Among the measures the Government is proposing as part of its Financial Services Bill package announced in the Queen's Speech is a new, hopefully simpler, change to the way in which overseas investment funds can be sold to UK investors.
When the Brexit transition period ends on 31 December 2020, the current rules that allow certain retail and wholesale funds constituted and managed in the EU to be marketed to UK investors will fall away. In the absence of knowing what, if any, alternative will be agreed between the UK and the EU, Treasury is taking the opportunity to undertake a fundamental review of how funds from any overseas jurisdiction can be marketed to UK investors.
Treasury says the current regime, regardless of Brexit, is not viable in the long-term, and proposes two new regimes, one for retail and one for money market funds.
On the retail side, the vast majority of overseas funds offered to UK investors are UCITS (Undertakings for Collective Investment in Transferable Securities, constituted and managed in line with EU Directives) from elsewhere in the European Economic Area (EEA). There are currently around 8,000 EEA UCITS that passport into the UK (nearly 4 times as many as there are UK-constituted UCITS), and these will still have the ability to do so until the end of the year, provided they have made the right notifications under the Temporary Permissions Regime ( TPR) introduced by the UK to help smooth the transition for firms currently relying on passports but ultimately wanting to continue business in the UK. Thereafter (or very soon thereafter) they will lose the ability to do so. They would then fall back on the existing regime for third party funds, under s272 of the Financial Services and Markets Act 2000 (FSMA), which requires an in-depth assessment of individual funds. Given that most passporting-in funds are benefiting from the TPR, this is an indication that they are likely to want to continue to market, and to make individual assessments of each under the current regime would be a significant operational challenge for the funds and the Financial Conduct Authority (FCA). So Treasury is proposing the Overseas Funds Regime (OFR) to take the place of s272.
S272 currently requires FCA to assess each application with a view to permitting the marketing of funds which meet the following requirements:
- It provides adequate protection to participants;
- The arrangements for the scheme's constitution and management are adequate;
- The powers and duties of the operator, and where relevant any trustee or depositary, are adequate;
- The operator, trustee and depository must be able to co-operate with FCA in information sharing and other ways;
- The scheme name must not be misleading or undesirable;
- The purposes of the scheme must be reasonably capable of being successfully carried into effect; and
- The participants must be entitled to have their units redeemed in accordance with the scheme at a price related to the net value of the property to which the units relate and determined in accordance with the scheme
What is "adequate" is assessed against the levels that UK authorised unit trusts, open-ended investment companies and authorised contractual schemes must meet, but the overseas fund must be an open-ended investment company with a "fit and proper" operator and, if relevant, trustee and depository. FSMA also gives guidance as to what FCA may take into account, and sets the framework for application – including that the applicant must give an address in the UK for service of notices on the fund operator. FCA then has 6 months within which to determine the application (or 12 months if it deems the information received is incomplete).
It is no wonder that not many funds apply for this status, and little doubt that the regime would not be sustainable for mass applications, with the result that the UK finds marketplace would be significantly damaged.
Money Market Funds
Money market funds (MMFs), while not UCITS, invest in liquid assets and provide an important cash management function for governments, corporates and financial institutions. Under the Money market Funds Regulation there is again a mechanism for qualifying funds to be marketed in the UK, which will fall away at the end of the transition period. Treasury says there are very few UK based MMFs, so it is important that investment in EU MMFs should still be possible.
EU funds that are not UCITS are, by default, alternative investment funds ( AIFs). As a result, they can be marketed to UK investors only:
- To professional investors under the terms of the AIF Managers Directive (AIFMD) or
- Otherwise, and this applies to EU and non-EU funds alike, to restricted classes of investors exempt from the FSMA financial promotion restrictions, under the National Private Placement Regime ( NPPR).
Treasury now proposes that the new OFR will apply to create a better, more streamlined, regime, for allowing retail and MMFs to be marketed to UK investors.
The OFR will operate under an equivalence regime, whereby the UK must grant equivalence to a jurisdiction, which will enable funds from those jurisdictions to benefit from the OFR. Treasury does not propose to repeal s272 FSMA, which will remain available for funds that are not eligible for the OFR because they do not have an equivalence determination.
An equivalence determination will allow:
- eligible retail funds to become “recognised” and able to be marketed in the UK; and
- eligible MMFs to gain "market access" to the UK – with a different process depending on whether the MMF wants to market to retail or professional clients.
Equivalence determinations will be made by statutory instrument. UK regulators will have the ability to make retail funds subject to appropriate requirements, including on disclosure, provision of investor facilities in the UK, reporting and fees, and will have the right to modify or withdraw determinations.
Treasury notes that sometimes funds are managed in a different jurisdiction to the one where they are domiciled and is willing in principle to allow this, provided the overall structure gives investors appropriate protection.
Decision making process
The equivalence determination process will be run by Treasury, after seeking advice from FCA and taking into account any other relevant factors. The key conditions will be that the regulatory regime of the relevant third country meets the required standard on an outcomes basis:
- for retail funds this means it must achieve at least equivalent investor protection to comparable UK authorised funds;
- for MMFs, the regulatory regime must be at least equivalent to the regime that applies to UK MMFs; and
- for either type of fund, Treasury must be satisfied there are, or will be, proper supervisory cooperation agreements between the FCA and the relevant overseas regulator.
Treasury will also have the right to require that the specified fund category must comply with additional requirements, if it thinks it necessary to ensure consistency and compatibility with the way the UK equivalent funds work.
Registering with FCA
Retail funds from jurisdictions with an equivalence determination will need to register with FCA. MMFs wanting to market to both professional and retail must either be from a jurisdiction which has an equivalence determination for both MMFs and retail funds, in which case they would register for recognition, or, if their jurisdiction is equivalent only for MMFs they will need to be recognised under the (amended) s272 procedure for retail marketing. MMFs wanting to market only to professionals will use the current NPPR notification mechanism.
FCA will have the power to suspend or revoke the recognition of a fund.
FCA's job will not be to check compliance by the fund with the relevant overseas regulations, and it is expected to rely on self-certifications from the funds stating that they are eligible, although it may ask for supplementary evidence. FCA will also have greater powers to impose additional informational requirements on the incoming funds, and will seek this information at recognition, similar to the current s272 regime, rather than as ongoing supervision. Treasury also proposes that FCA be able to require recognised funds to maintain facilities in the UK.
In terms of timing, FCA will normally have 2 months from receipt of a completed form to confirm registration or explain why a fund is not eligible. Reasons for refusal would include that the operator has knowingly or recklessly given FCA false or misleading information, that additional requirements would not be met or that it is necessary to protect the interests of potential UK participants.
MMFs wanting to market solely to professional clients will be able to continue to notify under the NPPR. If they want to market to retail clients as well, they will need to register as retail funds. They can do this either under the retail fund procedure outlined above, or, if they do not meet those conditions, can take the s272 route (as amended).
Reporting to FCA
Treasury proposes that operators of funds would need to notify FCA of any changes that might impact on their eligibility for recognition, and if they become aware that a fund has breached or is about to breach a relevant requirement. At that point, FCA may need to speak to the overseas regulator and consider whether the fund may continue to market in the UK, subject to any rectifications FCA might require. That said, FCA would have power to suspend or revoke recognition or market access of a retail fund or MMF.
Treasury is considering whether a regular confirmation that the fund continues to meet the conditions might be appropriate.
Ongoing obligations and financial promotions
There would be a number of ongoing obligations that would apply to all retail funds, regardless of whether FCA had applied specific additional requirements to any individual fund.
In terms of dispute resolution, Treasury is considering whether to extend the compulsory jurisdiction of the Financial Ombudsman Service (FOS) to cover funds recognised under the OFR, which would allow eligible UK complainants the automatic right to complain to FOS, but there would be practical difficulties in enforcing any FOS decision; and some commentators have suggested that FOS protection is a key benefit for investors, and to extend it to overseas funds would erode UK funds' potential competitive advantage. The other option is to build into the process the requirement to be able to rely on the home regulator's alternative dispute resolution (ADR) facility (but of course FOS would still be available for complaints relating to distribution activities undertaken in the UK).
On compensation in the event of fund default, the Financial Services Compensation Scheme (FSCS) would not currently cover overseas funds. Treasury is not convinced that there is a need to extend it, given that it is not aware that any UK investors in currently recognised funds (whether from within or outside the EU) have suffered losses because of a lack of an appropriate compensation scheme.
So Treasury is inclined merely to deal with the ADR and compensation points by way of disclosure, and seeks views on whether investors should expressly acknowledge their understanding of the consequences. This is separate to other investor disclosures – Treasury is aware that the PRIIPs disclosure regime is not popular but this is not the purpose of the current consultation, and says the current practice of FCA to require certain disclosures in the scheme particulars of the fund should be unaffected.
In terms of financial promotions, Treasury proposes that the operators of funds will not be considered authorised persons (unlike operators of currently passporting funds), and therefore an authorised person will need to approve their financial promotions, unless they fall within an exemption. Treasury is also seeking views on whether there may be any need to include these funds within the FOS and FSCS.
Finally, FCA will have the ability to charge appropriate registration and periodic fees; and Treasury plans that ISA wrappers will be available to recognised retail funds.
Changes to s272
The final part of the consultation looks at how to amend the current s272 process, which will still be required for funds that cannot use the OFR. It plans to simplify the current process so that:
- FCA needs to consider only matters which are the subject of current rules (rather than the current position, where it needs also to consider matters that could be the subject of rules);
- FCA can decide which changes it needs to approve (as opposed to having to approve all changes, however minor or irrelevant);
- No longer requiring advance notice of changes to the operator, trustee or depositary.
What does this mean?
While the changes are clearly a result of Brexit, and designed to enable EEA UCITS to be able to be marketed in the UK after the end of 2020, they should have a positive impact for the wider funds community as the new OFR will allow the UK to decide which non-EEA jurisdictions should be regarded as equivalent for the marketing of, particularly, retail funds. In principle, this should be good both for investors and for competition. And, for those funds that will not qualify under the OFR, the changes to the currently clunky s272 regime can only be an improvement, while the NPPR will be unaffected by these proposals.
Consultation closes (currently) on 11 May.