Regulatory competition is alive and well in Europe, and a recent innovation in investment fund structures in the UK represents the latest salvo in an ongoing battle for Europe’s fund management business. Reforms to UK limited partnership law in 2017, which (effectively) created a new fund vehicle for private fund managers, are clearly designed to build on an already popular structure in the face of increasing international competition.
In a recent article (available here), I describe the main features of the UK’s new Private Fund Limited Partnership (PFLP) organisational form, established under the Legislative Reform (Private Fund Limited Partnerships) Order 2017 (PFLP Law). The PFLP is a voluntary alternative to a traditional limited partnership, available only to partnerships that qualify as “collective investment schemes”. Existing limited partnerships can opt-in to the new regime if they qualify, and new ones can elect to be treated as PFLPs at the time of first registration or subsequently.
Most of the general law of limited partnerships continues to apply to PFLPs, but perhaps the most important modification is the provision for greater clarity on how limited partners – who enjoy limited liability in exchange for refraining from management activities – can exercise certain rights without being deemed to have taken on a management function. The so-called “white-list” of activities provided by the new law is quite extensive, and enables fund investors (who generally act as limited partners) to negotiate certain oversight rights and investor protections without putting their limited liability at risk.
The PFLP law also modifies the 1907 Limited Partnerships Act so that the limited partners in a PFLP are not required to make a capital contribution. Crucially, however, it also provides that – if they do contribute capital – that capital can be returned at any time during the partnership’s life. This is important because limited partners generally contribute capital to the fund partnership, but expect to receive it back when investments are realised. General UK limited partnership law stipulates that capital can only be returned at the end of the life of the partnership, which necessitates somewhat artificial provisions in the limited partnership agreement so that the bulk of an investor’s contribution is made by way of loan to the partnership. This device will no longer be needed, and will bring the UK vehicle more into line with other international structures.
There are various other changes designed to simplify the administration of the PFLP and to make the default position on fiduciary duties more like the position generally negotiated between the parties.
Effective since April 2017, the private equity and venture capital industry has welcomed these changes, which undoubtedly improve the competitiveness of the UK limited partnership structure. While this new option for private fund managers is not radically different from the existing structure, it does enable the UK to continue to offer an onshore structure that combines tax transparency with legal certainty, flexibility and relatively light administrative burdens, and the government’s clear hope is that this will encourage more private funds to remain onshore. The economic benefits of that are hard to quantify – but, at the very least, it protects revenue for UK-based professional advisers and, perhaps, helps to anchor European private funds in Britain.
For those who subscribe to the “race to the top” thesis of regulatory competition – arguing that the competition among jurisdictions that follows from the freedom for a business to choose its state or country of incorporation, improves corporate structures for the benefit of all – this will be a welcome move forward in the development of corporate law.
However, whether the UK’s new vehicle will actually encourage more fund managers to use a British structure for their funds is not clear. Brexit has put pressure on larger fund managers to use vehicles located in an EU27 country, since the regulatory treatment of UK funds after the UK leaves the EU remains unclear. That has driven many to use Luxembourg’s partnership structure. In addition, the UK tax environment as it applies to private funds has been somewhat unstable for the last few years, and the UK government – concerned about the use of limited partnerships for criminal activities – has suggested that it may make (as yet unspecified) changes to UK limited partnership law. These factors may be inhibiting adoption of the reformed vehicle.
Simon Witney is a Special Counsel at Debevoise and Plimpton.