25 June 2007
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In 2006 KKR Private Equity Investors launched the first permanent capital vehicle (PCV), raising $5bn (£2.52bn) in capital. KKR's permanent capital vehicle was established as a Guernsey limited partnership and listed the limited partnership interests on Euronext - one of the few internationally recognised exchanges that permit the listing of limited partnership interests.
KKR's success was reflective of:
- the wider investor base that arises from having a listed investment due to the investment restrictions in many pension funds and regulated funds on the level of unlisted investments they may hold in their portfolios;
- the increased investor interest in obtaining private equity exposure without the long-term capital lock-ins that are provided by many historic private equity models, ie the provision of liquidity in investments with alternative exposure;
- the fact that the limited partnership vehicle is the traditional vehicle of choice in the private equity industry due to the tax transparency and efficiency offered and also the more open environment of information disclosure to investors;
- the way that the investment manager is provided with the ability to focus on their area of expertise - investment management - and not run a dual role of capital raising and management as well as investment management, enabling them to be more focused and reducing the need to maintain liquidity in the investment portfolio to meet redemption requests in an open-ended environment; and
- the fact that proceeds from investment realisations are available for re-investment rather than being returned to investors as in previous private equity models.
Euronext has been attractive due to its less onerous rules for PCVs and its ability to list limited partnership interests. Unlike Euronext, the London Stock Exchange (LSE) does not permit a listed entity to have legal or management control of investee companies or to invest more than 20 per cent in a single investment, stopping feeder funds becoming listed PCVs on the LSE.
A Channel Islands investment vehicle has been used in these structures because:
- the Dutch Financial Market Authority (responsible for regulating Euronext) has recognised Guernsey and Jersey as two of the four jurisdictions with "adequate supervision";
- the favourable tax environment enhances investor returns; and
- the professional and experienced administration and service providers located in the Channel Islands and the flexibility to outsource routine administration tasks.
KKR's success in attracting such a significant amount of new capital has been a major talking point in the asset management and private equity industries and several players began the process of launching their own PCVs. Apollo (AP Alternative Investments) successfully raised $1.5bn (£760m) in capital quickly after KKR, but other names such as Doughty Hanson and Carlyle cancelled their plans to establish PCVs as the attractiveness of the initial PCV model was questioned by investors. This was due to:
- the additional complexities of the settlement of limited partnership transfers versus traditional equity securities;
- difficulties in compiling tax information for investors in limited partnerships as opposed to corporate forms in a more active change of investor environment;
- the length of time for the capital raised to be invested impacting negatively on performance; and
- the continual discount of KKR Limited Partnership's trading price relative to its net asset value.
A new generation of permanent capital vehicles has since arisen that has addressed some of these concerns with:
- the replacement of the limited partnership form with a corporate form; and
- capital being collected from investors over a period of time or called as the investment funding is required, eliminating or reducing the trading discount.
There has also been a shift of the PCV model from the private equity to the hedge fund industry with the successful launch of PCVs by Marshall Wace (MW Tops - $1.3bn (£660m)), Goldman Sachs (Goldman Sachs Dynamic Opportunities Fund - $500m (£252.3m)) and Boussard & Gavaudan (Boussard & Gavaudan Holding Limited - $300m (£151.4m)), and the increased use of AIM and LSE listings.
It was partly as a result of the decision by the Dutch regulator that the UK's Financial Services Authority (FSA) began considering interp-retations to the UK Listing Rules for offshore funds, fearing a loss of business to Euronext.
A recent development has been that the UK Listing Authority (UKLA) has advised that a secondary listing under Chapter 14 of the Listing Rules does not require a primary listing on another exchange. Brevan Howard (BH Macro Fund) has taken advantage of this regime, raising $800m (£403.7m) in capital in 2007, and several others are in the pipeline.
Not surprisingly, the UK investment management industry has reacted negatively to the ability of offshore companies to take advantage of the lighter secondary listing rules and avoid the additional requirements of a full primary listing. As a result, the UKLA has decided that in the first quarter of 2008 it will remove the ability to do secondary listings on the LSE and is expected to issue lighter primary listing rules for investment entities.
The new investment business rules were released on 31 May 2007, but there are several players currently looking at taking advantage of the known rule environment of the secondary listing environment. It is expected that the secondary listing rules will be grandfathered for companies listing under Chapter 14.
The new rules will be principles-based regulation, as opposed to the existing detailed prescriptive rules. Moving to a lighter Chapter 15 regime will enable the UK to compete more effectively against other exchanges in attracting listed investment vehicles, and we can expect a continued flurry of activity in the marketplace.
The latest development is a pipeline of listed 'permanent debt vehicles' by private equity houses, which they are using to provide the leverage element of their private entity investments, enabling investor access to the debt elements and returns of the private equity and hedge fund industries. The ability of the Channel Islands to pay interest gross (where information exchange is agreed with the investor) has made these attractive new vehicles domicile in the Channel Islands.
Peter Franks is a partner at Ernst & Young