Unpacking open-ended investment companies.

The FCA defines an open-ended investment company based on three core elements:

1.?????? It must constitute a collective investment scheme

PERG 9 makes clear that the company's very existence and structure comprises the collective investment scheme, not any particular assets or funds. The FCA states the scheme cannot be broken down into component parts - the corporate entity itself is the scheme.

This has implications for authorization. As the operator of the scheme, an open-ended investment company itself needs permission to operate the collective investment scheme constituted by its corporate structure.

2.?????? It must meet the property condition

The property condition requires that assets belong beneficially to the company and are managed by it or on its behalf. The aim must be to spread investment risk for investors.

It is worth emphasizing that investors do not have a beneficial interest in the assets. Their rights are against the corporate entity only. This factor helps determine the existence of a collective investment scheme.

Another key implication is that the property belonging to the company can be of any description - real estate, works of art, enterprises etc. However, it must be possible to value the property to satisfy the net asset value requirements in the third condition.

3.?????? It must satisfy the investment condition

This third condition is the most complex area for analysis. It contains two key tests:

The 'expectation test' - a reasonable investor would expect to be able to realize their investment within a reasonable timeframe.

The 'satisfaction test' - a reasonable investor must be satisfied they can realize their investment at a price reflecting net asset value.

The FCA states this condition relates to the company as a whole, not specific share issues. So a company is categorically open or closed-ended, not a hybrid. However, its status may change over time with significant operational transformations.

The reasonable investor is hypothetical, with knowledge and experience of markets and collective investment nuances. Their characteristics like risk appetite may vary depending on the company's target investors.

Redemption policies, public representations, actual company practices and constitutional documents needs to be examined in detail to determine whether a reasonable expectation of realization exists. The timeframe for realization also requires evaluation - what period is 'reasonable' given the asset classes invested in?

For the satisfaction test, the FCA makes clear that typical market pricing contains too much uncertainty to provide confidence in a net asset value basis. But third party guarantees on market prices may suffice in some cases.

Grey areas

Despite ample FCA guidance, determining open-ended status can be nuanced.

Mixed Share Classes - The FCA says the overall balance and impression across redeemable and non-redeemable share classes determines status, but each share class must be analyzed in depth individually. A minimal number of redeemable shares amongst mostly non-redeemable shares still suggests a closed-ended company.

Market Realization - The FCA voices skepticism on market trading satisfying the requirements of the satisfaction test in most cases. But third-party pricing guarantees may provide enough confidence in some instances. The prevalence of guarantees or interventions to support market prices at net asset value will influence interpretations.

Reasonable Timeframes - The periods considered 'reasonable' for realizing investments to meet the expectation test will vary based on asset classes held. Managers must evaluate appropriate timeframes given the underlying assets and their liquidity. Extended periods like 6 months may suggest closed-ended status.

Grappling with the complex landscape of share class distinctions, market pricing constraints, and realistic timeframes for asset realization, managers should adopt a holistic approach. This allows for a nuanced understanding of the often-ambiguous areas that arise during interpretation.

?

Suggested approach

• Review corporate documents, public statements and actual practices holistically to form reasonable expectation judgements. Avoid focusing on single issues of shares in isolation when applying the investment condition.
• Catalog all share classes along with their specific rights and redemption terms in detail. Analyze the proportions of redeemable and non-redeemable shares issued and the overall balance. Even a small proportion of redeemable shares may suggest open-ended status.
• Consider the redemption periods attached to share classes. Assess objectively whether these can be considered 'reasonable' for realizing the investments based on the liquidity profile of assets held. Be very cautious on extended periods.
• Do not presume standard market trading satisfies the satisfaction test. Verify whether robust third party pricing guarantees or interventions exist to support market prices reflecting net asset value.
• Conduct periodic reviews of the investment conditions as corporate policies and behavior evolve over time. Significant, sustained changes could necessitate reclassification from open-ended to closed-ended status, or vice versa.
• Evaluate the implications of open or closed-ended status across regulatory permissions, financial promotions, marketing communications and any advertising of the company's shares or securities.

The details provided on share class analysis, reasonable timeframes, market pricing limitations and regular reviews aims to equip new Managers with a strong foundation to understand whether an investment company meets the nuanced definition of open-ended status.