This briefing sets out some of the highlights of the issues discussed, which we hope will also be of interest to those who could not attend the seminar itself. It also picks out a few points from the short survey which formed part of the event.
Redemption in open-ended real estate funds
In our seminar we discussed some recurring themes on redemption mechanics. These have been considered in the context of funds experiencing difficulties and where significant restructuring is required, as well as on modernisation, or for new launches. Our headline observations are:
- Open-ended fund structures are most prevalent for core/core+ real estate investment strategies (with value add and opportunistic strategies favouring closed-ended fixed life structures).
- Some sponsors are considering hybrid models for core funds, where investors are offered the opportunity to exit during liquidity windows, which open up after a specified number of years.
- It is important to get redemption terms right from the outset; plus they always need to balance the interests of those investors who are redeeming and those continuing.
- Redemption mechanics must fit with the fund’s investment strategy, meet regulatory requirements and work across master-feeder structures.
We looked at the life cycle of the redemption process and mechanics, from serving notice, queueing and caps, deferral/ suspension, funding and pricing issues, to settlement. A few highlights from the issues raised are set out below.
- Lock-in periods (when investors either cannot redeem, or there are disincentives for early redemption, such as an additional redemption fee) are common following launch, or a during a stabilisation period after restructuring.
- We are seeing a shift to a vintage system, where redemption requests within a batch are treated pro rata.
- Redemption caps are common; the size of the cap will depend on the frequency of redemptions (e.g. 10-20% of fund NAV per annum).
- Managers can often defer redemption requests for 6 to 12 months where there are insufficient funds to meet redemptions, and for longer if there are a significant amount of redemption requests. A termination vote can be triggered if there is still insufficient liquidity following a deferral.
- The manager can exercise its discretion when funding redemptions, including providing a secondary trade mechanism, and may specify a waterfall of funding strategies, but usually subject to manager discretion. In specie distributions are usually only with the investor’s consent and approval of the investor committee.
- The manager may wish to waive the discount to NAV usually embedded in the redemption price (typically 2-2.5%), for instance, to facilitate a new subscription. Investors will expect a consistent approach.
Key recent tax developments
HM Treasury has published draft legislation relating to charging income tax on disguised investment management fees. If enacted in their current form, the effect of the proposals would be that any amount that an individual performing ‘investment management services’ receives (either directly or indirectly) from a fund involving at least one partnership, will be treated as a ‘management fee’ liable for income tax and NICs, unless it falls within one of the specific exceptions. ‘Investment management services’ are broadly defined and include researching potential deals and fundraising. The rules apply to the extent that any services are performed in the UK, and would therefore include a non-UK resident performing some services in the UK.
- The exceptions relate to ‘carried interest’ linked to performance, or returns from investments made by the individual. However, the carried interest exception in particular is drafted very narrowly and as a consequence many profit sharing arrangements commonly used in fund structures could be brought into the UK income tax net by these rules.
- Timing: the draft rules would apply to sums arising on or after 6 April 2015. As there is no grandfathering, existing structures will also be affected.
Meanwhile, new details continue to emerge of the European Commission’s investigations into tax rulings granted by EU member states to multinational companies, and whether these amount to unlawful State aid:
- On 17 December, the Commission announced that it had asked all member states to provide information about their tax ruling practices, thereby extending its enquiries beyond Luxembourg, Ireland and the Netherlands.
- On 18 December, the Luxembourg government announced that it would fully comply with the Commission’s requests for information on its tax rulings practice and patent box scheme, which it had previously resisted.
- On 16 January, the Commission published further details of its in-depth probe into alleged aid granted by Luxembourg to Amazon. This appears to focus on the same key issues as its investigations into tax rulings issued to Apple, Starbucks and Fiat.
The OECD continues to roll out its BEPS studies (the latest paper being Action 4, Interest Deductions and Other Financial Payments), with the UK already looking to implement some of the BEPS style reforms through the Diverted Profits Tax (which will come into effect in April 2015) and a consultation on cross-border hybrids with a view to legislating in 2017.
Against that background funds will need to:
- consider whether any existing tax rulings are “too good to be true”;
- refresh old tax rulings so that they are updated;
- ensure that future rulings are compatible with the arm’s length principle and do not confer an advantage that is out of line with the generally applicable tax system;
- manage associated reputational concerns; and
- put in place contingency planning to deal with BEPS-related changes of law.
And some other topical updates
We looked at some other trends and developments of interest to those in the real estate and private equity funds industry.
First, ELTIFs (the regulation for European Long-term Investment funds), a new investment framework for alternative investment in long-term asset classes (e.g. infrastructure, real estate, transport, energy). Some key points on ELTIFs:
- They are available to both the retail and institutional market. We expect ELTIFs to appeal to both HNWIs/ affluent retail investors and smaller institutional investors, and to fund managers who want to access the retail market on a cross-border basis.
- ELTIFs are closed-ended funds; although the manager can offer redemption from 5 years into the life of the ELTIF, or half way through its life, whichever is earlier, and provided liquidity systems and redemption limits are in place.
- Potential for secondary market, through transfers or listing.
- Commercial real estate has to be more than €10m in value and contribute to sustainable and inclusive growth in Europe (i.e. no speculative development).
- ELTIFs must be EU AIFs managed by EU AIFMs under AIFMD. Additional regulatory protections apply when marketing to retail investors.
Second, the Small Business, Enterprise and Employment Bill includes provisions to create a public register of individuals who, alone or jointly with others, have ‘significant control’ over a UK company. They are expected to take effect in January 2016, with the first filings to be made in April 2016. Two comments:
- The new public register will impact all UK private companies in fund and joint venture structures. Other entities are not are not currently caught, although we need to be alive to the possibility of later amendment to include limited liability partnerships (LLPs).
- A logical consequence of the UK being an early mover on transparency provisions is that businesses may choose to incorporate elsewhere, as the rules do not apply to foreign companies operating in the UK.
Third, ESMA’s call for evidence to the proposed passport extension under AIFMD has given the industry an opportunity to vocalise some of the issues that crop up when marketing under AIFMD – in particular, those causing cost, complexity and consternation. Two example situations which lead to inefficiencies:
- When cross-border marketing using the AIFMD passport, some member states’ regulators are charging administration fees (argued by many to be disproportionately high with opaque systems for disclosure and payment), expect to approve AIFM applications and require additional local appointments.
- Divergent and inconsistent approaches between member states as to what preliminary marketing activities can be carried out before an AIFM has its authorisation to market.
Funds First Survey
We asked our guests a few questions to gauge sentiment on certain topics. A selection of results is set out below.
- 39% thought that AIFMD has made Europe less attractive for investment business; 50% said wait and see until the passport has been extended. Only 2% thought that AIFMD had made Europe more attractive (the remaining 9% saying it had not had any impact).
- Joint ventures and club deals are expected to be the most popular investment approach in 2015 (49% of respondents), followed by non-listed funds (21%) then listed funds (14%). These align with the fund managers’ preferences reported in the INREV investment intentions survey 2015, although in our survey investment in funds come out ahead of direct investment and separate accounts.
- 81% of those at our seminar thought that the private equity industry needed to do more (even if just in part) to enhance its reputation following recent public scrutiny
- The risk of Brexit in a future referendum on Britain’s membership of the EU is expected to impact fund-raising or investment activities far more than the UK general election in May.
- Manager’s track record is cited by a majority (65%) as the most significant factor behind a successful launch; with a seed portfolio of existing assets coming second (21%).