The City watchdog is looking to restrict the power of some investment trust board members after criticism of its response to Saba Capital’s campaign against a group of UK funds.

The Financial Conduct Authority has proposed a series of amendments to the UK listing rules for close-ended investment funds, better known as investment trusts, in an attempt to “reduce the risk of harm” to smaller investors and allow boards to act independently.

Under current rules, the majority of boards must be independent of any investment manager in order to deal with conflicts of interest. However, the rules do not currently address situations where a board member has been originally nominated by a substantial shareholder.

The City watchdog argued this classifies as a conflict of interest and has now proposed banning them from voting on any board decisions, deals or fee arguments regarding the shareholder.

The FCA said in its proposal: “We consider this would complement and strengthen the existing requirements for a…board to act independently of its investment manager.”

Fee checks and voting power

The regulator also proposed to amend the definition of a related party to include incoming investment managers in a bid to prevent overcharging, as fee-protection rules are not automatically activated after the a new manager is hired.

If a fund wants to hire a new manager and the proposed fee structure triggers a percentage ratio of more than 0.25 per cent of the fund’s size, they must make a market announcement, secure board approval and hire an independent expert to verify that the fees are reasonable to shareholders.

For arrangements over five per cent, a full shareholder vote would be needed, with the related party unable to vote.

A fund must also get approval from the FCA and its shareholders if it wants to make material changes to its published investment policy.

But there are currently no restrictions on who can vote, allowing substantial shareholders with larger voting power to push through strategies for their own benefit, regardless of other shareholders.

The FCA proposed that larger shareholders who are appointed investment manager of the fund and associates should be strictly excluded from voting on a material change.

The watchdog said: “The intention is to help secure an appropriate degree of protection for shareholders in the instance that a substantial shareholder which is also an investment manager seeks…to amend the investment mandate for its own advantage.”

However, the body said it wished to hear views on the proposed rule and considered alternative options to the flat restriction, including a 20 per cent vote cap.

Saba woes

The consultation from the FCA comes as investment trusts criticise the regulator for failing to act against New York hedge fund Saba Capital.

Earlier this year, former Edinburgh Worldwide Investment Trust (EWIT) chair, Jonathan Simpson-Dent, accused the watchdog of leaving the industry exposed to aggressive activist campaigns despite the majority of shareholders rejecting them.

EWIT conceded defeat to Saba in April, after the investment trust failed to get enough votes in favour of the re-appointment of the five independent directors standing for re-election, which brought an end to Simpson-Dent’s tenure.

The hedge fund has set its sights on a number of struggling UK investment trusts, leading to alarm bells across the industry, which has called for stronger investor protection.

Richard Stone, chief executive of the Association of Investment Companies, said: “These proposals would strengthen investor protection, particularly when a substantial shareholder like Saba Capital seeks to replace the board and become the manager.

“They address a gap in the rules where a shareholder who wants to manage the company can seize control of the board to promote its own interests at the expense of other shareholders.”

Christian Pittard, Head of Investment Trusts and managing Director, Corporate Finance, at Aberdeen Investments, said: “The UK investment trust model is a genuine success story. Independent boards, real accountability of managers to shareholders, the flexibility of a closed ended structure that actually works in investors’ interests. And crucially, “one share, one vote” – giving shareholders a real voice, not a diluted one.

“The FCA is absolutely right to recognise that these features aren’t a flaw in the model, they’re the point.  But that doesn’t mean the job is done. There is always room to sharpen the rules where they fall short. That’s why we welcome the FCA’s decision to take a targeted, incremental approach rather than reach for wholesale reform. Getting this balance right matters: strengthening protections where needed, while preserving the ability of shareholders to engage.”

The consultation closes on 14 August.