Collective Investment Schemes

Unit trust and similar schemes remain important investment vehicles in the UK and abroad. The essence of such schemes is that they provide for the collective holding, management and investment of a pool of assets from which the earnings or gains on disposition are shared. These attributes are reflected in the definition of a collective investment scheme set out in the Act, s 235(1). Whilst such schemes may either be constituted in an unincorporated or incorporated form, the distinct characteristic of UK schemes has been that they have traditionally been based on the concept of trust. This provides for the collective holding of the property concerned as well as determining the general rights and liabilities of the parties concerned.

The principal advantages of unit trusts and similar schemes are that they allow the unit holder to share in the gains derived from the holding of a portfolio of shares, commodities or other assets but without the need to have any investment management experience or to be involved in the management of the fund as such.

The use of professional managers will allow the portfolio to be better managed while a separate trustee will act as a custodian and generally protect the interests of the unit holders. The authorisation of schemes will also ensure that they are subject to proper regulation with restrictions being imposed on the promotion of unregulated schemes to the general public. Managers are subject to various requirements concerning the assets in which trust funds may be placed depending upon the nature of the particular scheme. Borrowing or gearing is generally prohibited or, at least, subject to strict control. Tax advantages are also available such as with regard to the capital gains treatment of authorised unit trust schemes. Over 1,250 unit trust schemes are currently authorised in the UK with assets under management of over £400 billion.

The provisions set out in the Act apply to collective investment schemes as defined in s 235(1), subject to exemptions made by Treasury regulations. The Act will then cover such schemes as authorised unit trusts, OEICs and recognised schemes as well as certain unregulated schemes. Unregulated schemes may, for example, include unauthorised unit trusts or unauthorised OEICs or such other collective holding arrangements as bloodstock syndicates, limited partnerships or certain other pooling arrangements. The provisions will not apply to investment trust companies which are incorporated under the Companies Act and governed by that Act and the separate provisions in the Act concerning the issuance of listed and unlisted securities. An OEIC falls within the definition of a collective investment scheme and is to be governed by Treasury regulations made under Chapter IV of Part XVII of the Act and FSA rules made under those regulations. Schemes not covered will include life assurance schemes, partnerships and other forms of business association and other forms of parallel management which do not provide for the pooling of assets and gains.

Part XVII of the Act is in six Chapters. Chapter I contains relevant definitions and gives the Treasury power to exclude by order certain arrangements from being collective investment schemes. Chapter II prohibits authorised persons from promoting participation in a collective investment scheme unless an exemption applies. Authorised unit trust schemes, authorised OEICs and recognised schemes are exempt. Chapter III sets out the procedures and general rules to apply to the authorisation of unit trust schemes. Chapter IV gives the Treasury power to issue regulations in connection with OEICs. While this generally continues the earlier provisions, it also allows regulations to be issued concerning the establishment and regulation of new forms of OEICs in the UK which goes beyond the UCITS Directive of 1985 (see below). Chapter V provides for the recognition of overseas schemes. This generally includes schemes authorised in other EEA States, designated territories or other individually recognised countries. Powers of investigation are set out in Chapter VI in connection with authorised unit trusts and overseas schemes. Equivalent provision in connection with OEICs are set out in the Treasury regulations.

The purpose of this paper is to note the origins of English unit trusts and early forms of legal control. The provisions set out in the FSA 1986 are also referred to as well as the rights to cross-border marketing set out in the UCITS Directive within Europe. The main provisions contained in Part XVII of the Act are then considered in further detail, especially with regard to authorised unit trusts, open-ended investment schemes and recognised schemes.

Origins and Development

Early Controls

UCITS

The Directive applies to undertakings the sole object of which is the collective investment in transferable securities or capital raised from the public and which operate on the principle of risk spreading and the units of which may be repurchased or redeemed out of the undertakings’ assets at the request of holders. Action taken by a UCITS to ensure that the stock exchange value of its units does not significantly vary from their net asset value is to be regarded as equivalent to such repurchase or redemption. Excluded from the definition are close-ended schemes, schemes which raise capital without promotion of units to the general public or only to the public in non-member states, and certain other schemes in which the investment and borrowing powers are considered inappropriate.

All UCITS must be authorised by relevant competent authorities in a member state. This requires the approval of the manager, depository or trustee and the fund’s rules. The trustee is responsible for ensuring that the sale, issue, repurchase, redemption and cancellation of units by the management company take place within the law and the fund rules. The trustee must also ensure that valuations are carried out in accordance with the law and fund rules, observe the instructions of the manager (provided that these do not conflict with the law or fund rules), ensure that transaction consideration is remitted within the usual time and that the scheme’s income is properly allocated. The manager and the trustee must, in particular, act independently of each other and comply with the other conditions contained in the Directive.

The Directive sets out certain general principles in connection with the investment policies to be pursued by the UCITS. The types of property into which funds may be placed are specified and restrictions placed on the amounts of any individual investment to spread risk. Investments must generally be made in transferable securities although a certain portion of the assets may be made up of debt instruments or units in other UCITS. A scheme may be permitted to borrow up to ten per cent of the value of the fund.

The Directive provides for the regular publication of information to unit holders including a prospectus and an annual and half-yearly report by the managers. These must comply with requirements set out in schedule A and B to the Directive.

Whilst the pricing of units is left to be determined within each member state, it must reflect the underlying value of the assets held within the scheme less relevant charges or costs. The dealing prices of units must be regularly published.

Schemes which are authorised in accordance with the terms of the Directive may be marketed in other member states. This is subject to a two-month notification requirement only, accompanied by certain specified information. The host member state may otherwise apply rules only if justified by the general good. This may include more detailed advertising requirements. General provisions in connection with the revocation of authorisation are also set out in the Directive with procedures for authorities to act in cooperation in connection with breaches of relevant provisions.

The provisions set out in the Directive were reflected in the earlier regulations issued under the FSA (or the SIB as it earlier was). These will now be reissued under the Act. These include The Financial Services (Regulated Schemes) Regulations 1991 (originally made under FSA 1986) and the Financial Services (Open-ended Investment Companies) Regulations 1997 (under the Open-ended Investment Companies (Investment Companies with Variable Capital) Regulations 1996 (SI 1996/2827)).

Collective Investment Schemes

The essence is accordingly shared profit or income through collective investment. By s 235(2), persons who participate must not have any day-to-day control over the management of the property (although this does not exclude the right to be consulted or provide directions). The arrangements must specifically involve the pooling of contributions (and profits or income) and the central management of property by or on behalf of the operator of the scheme (s 235(3)). Where pooling may take place in connection with separate parts of the property, the arrangements will only constitute a single collective investment scheme if the participants are entitled to exchange or switch between the parts (s 235(4)).

The Treasury may by order provide that certain arrangements do not constitute a collective investment scheme either in specified circumstances or within particular categories of arrangement (s 235(5)). These exceptions were formerly contained in FSA 1986, s 75(5) to (7). They include parallel management arrangements, schemes not operated by way of business or not as an investment business as well as corporate group arrangements, employee share schemes, deposit-taking business, franchise agreements, timeshare-type agreements, contracts of insurance and occupational pension schemes.

A unit trust is a collective investment scheme under which the property is held in trust for the participants (s 237(1)). An authorised unit trust scheme is a unit trust scheme which is authorised for the purposes of the Act by virtue of an authorisation order issued under s 243 (s 237(3)).

An open-ended investment company (OEIC) is a collective investment scheme which satisfies both a property and an investment condition (s 236(1)). The property must belong beneficially to and be managed by or on behalf of a body corporate for the purpose of spreading investment risk and distributing the results of the management of the funds. Under the investment condition, a reasonable investor must expect to be able to realise within a reasonable period his investment (represented by the value of the shares or securities held in the scheme) on a basis calculated wholly or mainly by reference to the value of property in respect of which the scheme makes arrangements. This is without regard to any actual or potential redemption or repurchase of shares under company law in the UK or elsewhere within the EEA. This amends the earlier definition which only referred to the rights of participants being represented by shares in or securities in the company which may either be redeemed or repurchased or sold on an investment exchange at a price related to the value of the underlying property held. An authorised open-ended investment company means a body set up and authorised in accordance with regulations issued under s 262 (s 237(3)).

A recognised scheme is a scheme recognised under the provisions governing the recognition of other EEA schemes, schemes authorised in designated countries or territories or other individually recognised schemes (s 237(3)). Units means the rights or interests (however described) of the participants in the scheme (s 237(2)).

The trustee is the person holding the property on trust for the participants and the operator is either the manager of a unit trust scheme with a separate trustee or the company if the scheme is an OEIC (s 237(2)). Depository means any person to whom the property subject to the scheme is entrusted for safekeeping.

Restrictions on Promotion

The Treasury may specify circumstances in which the general prohibition is not to apply (s 238(6)) and have further power in s 239(1) to exempt single property schemes by regulation. Single property schemes are defined in s 239(3)(a) as schemes involving the management of specific buildings or groups of adjacent or contiguous buildings managed as a single enterprise with or without ancillary land or furniture, fittings and contents. In order to be exempted, the scheme units must also be dealt in on a recognised investment exchange (s 239(3)(b)). If exemption regulations are issued in connection with single property schemes, the FSA may issue rules imposing duties on the operator and trustee or depository (s 239(4)).

An authorised person may not approve a financial promotion if he would not be entitled to issue it directly under the general prohibition on the promotion of collective investment schemes (s 240(1)). An authorised person may be liable to private persons in damages following breach of the general restriction on promotion or restriction on approval of promotion (s 241).

Authorised Unit Trust Schemes

Authorisation

An authorisation order may be issued by the FSA if the scheme complies with the requirements as set out in the Act (s 243(1)(a)). The scheme must comply with the trust scheme rules which are to be made by the FSA (ss 243(1)(b) and 247) and a copy of the trust deed and solicitor’s certificate confirming compliance with the relevant requirements must also be provided (s 243(1)(c)). The manager and the trustee must be independent of each other (s 243(4)) and be bodies incorporated in the UK or another EEA State with a place of business in the UK (s 243(5)). They must be authorised persons with permission to manage or to act as a trustee as appropriate (s 243(7)). The name of the scheme must not be undesirable or misleading (s 243(8)). The scheme’s purposes must be reasonably capable of being successfully carried into effect (s 243(9)) and participants entitled to have the units redeemed at a price related to the net value of the property determined in accordance with the scheme rules (s 143(10)).

Applications must be considered within six months of receipt of the application (s 144(1)). If an application is to be refused, written notice must be given to the applicants (s 245(1)). If the application is refused, a decision notice must be issued with either applicant being able to refer the matter to the Financial Services and Markets Tribunal (s 245(2)). Under the previous legislation, there was no right of appeal to a tribunal and the only recourse was by way of judicial review.

A separate certificate of EEA compliance may also be issued by the FSA on request (s 246(1)). The request may either be made at the time of the original application or subsequently (s 246(2)). This will entitle UCITS compliant schemes to be marketed in all other European jurisdictions.

Trust Scheme Rules

Auditors may be disqualified by the FSA from auditing authorised unit trust schemes or authorised OEICs if the auditor has breached the terms of the trust scheme rules (s 249(1)). The FSA must follow the warning and decision notice procedure provided for in the Act (s 249(2)).

Scheme Particulars Rules

The FSA may modify or waive the application of any of the trust scheme rules or scheme particulars rules in connection with the particular scheme (s 250(1), (2) and (3)). The general rules with regard to modification or waiver of rules contained in s 148 will apply subject to certain amendments set out in s 250(4) and (5).

Alterations

Exclusion Clauses

Revocation

1. if one or more of the requirements for the making of the authorisation order are no longer satisfied;

2. if the manager or trustee of the scheme has breached a requirement set out in the Act;

3. if the manager or trustee has knowingly or recklessly given the FSA false or misleading information in any material particulars;

4. if no regulated activity has been carried on for more than 12 months; or

5. it is otherwise desirable to protect the interests of participants or potential participants.

If the FSA proposes to issue a revoking order, separate notice must be given to the manager and trustee which may be referred to the Financial Services and Markets Tribunal by either the manager or the trustee (s 255(1)). A decision notice must be issued where the FSA decides not to make a revoking order having issued a warning notice (s 255(2)).

Requests for revocation may also be made by the manager or trustee although this may be refused where matters have arisen which may require investigation or where revocation would not be in the interests of participants or would breach Community obligations (s 256(1) and (3)).

Intervention

Separate procedures apply to the giving and varying of directions on the FSA’s own initiative (s 259), refusals to revoke or vary (s 260) and notification of revocations and requested variations (s 261). Supervisory notices must be given to the manager or trustee setting out the terms of a proposed direction or, if the FSA considers it necessary for the direction to take effect immediately, the actual direction (s 259(1), (2) and (3)). The notice must contain specified matters (s 259(4)) including the right to make representations (s 259(4)(d)) which must be considered by the FSA (s 259(8) and (9)). If a direction is to be issued, an existing direction not revoked or directions varied on the FSA’s initiative (s 259(13)), the manager or trustee may refer the matter to the Financial Services and Markets Tribunal (s 259(10)). A warning notice must be given where the FSA proposes to refuse a request to revoke or vary a direction (s 260(1)(a) and (b)) and such a decision may be referred to the Tribunal (s 260(2)). Notice is also to be given where the FSA decides to revoke on its own initiative (s 261(1)) or to revoke or vary on request (s 261(2)).

Open-ended Investment Companies

The regulations made under the Act, s 262 by the Treasury may make provision for OEICs corresponding to those made for unit trust schemes in Part XVII, Chapter III, including provision for authorisation by the FSA (s 262(2)(1)). They may also confer functions on the FSA, which will presumably include making rules (s 262(3)(b)).

The current FSA regulations made under the Treasury Regulations of 1996 and governing OEICs are The Financial Services (Open-ended Investment Companies) Regulations 1997. These provide for the constitution of OEICs and the drawing up and publication of prospectuses. They also contain detailed provisions concerning pricing and dealing, including initial offers, issuing cancellation, sale and redemption, dilution levy, forward and historic pricing requirements and valuation. The investment and borrowing powers of the OEICs are set out in detail. These regulations give effect to but also develop the requirements set out in the UCITS Directive. Specific provisions are included with regard to securities companies, warrant companies, umbrella companies, efficient portfolio management, stock lending, cash borrowing and lending. The powers and duties of the directors and depository are also set out in some detail as well as other provisions on income, reports and accounts, shareholders’ meetings, umbrella companies and suspension and termination. The Regulations will now be reissued, as rules, with amendments once the Treasury have made their regulations under s 262.

The FSA has subsequently proposed certain amendments to the Regulations in connection with the tax implications of certain transactions, conversion of authorised unit trusts to OEICs and charging to capital (See Consultation Paper No 36, November 1999).

Recognised Overseas Schemes

Schemes Constituted in Other EEA States

By the Act, s 266(1), rules made by the FSA under the Act, apart from financial promotion rules made under s 145 (see chapter 12) and facilities rules made under s 283(1) (see below), do not apply to EEA schemes recognised under s 264.

The FSA may suspend the exemption given by s 238(4)(c) from the restriction on promotion set out in s 238(1) where the operator of an EEA recognised scheme has contravened the financial promotion rules (s 267(1), (2) and (8)). This enables the FSA to stop promotion of a scheme even though it cannot suspend the scheme’s recognition. Here the supervisory notice procedure will apply (ss 267 and 395(13)(3)). The home state authorities and operator must also be informed if the FSA proposes to direct suspension (s 268(3)). The operator must be informed that it may refer the matter to the Financial Services and Markets Tribunal.

Schemes Authorised in Designated Countries or Territories

A warning notice must be issued by the FSA if it intends to refuse approval of a particular scheme (s 271(1)). The warning notice must be received by the operator before the end of two months of the date of the application or it will have no effect (s 271(2)). A decision notice must subsequently be issued if the FSA is to refuse approval (s 271(3)(a)). The matter may be referred by the operator to the Financial Services and Markets Tribunal (s 271(3)(b)).

Individually Recognised Overseas Schemes

The Act includes further provisions concerning the procedures for making applications for recognition and their refusal. Applications must, in particular, be considered within six months (s 275(1)), with warning and decision notice procedures applying in connection with proposed refusals (s 276(1) and (2)).

S 277(1) requires notice to be given to the FSA of any proposed alteration of an individually recognised scheme. The proposal must not be implemented unless it is approved by the FSA (s 277(2)). At least one month’s notice of any replacement of the operator, trustee or depository must be separately provided to the FSA (s 277(3)).

The FSA may make rules imposing duties or liabilities on the operator of a recognised scheme equivalent to those set out in the scheme protection rules of an authorised unit trust (s 278). Recognition may be revoked on similar grounds to those applied to authorised unit trusts and OEICs (s 279). Less drastically, the same grounds can also lead under s 281 to directions to suspend the recognition until problems have been rectified. In both cases, there are similar procedures including the issuance of supervisory notices with powers to act immediately in cases of urgency (ss 280 and 282).

Facilities and Information in the UK

The FSA may give a written notice to the operator of any recognised scheme requiring invitations or inducements to participate in the scheme which are communicated by the operator, to include explanatory information specified in the notice (s 283(2)). Such a requirement may apply to communications originating outside the UK only if they are ‘capable of having an effect’ in the UK (s 283(3)).

Investigations

The person appointed to conduct the investigation may also investigate any other scheme with the same manager, trustee, operator or depository as the scheme which he or she is appointed to investigate (s 284(2)), and, here, OEICs are included in light of the need of an investigator to form a complete picture. The investigator may require any person to produce documents in his possession or under his control which are considered to be relevant, attend before the investigator or otherwise provide any assistance as may reasonably be required (s 284(3)). Various of the provisions of Part XI concerning investigations are applied to s 284 investigations by s 284(4) to (7). Section 284(8), (9) and (10) contains provisions on banking confidentiality similar to those in s 175(5).

Comment and Conclusions

The extension of the concession with regard to the conversion of authorised unit trust schemes into OEICs is interesting. A considerable number of schemes, approximately one-sixth, have already converted and presumably more will follow in early course. The reason for including all of the detailed provisions with regard to such matters as revocation, directions and investigations in the regulations rather than the Act is slightly anomalous. While a largely unified system of supervision and control is created under the Act with regard to most schemes, OEICs are to be governed by their own regulations. This is slightly unfortunate although not of any particular significance to the extent that almost identical provisions will be included. Of possibly more interest are the new types of open-ended scheme which may be permitted in the future.

It remains to be seen what further innovations may take place within the market. While London and Edinburgh should retain their status as leading financial centres in the traditional unit trust areas, hopefully their expertise can also grow with regard to new forms of open-ended facilities.