Author Richard Sheen
Turning first to the listed fund sector, 2016 was a slower year for fundraising than previous years with only around five IPOs. The year did finish on a high note and December was the strongest month for issuance in the year with approximately £1.1 billion raised. However, a mood of uncertainty has continued into the first few months of 2017. The unresolved shape of Brexit (see below) and the prospects for political shocks in both the US and the Eurozone continue to influence investor sentiment. Investors in the sector continue to demonstrate appetite for income, which has been most readily found through investment in funds focussed on alternative and illiquid asset classes such as property, infrastructure and debt.
In the year to date, there have not been many announced fundraisings for listed closed-ended funds. A good example of the type of product that has demonstrated traction over the past few years is the proposed IPO of Impact Healthcare REIT plc which is seeking up to £200 million to invest in healthcare real estate assets and which was announced on March 7. This fund, in common with many other launches in the current environment is focussed on quarterly income distributions with an initial target annual yield of six per cent. Also instructive is the fact that the fund is being launched with a seed portfolio of existing residential care homes – a common concern for investors on fund IPOs is the ability to secure investments and the timing of the ramp-up period. Other recent IPO announcements include BioPharma Credit PLC, which will invest in debt in the life science industry and is again a predominantly income focussed vehicle.
The fund raising market for private funds remains significantly fragmented. While substantial established managers, and those with niche propositions for which there is investor appetite, have little difficulty in raising funds, smaller managers often continue to experience difficulty in attracting capital. Global macro-economic uncertainty feeding into asset price volatility has also slowed both investor demand for certain asset classes as well as deployment by managers of what is reported in some sectors as a record amount of uncalled capital. However, there remains strong demand for alternative assets exposure generally; with debt remaining particularly popular. However, managers of more traditional asset classes such as private equity are also reporting strong investor interest.
As regards Brexit, planning with certain asset managers is well advanced in some cases based on the "worst case" assumption of a clean break with Europe and loss passporting rights. Other managers are taking a wait and see approach depending on how the negotiations between the UK and the EU pan out over the next year or so. As has been previously discussed in this column, the impact of Brexit is likely to be very different depending on the type and size of the asset manager, the scale of its activities, current distribution model and geographical spread. A recent European Capital Markets Institute policy brief outlines four major risks to the industry: loss of the passport, potential constraints on outsourcing of core activities to third countries, the limitations on management of EU assets and the impact upon financial infrastructure (including staffing).
Brexit aside, the impact of regulatory change on the industry continues to be a significant concern for managers including as to the impact of changes such as MiFID II as well as the potential fall-out from the FCA’s Asset Management Market Study. Navigating these regulatory challenges must also be seen in the context of the economic pressures on the industry including fee pressure and cost increases which are affecting the asset manager business model. The last couple of weeks have seen a number of potential asset manager mergers announced, including Standard Life’s all share £3.8 billion possible offer for Aberdeen Asset Management. Rationalisation and synergies appear to be a key motivation behind this deal and analysts have pointed to the need for active managers to achieve greater scale to mitigate the impact of regulatory and compliance costs and to compete more effectively on price. That said, in the wider context active managers are under sustained threat from the large passive fund managers whose cost base is typically materially lower. March also saw the agreement to sell Allfunds Bank, one of the largest European fund platforms to US private equity firm, Hellman & Friedman.
Speculation exists as to further deals in the sector on the back of the proposed Aberdeen transaction and other recent tie ups including Janus and Henderson, particularly in the mid-sized asset manager sector (the so called "squeezed middle"), lacking the economies of scale of larger managers. Candriam Investors (formerly Dexia Asset Management) has announced a strategy of targeting illiquid fund managers including private equity, real estate and infrastructure. Wealth manager, Julius Baer has announced that it will consider an acquisition in the UK potentially driven by opportunities created by Brexit.
Corporate tax – extending substantial shareholdings exemption, but restricting relief for funding costs and losses
Author: Andrew Roycroft
Points arising from the changes to SSE and the interest/loss caps which will be of potential interest to investee companies.
In recent years, UK Governments of various political complexions have used changes to corporate taxation as a tool to attract inbound investment. This is reflected in exemptions from tax for gains on substantial shareholdings in trading companies, for dividends from overseas companies and for overseas branch profits, as well as successive reductions in the rate of corporation tax.
This policy seems set to continue in the face of a continuing uncertainty about the UK’s economic outlook, with what was a relatively low-key Budget confirming changes proposed in the Autumn Statement to the UK’s participation exemption for substantial shareholdings in trading companies. The changes will extend the availability of that exemption.
Details of the proposed changes to this exemption were published in December. Currently, the selling company must be part of a trading group. This requirement has proved difficult to apply in practice, primarily because of the uncertainty which it creates for trading groups which have mixed activities (trading and investments) or complicated group structures. This will be removed; the seller need not be part of a trading group.
Amongst other relaxations to the conditions for this exemption is a change which is potentially beneficial for UK-based asset managers acting for tax exempt investors, regardless of where the underlying asset is located. This change removes, for certain shareholders, the requirement that the investee company be a trading company.
This only applies to UK corporate shareholders – for example, a UK intermediate holding company – which is owned by "Qualifying Institutional Investors"; full exemption is available if QIIs own at least 80 per cent of the UK corporate shareholder, with a proportionate exemption for companies whose QIIs own between 25 per cent and 80 per cent. In addition to removing the trading company requirement, the 10 per cent minimum shareholding requirement need not be met provided the initial investment was at least £50 million. The reason for this relaxation is to encourage the use – or at least remove one of the disadvantages of using – UK companies by otherwise tax-exempt investors as a holding vehicle for their investments in non-trading assets, particularly infrastructure and real estate assets. This is reflected in the limited category of QIIs, which is currently restricted to certain pension schemes, life assurance companies, sovereign wealth funds, charities, investment trusts and widely marketed UK investment schemes. As yet, REITS are not included in the class of QIIs.
All these changes take effect for disposals after March 31, 2017, and so will have retroactive effect – potentially allowing the exemption to apply to a disposal of an investee company where there might have previously been doubt (for example, because of the old ‘member of a trading group’ requirement) as to the availability of the exemption.
Despite the economic uncertainty of a post-Brexit Britain, the UK Government is also proceeding with the caps on both the use of carried forward tax losses and on corporation tax relief for interest expense/other funding costs. Although the former might be seen as an acceptable cost for the greater freedom to use post-April 2017 losses against all forms of income, it is questionable why the UK Government needs to proceed at such speed with the interest cap whilst other countries are taking a more measured approach to this aspect of the OECD’s BEPS (Base Erosion and Profit Shifting) recommendations. There are genuine, and significant, concerns with the interest cap, which can also be levelled to a lesser degree at the carried forward loss cap, about the complexity of the legislation. The draft legislation was released in stages, with some parts still incomplete or defective; for example, the initial draft prevented entirely UK groups from utilising any carrying forward disallowed interest expense. This is far from ideal for managers seeking to model the impact of the changes on the post-tax return for investments, particularly long-term projects.