those proposed in CP20/5, save for effective date of the changes.

The following changes were made under the Listing Rules (Open-Ended Investment Companies) Instrument 2021:

  • disapplication of all premium listing requirements for OEICs, including
    • the operational control rule
    • related party transactions rules and the requirement for issuers to provide a statement that such transactions are fair and reasonable
    • governance and transparency obligations in relation to share issuances
    • certain Listing Rules requiring OEICs to obtain prior shareholder approvals, however note the issuer must still give 20 business days' notice of cancellation of any intention to cancel the listing of a sub-fund or to transfer to a different listing category
    • the requirement to notify via a Regulated Information Service any single person or entity holding more than 10% of the issued shares in any class
    • the requirement to include information in the annual report duplicative of requirements under other regulation applicable to OEICs
    • the obligation to disclose how an OEIC has applied or departed from the Code
  • relabelling of the listing segment for OEICs as a standard listing
  • introduction of a standard listing regime for OEICs under new chapter LR16A
  • removal of the obligation on an OEIC to appoint an FCA-approved sponsor
  • streamlining the listing application process for OEICs
  • removal of the requirement for OEICs to publish FCA-approved listing particulars

Under LR16A OEICs will continue to be subject to the overarching Listing Principles set out in LR7.2.1R, which require OEICs to:

  • take reasonable steps to establish and maintain adequate procedures, systems and controls to enable it to comply with its obligations
  • deal with the FCA in an open and co-operative manner

Effective date of the new rules

The FCA initially suggested a three-month transition period from publication of the new rules to their effective date. In the end, however, the rules will be coming into force on 4 January 2022, just under a year after their publication. The motivation for this delay was concern over automatic reclassification of ETFs currently listed under premium segments.  Issuers need time to engage with other jurisdictions where these ETFs are listed since in many cases holding a UK premium listing was made a condition for listing in those jurisdictions. The extension of the transition period will give affected firms a better chance to retain overseas listings despite the move to the new standard listing regime.

How Eversheds Sutherland can help

If you have any questions about the transition period or the risk of funds being de-listed by overseas exchanges, or you are interested in exploring opportunities under the new listing regime for ETFs, please get in touch. Eversheds Sutherland’s market-leading retail funds and closed-ended funds teams have in depth knowledge and unrivalled breadth of experience in launching OEICs and closed-ended alternative investment funds on the SFS and the premium segment of the FCA’s Official List. Our understanding of the sector and experience with the practical implementation of new governance arrangements makes us very well placed to advise you on product launches under the new regime.