The charities investment market is a substantial one with the top 10 investment firms serving the market managing just over £32 billion of assets for nearly 1600 charities. Having a pooled investment vehicle which is regulated directly by the FCA, tax efficient for charities and with features which are able reflect the particular needs of charity investors has been an aspiration for some years now.
Following work spearheaded by the Charities Investors Group (CIG) involving a working group made up of the CIG, Charity Commission, the Financial Conduct Authority (FCA), HMRC, the Investment Association (IA) and the Charity Law Association, the Charity Authorised Investment Fund (CAIF) which was first announced in the Budget of March 2015, is finally available for use. The FCA published its amended rules on 1 October 2016 which includes chapter 14 of the COLL Sourcebook with specific provisions for CAIFs.
In this briefing Grania Baird (a participant on the CAIF working group), seeks to respond to key questions interested parties in the CAIF may have.
1, What is a CAIF?
A CAIF is both an FCA authorised investment fund and a registered charity. As such the CAIF must comply with the requirements applicable to FCA authorised funds, as well as those applicable to a charity. As the CAIF is a charity it will be treated as such by HMRC and benefit from the direct tax exemptions available to charities. As the CAIF is an FCA authorised fund, it is considered a special investment fund and management fees will be exempt from VAT.
2. Why is the CAIF being introduced?
There are existing fund structures which can be used for charity investors, including common investment funds, charitable unit trusts, FCA authorised funds, and offshore structures. However, for a variety of reasons generally none of these existing fund structures are considered ideal. If an unregulated fund structure is used (which includes common investment funds), currently (in most cases) the charities are vulnerable to suffering irrecoverable VAT on management fees. In addition most unregulated structures (other than common investment funds) are difficult to market to the wider charities market and are usually considered only appropriate for more sophisticated charity investors.
Although common investment funds were specifically created for charity investors and benefit from certain bespoke features (such as the ability to operate income smoothing and/or to have an independent board representing the interests of unit holders), the Charity Commission has become reluctant – absent a clear need - to authorise more common investment funds. Even certain existing FCA authorised funds targeted at charities have downsides: some have used tax elected fund status to minimise tax leakage, but this brings added administration; and the current FCA rules do not allow for the bespoke features available to common investment funds.
For the reasons mentioned above, and no doubt others, there has been a desire and push for a new bespoke vehicle for charities and hence the CAIF.
3. Who regulates the CAIF?
The CAIF will be dual regulated by the FCA and the Charity Commission. The Charity Commission will be responsible for registration of the CAIF as a charity and will regulate the CAIF (and the charity trustees) in respect of compliance with charity law. The FCA will be responsible for authorising the CAIF as an authorised fund and will regulate the operation and administration of the CAIF and its compliance with the financial services law and regulation including the FCA Rules. The FCA and the Charity Commission have agreed arrangements to ensure their respective roles are clear and that the regulation and supervision of CAIFs operates as intended.
4. Which FCA fund structures can be used?
The FCA has confirmed that a CAIF can be established as a non-UCITS Retail Scheme (NURS), UCITS or Qualified Investor Scheme (QIS) type of authorised fund. Which type of scheme is used will depend on the target investors and the investment objective and policy of the proposed scheme. In terms of structure, the Charity Commission's current position is that it is comfortable a CAIF can be established as an authorised unit trust. The alternative FCA structures of an OEIC, or using one of the authorised contractual scheme (ACS) structures, will be the subject of further dialogue with the Charity Commission.
An umbrella authorised unit trust CAIF can be established, provided each sub-fund is capable of being a CAIF.
5. What are the novel features of the CAIF?
In addition to the unique nature of the CAIF (being both an FCA authorised fund and a registered charity), there are a number of optional features available to use within a CAIF which are novel in the authorised funds context. These optional features are:
- Advisory committee – the idea behind the advisory committee is to seek to replicate the role of the advisory board in a common investment fund, but without the committee having executive powers. An advisory committee which only has a consultative function is now contemplated in the FCA rules. Members of the advisory committee must be independent of the manager of the CAIF (Manager) and trustee of the CAIF (Trustee) and their role will be to represent the interests of unit holders, and to be consulted on various matters regarding the operation of the CAIF. The advisory committee will have the power to convene a meeting of unit holders, and must prepare an annual report. If the CAIF has an advisory committee this must be included in the trust deed and prospectus. Although the advisory committee is not mandatory, without such a committee any increases in the rate of remuneration of the Manager or Trustee, or other increases in charges, must be pre-approved by the Charity Commission.
- Income reserve account – the ability to hold back income from one accounting period to another and pay out previously held back income is one of the unique features of common investment funds and allows such funds to maintain a regular level of distributions which is appealing to charity investors. The FCA rules allow a CAIF to operate an income reserve account provided this is used solely for the purpose of avoiding fluctuations in income for allocation/distribution and is subject to certain conditions, including a limit of 15% of income being transferred to the income reserve account in any one accounting period. If an income reserve account is to be established this must be included in the trust deed and prospectus.
- Total return approach – the ability to return capital as well as income in distributions is a concept increasingly familiar to the charities market, particularly to those charities which have permanent endowment funds. Under the FCA Rules, the CAIF will be able to operate a total return approach where this is for the purpose of meeting a pre-determined target return, which is consistent with the investment objective and policy of the CAIF. Again, if such an approach is to be adopted this must be included in the trust deed and prospectus.
6. Who can invest in a CAIF?
The CAIF is for investment by charity investors. These are defined as charities within the meaning of Section 1 of the Charities Act 2011 and Schedule 6 to the Finance Act 2010 (thereby including charities in Scotland and Northern Ireland that also qualify for UK charity tax reliefs). As a CAIF itself will be a registered charity it can invest in other CAIFs. In addition, it is accepted by the Charity Commission that nominee companies can hold units in a CAIF provided the underlying investors are charities.
The Manager will also be permitted to hold units in the CAIF for box management purposes, provided that any profits from this activity are paid into the CAIF.
7. What is the CAIF's charitable object?
All charities must have an exclusively charitable object. The charitable object for the CAIF was subject to discussion and debate during the consultation stages. Although the Charity Commission has not prescribed what the charitable object of the CAIF must be, it has agreed that a wide objects clause which expresses the purpose of the CAIF as being to further the charitable purposes of the CAIF's investors would be acceptable. Model wording for this form of object is included in the model trust deed (see What industry guidance is available? section below).
8. Who will be the charity trustees?
The charity trustees will be the Manager and the Trustee and will be subject to the obligations of charity trustees under charity law. Members of the advisory committee will not be considered charity trustees, nor will delegates of the Manager or Trustee.
9. How is a CAIF created?
As regards the Charity Commission – a special procedure has been developed for CAIFs in respect of the registration process. A draft application form and the draft documents for the CAIF will need to be prepared (including the trust deed and prospectus) and submitted to the Charity Commission (the pre-application stage). Once a "minded to approve" letter is received from the Charity Commission, the FCA application for authorisation process can commence.
As regards the FCA – the normal fund application for approval process will need to be followed but after the "minded to approve" letter has been received from the Charity Commission. For an authorised unit trust the FCA process involves the normal Form 242 and supporting documents, including draft trust deed and prospectus and the appropriate FCA fee. The Manager will need to have the necessary FCA permission to manage the particular type of CAIF envisaged (e.g. permission to manage a UCITS or an alternative investment fund (AIF) as applicable). The FCA normal guidelines on naming of authorised funds will apply.
Once FCA approval has been given, the CAIF application will then be returned to the Charity Commission for final registration with the Charity Commission. This will involve submission of the executed trust deed (with at least £5,000 in an account for the CAIF or pledged to charity). Registration by the Charity Commission should then follow shortly.
Clearly this is a new process for the Charity Commission and a new vehicle for both regulators so it may take a few applications before the process runs smoothly. However, the process has been designed to try to ensure that applicants are given sufficient feedback at a relatively early stage from the Charity Commission.
10. What industry guidance is available?
The Investment Association has produced a model trust deed based on its existing model authorised unit trust deed in conjunction with members of the working group. This has been shared with the FCA and Charity Commission, both of which have reviewed and provided comments on it, although they have not "approved" the model deed as a binding precedent.
In addition, the CAIF working party has provided guidance which can be accessed from the Investment Association website here.
It has taken a number of years, but the CAIF represents a positive outcome for the charities investment market. The CAIF opens the door for new charity pooled investment funds to be established, as well as the conversion of existing common investment funds to the new model. The CAIF will be regulated by the FCA and the Charity Commission in a manner which is appropriate to the competencies and statutory roles of each regulator, as well as having a tax efficient structure and using certain bespoke features in order to address the needs of the relevant target charity investors.
It will be interesting to see how many existing common investment funds look to use the new CAIF structure. It is certainly something we expect Managers to be actively considering.
 This figure is based on the Charity Investment Spotlight report published by Wilmington Insight in June 2016 and is available here.
 This is helpful as the position of the Charity Commission has been that a Manager's name could not be included in the name of a common investment fund (this practice will not be followed for the CAIF).