The UK Overseas Funds Regime
The UK government has outlined a new overseas funds regime in the Financial Services Bill 2019-21. The regime, once passed, will provide a framework for non-UK funds to be marketed to retail investors in the UK after Brexit.
The government intends the Financial Services Bill (the “Bill”) to be the first step in shaping a regulatory framework for the UK’s financial services sector outside of the EU. In its press release, HM Treasury highlights a number of specific objectives, including promoting openness between the UK and overseas markets, for which the overseas funds regime (the “OFR”) is one part. See our separate note on the other aspects of the Bill. Changes to the current draft of the Bill may be agreed during the parliamentary process, however it is expected to become law before the end of the Brexit transition period (which, if not extended, will be 31 December 2020).
The OFR proposals follow a consultation by HM Treasury which ran from March to May 2020. Our note on the consultation is available here. HM Treasury published its consultation response on 9 November 2020. The rules in the Bill largely follow those proposed in the consultation with a few modifications.
Temporary Marketing Permissions Regime
In its consultation on the OFR, HM Treasury noted that there are in excess of 8,000 EEA UCITS currently marketed in the UK under the passporting regime. Passporting will cease at the end of the transition period. A short-term temporary marketing permissions regime (the “TMPR”) will operate immediately after the end of the transition period to ensure that funds being marketed in the UK prior to that date can continue to access the UK market for a limited period, provided such funds notify the FCA of their wish to continue marketing under the TMPR.
Currently, funds which cannot benefit from a passport to market to retail investors in the UK (for example because they are a non-EU fund) can apply for individual recognition to be able to do so under section 272 Financial Services and Markets Act 2000 (“FSMA”). This requires an in-depth assessment by the FCA to ensure that the fund affords adequate protection to UK investors and meets several other UK tests. Given the significant number of funds which would need to be assessed for suitability to market in the UK after TMPR, a more streamlined process is needed to achieve this in a timely manner. The OFR will therefore give HM Treasury powers to determine whether an overseas jurisdiction and type of fund is “equivalent” to a UK authorised fund. If so, that type of fund can benefit from a fast track process to be recognised and registered for marketing to retail investors in the UK.
The TMPR was originally planned to run for up to three years, with funds allocated “landing slots” during that period to apply for full recognition in the UK, however the Bill extends the TMPR period to five years, i.e. to end of 2025 for UCITS. This is intended to allow enough time for the UK equivalence assessments to be carried out, and for UCITS to then exit the TMPR by applying for recognition either via the OFR or via s272 FSMA.
Ordinarily the FCA would have a two-month timeslot to consider applications under the OFR, but this has been disapplied for those funds leaving TMPR to ensure the FCA will be able to effectively manage the flow of funds leaving the TMPR.
The proposed Overseas Funds Regime
There will be two new equivalence regimes based on the principle of ‘outcomes-based equivalence’: one for retail investment funds and one for money market funds (“MMFs”). HM Treasury will assess different overseas regulatory regimes applicable to particular types of fund and determine whether they are “equivalent” to comparable UK authorised funds and hence benefit from the OFR recognition process.
The retail equivalence regime in the OFR and s272 FSMA applies to both a collective investment scheme as a whole, and to parts of a scheme, i.e. the sub-funds. Application for recognition is to be made at sub-fund level - this is because sub-funds under the same umbrella may differ in their characteristics, meaning that they may not all fit the criteria of an equivalence determination.
Retail investment funds
Funds using the new OFR will be known as “section 271A schemes”, and the provisions are set out in new sections 271A to 271S to be included in FSMA by the Bill.
Equivalence assessment: The conditions to be satisfied when granting equivalence for retail funds remain unchanged from the proposals in the consultation. Different regulatory regimes for overseas retail funds can be determined equivalent to the most relevant (i.e. comparable) type of UK authorised fund, if they provide at least equivalent investor protection. HM Treasury must also be satisfied there are, or will be at the point of recognition, adequate supervisory cooperation arrangements between the FCA and the national regulator in the overseas country. HM Treasury will specify jurisdictions and types of fund that have been assessed as “equivalent” by way of statutory instrument.
HM Treasury will have the power to modify or withdraw an equivalence determination, subject to a transitional period during which those funds can apply for individual recognition under s272 FSMA, if equivalence is withdrawn. Existing investors in such funds would not be required to divest, however.
Additional requirements: The Bill also includes an ability for HM Treasury to impose additional requirements on overseas funds. Additional requirements may be necessary in relation to aspects of the UK framework which are judged to be important to ensure consistency between overseas funds and those on offer in the UK. Any such requirements will be made in separate statutory instruments, alongside the equivalence determinations, and are not specified in the Bill itself. The FCA will also have the power to make or amend its rules to give effect to any additional requirements. A provision has been included in the Bill which requires HM Treasury to have regard to what is required of comparable UK authorised funds when specifying additional requirements for overseas funds - this was included to address concerns about proportionality raised by respondents to the consultation. The FCA will also have information gathering powers, for example to require certain ongoing reporting from overseas funds.
Recognition and notification processes: Following an equivalence determination, retail funds will be required to register with the FCA to become recognised. This process is intended to be simple and straightforward – the FCA will not be responsible for verifying funds’ compliance with the overseas regulatory regime and will be permitted to accept self-certifications from funds that they are eligible for recognition. However, if HM Treasury has imposed additional requirements in respect of the relevant type of fund, the FCA will need to be satisfied that the relevant fund complies with those and will gather relevant information from the fund at the time of registration. The FCA will ordinarily have two months to confirm a fund’s recognition or provide reasons why it is not eligible.
Suspension or revocation of individual funds: The FCA will have the power to suspend or revoke recognition of an individual fund.
Financial promotion: Operators of funds recognised under the OFR will not be deemed authorised persons in the UK for financial promotion purposes, which differs from the current approach for passported UCITS but is similar to the approach taken for funds recognised under s272 FSMA. This means that financial promotions for funds recognised under the OFR will need to either be approved by a UK authorised person or fall within an exemption to the financial promotion rules.
Money Market Funds
A slightly different process applies to money market funds. The Bill modifies the EU’s Money Market Funds Regulation 2017 as it applies in the UK after the end of the Brexit transition period, to include a new process for marketing such funds in the UK to professional and/or retail investors, through a new Article 4A. Under the MMF equivalence regime, HM Treasury must be satisfied that the regulatory and supervisory regime of the overseas country or territory has equivalent effect to the MMF Regulation in the UK.
MMFs marketing to retail and professional investors would need to benefit from both an MMF equivalence determination and a retail fund equivalence determination, and will then need to follow the recognition process outlined above for retail funds. If they are missing a retail fund equivalence determination for their jurisdiction, then they will need to apply under s272 FSMA for individual recognition before they can market to UK retail investors.
MMFs which choose to market solely to professional investors will need to benefit from an MMF equivalence determination and must then follow the notification procedure under the UK’s national private placement regime.
Section 272 schemes
As noted above, the current process for overseas funds to become individually recognised to market to retail investors in the UK is under s272 FSMA. This regime will remain in place for funds which do not benefit from a blanket equivalence assessment under the OFR, however the Bill makes some changes to the regime. In particular, the FCA is currently required to have regard to any rule of law and any matters which are or could be the subject of rules, when assessing an individual fund under s272 FSMA. The government will change this so that the FCA only needs to consider matters which are the subject of current rules. There will also be some relaxation about which types of changes to the fund that the FCA would need to approve.
The future of UK financial services
On 9 November 2020, the Chancellor made a statement on the UK's future approach to financial services. In that statement, the Chancellor announced that to further enhance the UK’s attractiveness for asset management, the government will soon publish a consultation on reforming the UK’s funds regime. To encourage investment in long-term illiquid assets, such as infrastructure and venture capital, the Chancellor announced his ambition to have the UK’s first Long-Term Asset Fund launch within a year. A number of equivalence decisions were also announced – see our separate note here.
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