Proposed EU legislation could damage the investment trust industry.
Investment trusts are a fairly popular pick with Foolish readers -- and, as I wrote here, they can be expected to become even more popular as the Financial Services Authority's forthcoming Retail Distribution Review comes closer.
So there was alarm among investment trusts and similar closed-end funds last summer when European Union legislation, inspired by the credit crunch, looked to impose draconian rules and regulations limiting their activities.
That wasn't, in fact, the actual intent of the EU's proposed Alternative Investment Fund Managers Directive (AIFM). But by casting its legislative net so wide, in its efforts to stamp out what it saw as market abuse, EU legislators scooped up the UK's investment trusts in their trawl, prompting no little alarm.
Mistaken identity
So investment trusts have been fighting back -- either individually, marshalling their shoulders to the cause, or collectively, via bodies such as the Association of Investment Companies.
What didn't they like? A major stumbling block was that the draft legislation had the managers of conventional open-ended investment funds in its sights -- and not closed-end investment trusts, quoted on the Stock Exchange, and with independent boards of directors held accountable to shareholders. And the two are very different.
Consequently, as worded, the draft legislation imposed strictures on investment trust managers that ran directly counter to both their business models and their investment practices.
Trusts had to offer redemption on demand, for instance -- a bizarre requirement, when one considers that investment trusts' shares are bought and sold on the Stock Exchange. More seriously, perhaps, the wording of the draft law prohibited trusts from issuing shares, thus preventing the formation of new trusts, or any capital reorganisation by existing trusts.
There was also a prohibition on the use of non‑EU service providers, which would affect trusts who use, for example, an Asia‑Pacific firm to manage their assets in that region.
Investment trusts were also concerned about duplicate and parallel legislation -- both from a compliance perspective where the proposed law differed from (and conflicted with) existing legal requirements, as well as from a cost point of view.
In all, a dozen or more requirements were enough to raise very significant concerns -- with countless more minor niggles just adding cost and administrative overhead.
Doomsday scenario
As a holder of a SIPP with £2.6 billion FTSE 100 investment trust giant Alliance Trust (LSE: ATST), I started to hear about the draft legislation during the summer. Alliance Trust executives, it seemed, were keen to bang the drum during their regular investors' roadshows, urging investors to contact their MEPs and make representations about the proposed legislation accordingly.
And the message was stark. "If it had gone through as it was drafted in the early summer, there were -- point blank -- provisions in the original legislation that wouldn't allow investment trusts to work as they do," notes Donald McPherson, Alliance Trust's company secretary, and the board executive tasked with leading the charge. "Quite clearly, there were provisions in the original draft that were written by people who had no idea of how investment trusts worked."
A document on Alliance Trust's website paints an equally bleak picture. "If the Directive passed into law unchanged, the current legal structure of investment trusts could not be maintained, with the result that trusts would be forced to liquidate," it notes.
Fighting back
Such drastic action now seems unlikely. A lot of work has taken place to educate European legislators, and to suggest alternative wording that would lessen the blow. And after making representations to MEPs as well as to the UK authorities feeding-in to the drafting process, progress is being made.
Just before Christmas, for instance, the EU's (then) Swedish presidency proposed changes that would make the intended regulations more sympathetic to investment trusts. It removed, for example, the restrictions on the ability of investment trusts to issue shares, and recognised that closed‑ended funds should not require redemption rights.
"We're encouraged by the direction of travel," says the AIC's director of public affairs, Guy Rainbird. "The debate has been constructive, and our concerns have been listened to."
But not yet enacted into a final form of words that removes those concerns. Dialogue at a high level is still taking place, and as the AIC notes, "the Swedish draft does indicate where debate has reached, but is not a settled position."
And considerable certainty still surrounds the views of MEPs -- who have an equal, and parallel, voice in the drafting process. Hopes that smaller investment trusts could be exempted altogether, for instance, now look likely to be dashed, say insiders.
So where does all this leave us? Not out of the woods yet.
"I'm fairly confident that investment trusts will survive in some form, and be able to reorganise their affairs [in order to comply], says Alliance's Donald McPherson. "But it will involve increasing the cost of compliance, without generating any improvement in investment protection."
Europe's MEPs are the major stumbling block, and have until 21 January to comment on the present state of the draft, and table suggested amendments. I suspect that most Fools -- like me -- won't know the name of their MEP. If you're an investment trust investor, or are likely to be one in the years ahead, now would be a very good time to rectify that, with a sharply-worded letter.
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As noted, Malcolm holds a SIPP with Alliance Trust.
