Medicinal Cannabis in the UK: Fund Structuring, Investment and Listing Considerations

The value of the global medicinal cannabis market is projected to reach US$62.7 billion by 2024, with over US$22 billion of that market generated by Europe and an estimated excess of £2 billion likely to be generated in the UK. Despite the potential scale of this nascent market, the UK seems to be relatively slow to issue permissions for medical cannabis companies to operate, with only two licences issued as of January 2021 for the cultivation of medicinal cannabis in the UK.

Investing in medical cannabis involving the UK takes three main forms:

1. structuring and operating an investment fund (potentially domiciled in the UK) planning to invest in medicinal cannabis assets (whether inside or outside of the UK);
   
2. deploying capital to acquire or invest in medicinal cannabis companies (whether inside or outside of the UK);
   
3. and listing a business on the UK markets which operates in the medical cannabis area.

1. Medical Cannabis Fund Formation, Management and Marketing

Fund Formation

1.1 The first issue fund managers will need to consider when establishing a fund with the intention of investing in medicinal cannabis is where they wish to domicile the fund. For fund managers seeking to launch a medicinal cannabis fund, the normal domicile decision (typically based on tax and market expectations) can be much more complicated. This is because in many jurisdictions, the laws relating to medicinal cannabis are not clear and it may be difficult to identify a jurisdiction in which the fund can be domiciled with the clear support of local regulators.

1.2 For example, in certain jurisdictions, such as the Cayman Islands and Bermuda, provided that the underlying activities in which the fund invests are legal in the jurisdiction in which they are carried out, the fund should not face obstacles with the local regulators. Other jurisdictions, such as the Channel Islands, may require that the underlying activities in which the fund invests are legal not only in the jurisdiction in which they are carried out, but also locally. In a jurisdiction where this is the case, fund managers will need to consider not only relevant local laws, but also laws relating to secondary offences such as proceeds of crime laws. Local legality may not always be a straightforward analysis. For example, in the United States, where most medical cannabis investment is currently taking place, there is currently a discrepancy between laws at the state and federal level that may make it difficult to domicile a fund, even in jurisdictions where it is sufficient that the underlying activities in which the fund invests are legal in the jurisdiction in which they are carried out. Prospective fund managers should therefore be mindful of the local regulatory environment in the jurisdiction in which they intend to domicile the fund and may wish to consider approaching local regulators on a “no names” basis to test the waters before making a decision. They should also seek careful advice from counsel.

Fund Management

1.3 Once a fund manager has determined where to domicile their fund, they will need to consider structuring the management entity. Broadly, the issue in relation to advising on investments in medicinal cannabis companies that UK investment managers should understand revolves around the Proceeds of Crime Act 2020 (“PoCA”) and whether the fees (both management fees and performance fees) they receive from the fund are (indirectly) proceeds of a criminal activity with the consequent risk that PoCA offences are committed.

1.4 No formal guidance on this topic has been issued by the authorities, and therefore it appears that a fund manager in the UK does not yet have complete clarity as to whether or not they may be caught by the legislation. While PoCA provides for a mechanism for UK fund managers to self-report and for the National Crime Agency (“NCA”) to consent to such activity, the NCA has so far exercised its discretion to neither grant nor deny consent to deal when a suspicious activity report (“SAR”) is filed and therefore it is left to the UK investment manager to determine (usually on the basis of careful legal advice) whether they would be committing an offence. For further details on the SAR process and potential delays this may cause for investments, see section 2 below.

1.5 The UK’s anti-money laundering laws are contained in Part 7 of PoCA. They criminalise dealing with, or entering into arrangements in respect of, the proceeds of “criminal conduct”. Importantly, the definition of “criminal conduct” in PoCA captures conduct which is lawful overseas, but would be a crime were it to occur in the UK. If this definition catches revenue generated by an overseas licensed cannabis producing portfolio investment, then the anti-money laundering responsibilities established by PoCA and subsidiary legislation could be engaged, meaning that the adviser will commit an offence if it receives fees related to these activities. Investors in the fund may also find themselves committing an offence when they receive distributions from the fund.

1.6 The legality of any investment scheme or product is fact specific. However, it is possible that a UK investment manager will not fall foul of the UK’s anti-money laundering rules in a situation where:

1.6.1 an investment (whether by share acquisition or otherwise) is contemplated in, and returns are thereafter intended to be received from, an overseas cannabis production and/or distribution business;

1.6.2 this business is licensed and operating lawfully in the country in which it is carried out;

1.6.3 the nature of the overseas cannabis production business is in the public domain; and

1.6.4 neither the fund nor any agent or subsidiary through which an investment is undertaken is suspicious that it is being misled or deceived about the investments, the transactions comprising the underlying business or the participants in it.

1.7 It is important to note that, at the time of writing, there is considerable debate about the application of PoCA to investments in medicinal cannabis outside of the UK and the analysis in each case will be extremely fact-specific and there may currently be some divergence of opinion. Until such time as guidance is received from the authorities, the laws are clarified or there is a consensus opinion in the market, fund managers would be wise to seek specific legal advice.

Fund Marketing

1.8 Once a manager and fund have been formed and are suitably domiciled, the next step will be to raise capital for the fund. When marketing the fund in different jurisdictions, UK investment managers should note that each jurisdiction will have its own rules in relation to marketing a fund, and possibly further rules relating to marketing a fund investing in the medicinal cannabis sector.

1.9 Similarly to the issues faced by a UK investment manager, it is important for investors to understand how the returns from their investments in a fund investing in the UK medical cannabis sector will be treated in their jurisdiction, and in particular whether they will be considered to be proceeds of a “criminal activity”. It therefore falls to each investor to determine this in accordance with the relevant legislation in their own jurisdiction.

1.10 Finally, as with all medical, scientific or research-based investment strategies which are rapidly evolving, managers of funds investing in medicinal cannabis must take care when presenting the investment strategy and producing marketing documents (such as the prospectus) as the investment strategy sections will likely provide forward-looking statements regarding an industry which remains largely unresearched in comparison to other, more mature, industries. Disclosures and disclaimers will need to be carefully reviewed to ensure that any such statements are properly qualified, otherwise investors may seek to claim against the fund for losses caused by any of those statements subsequently being found to be untrue.

2. Investing in Cannabis-Related Businesses Under the UK Regime

In this section, we give an overview of the key legislation and risks downstream investors (e.g. private equity funds) should be aware of when investing in UK-based medicinal cannabis-related businesses in the UK, and we give a brief overview of current and prospective developments in the field.

The UK Medicinal Cannabis Legal Landscape

2.1 Downstream investors in the UK seeking to invest in businesses whose operation involves cannabis face a number of issues depending on whether the target in question is a business licenced to operate with cannabis in the UK or overseas.

2.2 Broadly, the key pieces of legislation relating to the licensing of cannabis production, trade and possession, as well as related obligations for investors investing in cannabis businesses in the UK, can be split into three categories:

2.2.1 United Nations (“UN”) conventions governing controlled and psychoactive substances in member states¹;

2.2.2 UK legislation giving effect to the relevant UN conventions by (i) governing the licensing, production of, trade in and possession of controlled drugs; and (ii) governing the marketing and licensing of medicinal products (“Medicines Regime”)²; and

2.2.3 money laundering obligations derived from UK and EU legislation (in the form of retained EU rules), placed on investors and professional advisers (such as bankers, lawyers and others) facilitating investment into cannabis-related businesses (“AML Regime”)³.

2.3 Cannabis is a Class B controlled drug under the Medicines Regime⁴ and as such, it is unlawful to cultivate, possess, supply, produce, import or export this drug and its derivatives except under a UK Home Office licence. It is important to note that, even if a company never physically handles a controlled drug product but transfers legal title to the same from one company to another in the UK, there is a risk that this could be viewed as a “supply” or “offer to supply” under the Medicines Regime, thus requiring a licence.⁵ This means that in theory, a private equity investor who plans to acquire or invest in a UK-based medicinal cannabis related business may require a UK Home Office licence for such activity. This is a point on which we suggest that legal advice is obtained in relation to each specific situation.

2.4 At the end of 2018, the UK government amended parts of the Medicines Regime to allow cannabis-based products to be employed for medicinal use in humans (“CBPM”) – a defined category of cannabis, cannabis resin, cannabinol and cannabinol derivatives – provided (i) the CBPM is not an investigational medicinal product and is prescribed by a specialist medical practitioner; or (ii) it is an investigational medicinal product without a marketing authorisation for use in a trial; or (iii) it is a CBPM with a marketing authorisation⁶ (e.g. such as GW Pharmaceuticals’ Epidyolex product)⁷.

2.5 Specifically in relation to CBPMs, provided that a business is licensed by the UK Home Office under the Medicines Regime (which includes limb (iii) above), there is no prohibition to investing in it.

2.6 However, where the target cannabis business operates overseas, difficulties may arise for UK investors if the target has not been issued with local licences in the overseas jurisdiction and does not operate in full compliance with its legal obligations. Under the Medicines Regime, it is an offence for anyone who assists or induces the commission of an offence punishable under the provisions of a corresponding law in force in any place outside of the UK. Consequently, a UK investor that invests in an overseas target which is not compliant or not fully compliant with the provisions of the applicable local equivalent to the Medicines Regime⁸, risks falling foul of the UK Medicines Regime. Specific due diligence on a cannabis business, or a target itself holding interests in cannabis business (supported by robust local legal and regulatory analysis) will be vitally important to mitigate investment risk.

2.7 In addition, where the overseas target is not fully compliant with the local regulatory regime, or where the conduct is compliant with overseas regulations, but the conduct is unlawful according to UK legislation (e.g. the supply of cannabis for recreational use), the income generated by an investment in the same could trigger AML Regime obligations on the UK investor under the PoCA. Under PoCA, relevant offences include (i) concealing, converting or transferring criminal property; (ii) entering into or becoming involved in an arrangement to launder; (iii) using, acquiring or possessing criminal property. As mentioned in section 1 above, a UK investor may be at risk of inadvertently committing each of these offences because “criminal property” is defined as including property which has been obtained as a result of or in connection with conduct which, if carried out in the UK, would be criminal (e.g. cultivating cannabis without or not in compliance with a licence). Where PoCA is triggered in this way, the risk of liability under these offences can be neutralised if a SAR – a report alerting the NCA to potential money laundering or terrorist financing activity – is made to the NCA and consent is obtained to carry out the conduct. A further issue to take note of is the potential delay to the transaction timeline if a SAR has to be filed.

2.8 Where a SAR is filed:

2.8.1 unless there is a refusal from the NCA to allow such an investment to proceed within 7 working days from the first working day after the SAR is filed, the consent is deemed to be given⁹;

2.8.2 where the consent to proceed is refused, there is a moratorium period of 31 calendar days (starting on the date of the refusal notice), where the UK investor may not proceed with the investment. This period of moratorium can be extended by a court order for up to 186 days.¹⁰

2.9 Despite the potential delay to investments, where a UK investor is unsure whether to file a SAR to the NCA, in many cases it is best to submit a report, as any other parties facilitating an investment where a suspicion of money laundering arises in this way (e.g. bankers, lawyers, accountants and other parties involved in the relevant transaction) are likely to file a SAR in any case.

2.10 Given the present uncertainties in the application of some of the UK legislation pertaining to medicinal cannabis investments, it is important to proceed on the basis of specific advice taking into account all of the relevant facts around a proposed investment.

3. Listing on the London Stock Exchange

The legalisation of medicinal cannabis in the UK in 2018, mentioned previously, was inevitably of considerable interest to UK institutional investors keen to develop a potentially substantial investment opportunity in a new asset class. However, the reality of companies and investors being able to participate in this new market has been slowed by certain factors, including the PoCA complexities referred to above.

FCA Guidance

3.1 The UK Financial Conduct Authority (“FCA”) received a large number of queries and requests for guidance from companies focused on the medical cannabis market looking to take their company public on the London Stock Exchange (“LSE”) (either on to the Official List maintained by the FCA of securities issued by companies traded on the LSE’s Main Market or onto AIM, the market operated by the LSE designed primarily for emerging or smaller companies). On 18 September 2020, the FCA published their approach to listing companies operating in this industry on the Official List, which can be found here. It should be noted that whilst this guidance does not apply to any companies wishing to list their securities on AIM, we expect the AIM team to track the approach suggested by the FCA.

The key themes of the FCA’s guidance are as follows:

1. Recreational Cannabis Companies: The proceeds from recreational cannabis companies, even when they are located in those jurisdictions that have legalised it, are considered to be proceeds of crime by the FCA and therefore the securities of such a company would not be admitted to listing on the Official List in the UK.
   
2. UK-Based Medicinal Cannabis Companies: UK-based medicinal cannabis companies can have their securities admitted to listing on the Official List (provided they have the requisite Home Office licences).
   
3. Overseas Medicinal Cannabis Companies: Overseas licensed companies may have their securities admitted to listing on the Official List provided PoCA does not apply and they satisfy the other eligibility criteria for listing. However, such overseas companies will need to satisfy the FCA (i) as to the PoCA risk (and the FCA will need to understand the legal basis of the company’s overseas activities, for example, the nature of the local licensing and the licences the company holds) and (ii) that their activities would be legal if carried out in the UK.
   

Questions remain; further FCA clarity required

3.2 The FCA guidance does not expressly capture non-medicinal (and non-recreational) cannabis companies, for example “wellness” companies supplying CBD oils and tinctures (which are low in Tetrahydrocannabinol [THC], the principal psychoactive constituent of cannabis). However, a prudent assumption would be that the products of overseas “wellness” cannabis companies would need to fall under the UK thresholds for those products (i.e. 0% THC), even if the products are not marketed in the UK and are not considered to be recreational cannabis products overseas.

3.3 This question of UK legality equivalence also gives rise to some practical issues (yet to be formally clarified by the FCA) – one view, confirmed by other market participants, would suggest the comfort required by the FCA could be given by way of the provision of a legal opinion under the local law of the overseas company stating that the company holds the necessary regulatory licences to operate under the local jurisdiction; with a further legal opinion by English lawyers explaining to the FCA how the activities of the overseas company would be legal “if carried out in the UK”, noting the equivalent measures in place under the UK licensing regime; and confirmation that the company is not involved with recreational cannabis in any capacity.

3.4 The FCA has confirmed that it applies a strict interpretation of PoCA (that may prove to be stricter than that applied by the English courts) which may have broader implications than listing applications and could leave UK companies with overseas investments in the cannabis industry with difficult decisions about how to realise or otherwise operate investments that may fall foul of the FCA’s strict interpretation of PoCA.

3.5 Clearly, issues remain to be clarified and as the lawful cannabis industry grows overseas, the UK government could choose to provide further guidance in this area. The FCA has stated that a guidance consultation in relation to the views expressed on listing applications will follow in "due course" and, if so, this would be of potentially considerable interest to the market and its participants. That said, some companies feel able to operate in the current environment and MGC Pharma floated on the London market earlier this year (the first medicinal cannabis related company to join the main market), Kanabo reversed into Spinnaker Opportunities plc and Oxford Cannabinoid Technologies Holdings PLC recently completed its London IPO. Each of these companies is assumed to have satisfied the FCA’s requirements.

Footnotes

1. Single Convention on Narcotic Drugs of 1961; Convention on Psychotropic Substances 1971; Convention against the Illicit Traffic in Narcotic Drugs and Psychotropic Substances 1988
2. Misuse of Drugs Act 1971 (MDA 1971); Misuse of Drugs Regulations 2001 (MDR 2001); Medicines Act 1968 and Human Medicines Regulations 2012
3. Proceeds of Crime Act 2002 (POCA); Money Laundering Regulations 2017; relevant parts of the FCA Handbook
4. Part II, Sch.2, MDA 1971; Sch.1, MDR 2001
5. This is reported as a view taken by the Medicines and Healthcare Products Regulatory Agency. Secondary source: click here.
6. Section 16A MDR 2001
7. Home Office Circular, re-classifying Epidyolex in the UK as a drug under Sch. 5 MDR 2001: https://www.gov.uk/government/publications/circular-0012020-epidyolex-scheduling-si-2020-no-559/circular-0012020-epidyolex-scheduling-si-2020-no-559
8. Section 20 MDA 1971
9. Section 335 POCA 2002
10. Sections 336A-D POCA 2002