Since the FCA published the Consultation on the new Public Offers and Admissions to Trading Regulations regime (POATRs) (CP24/12), I have been reading the responses with interest. The overwhelming feeling is that this is a "thing", that nobody believes will have any real impact on markets in the UK. At a time when markets are competing with the hangover from BREXIT, high interest rates, an economy trying to recover from the uncertainty created by the last Government, poor liquidity and low valuations, people want regulators and politicians to do some"thing", but merely represents a ‘thing’.
One response caught my eye in particular though, the Association of Investment Companies (AIC) declaring this as a "victory for common sense" and a change that will "empower investment companies to raise capital more easily". Interesting views from an organisation that, in part represents, the interests of the VCT industry, an industry which, at a time when close to no money has been raised through capital markets in the UK, has raised in excess or close to £1 billion in each of the last three years, using…you guessed it prospectus documents. The prospectus document therefore clearly offers some attraction and comfort to the vast army of retail investors that invest in VCTs.
So what are the AIC's concerns with the prospectus document?
The statement gives some further detail, citing the cost and burden of producing prospectuses as the main reasons to celebrate getting rid of them.
Taking these in turns, generally on the deals we work on in the closed-ended funds space the costs directly associated with the production of the prospectus are between 0.1% and 0.5% of the fundraise, I think it is safe to say that costs at this level will quickly find a home if a prospectus is no longer required. The FCA itself acknowledged in the Consultation Paper that the costs of producing a prospectus are less of a concern to funds than commercial companies. In the VCT space, due to the structure of fundraisings where costs are paid by the investment manager out of promoter fees, the lack of a prospectus will not result in any cost savings for VCTs or investors.
In terms of burden, we presume that the AIC is meaning the time taken to produce a prospectus. Generally we advise clients that they should factor in 10 to 12 weeks from us putting pen to paper and the FCA stamping off on a prospectus in relation to a secondary fundraising. However, our record for a vanilla equity trust prospectus on a secondary fundraising is 6 weeks. Generally this time period runs alongside other processes, for example producing roadshow documents, warming up investors and giving Boards the opportunity to review documentation. There have been occasions, particularly in relation to real estate investment trusts (REITs), where the time needed to produce a prospectus have resulted in concerns around timing for completing portfolio acquisitions, but I am not aware of any situations where deals have fallen through due to prospectuses.
The other factor, not cited by the AIC, which is a concern to certain investment trust boards is the frustration at having to produce a prospectus in order to issue shares in relation to premium control policies. This is a genuine issue, but has not been a concern in recent years due to the discounts at which most investment trusts are trading and has only really been an issue up until the point where an investment trust reaches scale.
All of this celebration in the change to the prospectus rules misses the elephant in the room, the point limited to a footnote in the Freshfields briefing note, but not highlighted anywhere else. The changes to the Prospectus Rules cuts the last string of hope that retail investors had to participating in secondary fundraisings in the UK.
What is the issue?
Prospectuses act as an important exemption to the financial promotion rules. Although the FCA have said in one set of rules that a prospectus document will no longer be required, the financial promotion rules still provide that some form of document is required in order to market shares to retail investors. At the same time the FCA, to far less fanfare, have quietly been building up the financial promotion rules making the rules on what information the document must include far more stringent, reducing the number of people that can sign off on financial promotions and increasing the burden of responsibility on the party that does sign off on the document.
Do we care about retail investors participating in secondary fundraisings?
The London Stock Exchange (LSE) seemed to care when they made a sizeable investment in Primary Bid in an attempt to increase access for retail investors to secondary fundraisings and part of the AIC's mission statement is to support investors (including retail investors) making informed decision about investments in closed-ended investment companies.
The commercial company space has long lost interest in retail investors in the context of secondary fundraisings, being viewed as causing too much hassle and not bringing in enough money to make that hassle worthwhile. Similarly for an investment trust a raise of between £5 million and £10 million is generally viewed as a great success for a retail offer on a secondary fundraising, which is often not a substantial amount in the context of the fundraise as a whole.
Retail investors, do however play an important role both in diversifying an investment companies shareholder base, but investments by retail investors are also part of the heritage of investment trusts in particular and therefore their interests and ability to participate should be protected. VCTs on the other hand only market their shares to retail investors due to the tax reliefs associated with an investment in VCT shares only applying to individuals and so any change to how they gain access to retail investors is fundamental to their business.
So issuers will just sign off on marketing documents as financial promotions?
Many investment trusts include offers for subscription and/or intermediaries offers (i.e. offers to retail investors) in prospectuses because they are producing a prospectus anyway and therefore why would you not include another potential revenue stream. If this situation is flipped and the inclusion of an offer to retail investors is going to be more costly (in paying a party to sign off on a substantial financial promotion) and more burdensome (in producing a financial promotion document), why would any issuer bother with a retail offer?
Question marks also arise as to who would sign off on any financial promotion for a retail offer? The obvious answer is the investment manager, however this raises concerns around an investment manager effectively "marking their own homework", picking and choosing the information that they want to include in that document.
The Board of non-executive directors of an investment company would have little say on what was included in the document as this would be decided by the compliance department at the investment manager, removing an important opportunity for Boards to challenge their investment manager.
Any time in the process saved through not producing a prospectus will surely be eroded by the processes that a compliance department would need to go through in order to properly sign off on a substantial financial promotion such as this.
The alternative is that a third party is hired to sign off on the financial promotion, which will surely erode much of the cost savings from not producing a prospectus.
Does it really matter if investors can't participate in secondary fundraisings? Can't they just invest through the secondary market?
In particular in relation to VCTs, investors have to invest in new issues of shares in order to receive the tax reliefs associated with VCT shares. As VCTs only market to retail investors this change to the rules will affect them more than most investment companies. The ability to volunteer to produce an FCA approved prospectus is a welcome option, in particular for VCTs.
Retail investors don't read prospectuses anyway, why does this matter?
I am not sure this is true of all retail investors, but evidence would certainly suggest that there is a body of retail investors that do not read prospectuses either due to a lack of time or a feeling that the prospectus document is difficult to read. However, the parties that advise retail investors, such as platforms and IFAs, do read prospectuses and often reproduce the information set out in the prospectus in more digestible format for investors to make investment decisions. The detail required by a Prospectus provides a full brief of information for investors and their advisers, allowing them to make an informed decision.
Prospectuses are useful tools for these parties because they provide uniform information that can easily be used to compare different investment vehicles. If each investment company is no longer required to provide the same information, it will be up to the adviser to either interpret the information provided in a way that allows for comparisons or to seek the additional information that they require from investment companies and their investment managers. The quality of information provided to investors will therefore be reduced and will be highly reliant on the skills of their adviser, which we believe is a disadvantage to retail investors.
We believe the argument that all the information that investors need to make an investment decision is publicly available is flawed, in particular in relation to retail investors. It is difficult to believe that the majority of retail investors have the time or tools available to them to find and compile all the relevant information through annual reports, company updates and RNS announcements. Since the introduction of the Consumer Duty we have seen more and more investment platforms and IFAs providing substantial due diligence questionnaires to investment managers before allowing closed-ended investment vehicles on to their platforms. If these organisations, with the resources that many of them now command and a prospectus, feel that they need to seek additional information from investment managers, what hope does an individual retail investor have of finding all of the information that they require to make an informed investment decision, without even a prospectus.
The prospectus provides all the information that retail investors require in one easily accessible place. To get rid of these documents in the context of closed-ended investment vehicles at a time when so much focus is on the Consumer Duty and protecting the interests of retail investors seems somewhat odd.
Prospectuses also set closed-ended investment funds apart from other investment vehicles, in the eyes of retail investors and advisers to retail investors, as they are FCA approved documents. Investment companies are not under the same time restraints that many commercial companies face when raising capital and due to the straightforward nature of the vehicles there are not the same cost issues.
It seems odd therefore that the AIC are celebrating the demise of a document that gave their members easy access to retail investors, a platform that set them apart from other investment vehicles and gave investors, or at least their advisers, the ability to compare and contrast different vehicles easily and quickly, but maybe I have spent too much of my life writing prospectuses!
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