What is an unregulated collective investment scheme (UCIS)?
A Collective Investment Scheme ('CIS') is one which enables investors ('persons') to participate in the profits or income from an asset / property, in which the profits are pooled and the investors do not have day-to-day control over the management of the property involved (FSA handbooK PERG 9.4). Note that a share in a company, while essentially serving the same purpose, does not constitute a CIS. If a CIS is regulated you should be able to find it on the FSA website.
An Unregulated CIS (UCIS) is simply an investment which is not subject to a strict set of rules and reporting requirement laid down by the FSA. However, while the fund will normally fall outside the Financial Services Compensation Scheme (FSCS) and will not be subject to the Financial Ombudsmen, it is a little misleading to think of them as unregulated because the Operator of UCIS are regulated by the FSA and subject to regulation and specified standards. There are also strict FSA regulations surrounding the promotion of UCIS and who can invest in them.
There is a very useful fact sheet which the FSA have put together for Financial Advisers on UCIS which explains exactly what a UCIS is, what the obligations are on an adviser and what the adviser can and can't do. From this the key aspects to point out are that you cannot promote a UCIS to clients who have not been identified as 'high net worth investors' or 'sophisticated investors'.
UCIS, EIS and VCTs and the Green Investor
There are a number of examples of UCIS for investors interested in social and environmental investment opportunities and still more opportunities if you include qualifying Enterprise Investment Scheme ('EIS') companies and Venture Capital Trusts ('VCT's). For example, Goldfield Partners successfully raised £10m in 2011 for their Solar EIS fund which qualifies both as an EIS and an UCIS and which invested in solar panels on residential roofs.
How do the risks compare?
The UK regulatory environment is complicated and it is designed to protect the consumer. While there is the presupposition that an UCIS will carry higher risks than 'regulated' investments, wealthy investors should still consider them because they may turn out to be very suitable long term investments. If being regulated resulted in better outcomes life would be much simpler. Regulation carries with it extra costs and a requirement for the Operator, or management team to have a larger infrastructure in place which can deter fund managers from going down the regulated route.
The most important assessment an investor needs to make (irrespective of its regulated status) is the underlying investment proposition of a fund and the ability of the management team to carry out the investment strategy. The investment strategy of a fund, or company, can vary substantially in risk. In the clean energy sector we, at Holden & Partners, are very conscious of this and it is a more important consideration than the regulated status of the investment itself.
Wind Energy EIS
One example of a high risk business strategy was the funding of a company then known as Wind Energy in 2004 which had put together potential wind farm sites in Scotland on which the company was going to seek planning. This began as an EIS company, but it lost its EIS status subsequent to the investment when a second round of funding was needed resulting in investors having to stump up with the cash they had previously reclaimed from the Inland Revenue. Fortunately in this instance one of the smaller sites (22MW) did get planning returning nearly all of the investors money, but there remain two or three sites still in the planning arena 8 years on. This investment was clearly for investors who could afford to invest with the very high possibility of losing all of their money. All of the money raised for Wind Energy Limited was spent speculatively on trying to obtain planning permission, which anyone with experience of any planning application will know can be highly risky.
Goldfield Solar EIS fund
The Wind Energy EIS was not an UCIS but was only appropriate for high net worth, or sophisticated investors. The Goldfield Solar EIS fund also fell into this category, but had the added FSA complication of being an UCIS, this is because investors were put into a collection of EIS companies thus falling within the definition of a CIS. However, from an investment perspective it was not nearly as speculative. It did not promise a ten times return like the wind energy investment, because fundamentally the fund was buying into a long term income stream created by the sun, solar panels and the government's feed-in-tariff legislation. However, from a regulatory perspective (in terms of who this scheme could be marketed to) it is viewed in the same light as the wind energy investment. As an adviser, our job at Holden & Partners is to assess whether an investment is suitable for a client and the difference between the wind energy investment and the Goldfield Solar EIS fund is simply that the latter is much more likely to be appropriate for a broader range of clients. However, as you will see below for many IFA firms being a UCIS would have ruled out the Goldfield EIS Solar fund as an option, but not the Wind Energy Limited EIS.
Foresight Solar VCT
The risk dynamics of the Foresight Solar VCT which raised £38m in 2011 are not too dissimilar to the Goldfield Solar EIS fund. However, while VCTs (venture capital trusts) may have a similar risk profile to an UCIS these can be more widely promoted to retail investors. This is because, while the investment risk may not be too different, a VCT is a listed vehicle, issues a full prospectus which has been approved by the FSA and in theory at least there is a traded market in its shares. This means that an investor is more likely, though not certain, to be able to exit the investment when they want, but not necessarily at the price they want.
This liquidity factor is a key issue and is often one of the biggest risks to an investor in an UCIS, EIS or VCT, particularly in the 'green' or 'renewables' area. A forest investment for example will normally require the investor to have a 10 year plus investment horizon and little ability to exit early if the investor needs the cash in an emergency. Equally while solar panels may be a good investment with the government Feed in Tariffs, there is no proven secondary market in the UK for these assets and investors need to go into such investments, whether they be in a VCT, EIS or a UCIS, happy with the income returns and not in a position in which they may need their capital back. It is this lack of liquidity which often stops pension trustees from allowing investors to use their pensions to buy an UCIS.
What are the FSA's concerns?
The FSA's biggest concern is that investors in UCIS are provided with the right level of information and have the ability to understand the risks involved in UCIS. This is because UCIS are often investing in illiquid assets, in new markets, or with untried technology. To this end there are various strict rules on the promotion of UCIS and information which needs to be provided initially to an investor to make an assessment of those risks. A number of UCIS have in the past resulted in investors losing substantial amounts of money (see recent SFO enquiry into Sustainable Agroenergy). In this scenario an IFA needs to be certain that they carried out sufficient 'due diligence' prior to recommending the investment and that the investment was 'appropriate' to the investor at the time.
Can your adviser recommend UCIS?
UCIS, EIS companies and VCTs are all issued with significant risk warnings and the first two can only be marketed to 'high net worth' individuals or 'sophisticated investors'. Investors though must realise that the structure of the investment is not the main risk factor to consider.
Many financial advice firms will not allow their financial advisers to recommend an UCIS. In theory this is because of the extra compliance risk and extra level of work needed to recommend these types of products. However, this is not always the case. There were for example IFAs who could recommend the 3 individual £2m solar EIS companies which Goldfield launched subsequent to their Solar EIS fund, but who could not recommend the Goldfield Solar EIS fund, which spread investors risk across five £2m EIS companies, because it was an UCIS. Thus regulation actually pushed some IFA firms towards a less diversified portfolio of assets because the alternative was an UCIS.
Ironically, it is often possible to buy these products without advice direct, or through an investment club provided you can demonstrate that you meet the requirements of a 'high net worth' or 'sophisticated' investor.
So why look for and invest in an UCIS?
While it is important to understand the regulatory implications of investing in an UCIS, an UCIS is simply a way of a group of people coming together to invest in something which they could not afford to do alone. All important is the investment proposition itself and what risks and returns this offers. While investing with others can often lead to illiquidity an UCIS can be used to buy real assets such as commercial property (where the UCIS structure is often to be found), or solar panels which have an income dynamic and risk profile which can compare very favourably, or at the very least be uncorrelated, to regulated investments and ordinary equities. To my mind it is therefore a very useful area for wealthy investors to be informed of and should be a part of an IFA's armoury.