More than 8,000 EEA-domiciled funds and sub-funds currently access the UK retail market via the “passporting” mechanism enshrined in the UCITS directive. This “passporting” regime will cease at the end of the UK’s transition period – currently scheduled for the end of 2020.
The UK Government is now consulting on a new process for allowing investment funds domiciled overseas to be sold to UK retail investors.
The proposed Overseas Funds Regime (or OFR) will introduce two new routes into the UK based on the principle of equivalence: one for retail investment funds and one for money market funds.
In this briefing we provide an overview of the proposals for retail investment funds – focusing on the implications for EEA retail funds who wish to retain access to UK retail investors.
What is the current position?
There are currently two routes into the UK market for funds in other jurisdictions who wish to market to retail investors:
- EEA funds which are classified as UCITS can seek recognition from the FCA. Recognised UCITS are “passported” under s.264 FSMA and are listed as recognised funds on the FCA register. More than 170 stand-alone funds and 8,140 sub-funds are currently passported into the UK in this manner.
- Non-EEA funds (or EEA funds which are not classified as UCITS) can seek “individual recognition” under s.272 FSMA. This requires the FCA to conduct an in-depth assessment of the fund, the operator and the depositary. In practice this route is very rarely used and accounts for only 6 stand-alone funds and 26 sub-funds currently being marketed in the UK.
The “passporting” route for EEA UCITS will cease at the end of the transition period (currently scheduled for theend of 2020). However, all funds which have passported into the UK before the end of the transition period will be able to use the “temporary marketing permissions regime” (TMPR) for a limited time. Once the TMPR ends, the current withdrawal legislation anticipates that all EEA UCITS will have to apply for marketing permissions via s.272 of FSMA in order to access UK retail investors.
What are the UK Government’s proposals?
There has long been recognition that it would be extremely operationally burdensome for the FCA to process s.272 applications for the 8,000+ funds that have notified the FCA of their intention to use the TMPR after the end of the transition period. As expected, HM Treasury is now consulting upon a more streamlined regime for overseas funds to gain UK marketing permissions. This will be known as the Overseas Funds Regime (or OFR).
Crucially, the OFR will potentially be open to all overseas retail funds (not just EEA UCITS). HM Treasury has noted that this regime therefore has the potential to “promote the interconnectedness of financial markets and consumer choice, advance trading opportunities around the world, and support bilateral agreements with other countries.”
The s.272 route to marketing recognition will remain available for funds which are not eligible to be recognised through the OFR.
How will the OFR operate for retail investment funds?
For an overseas retail fund to be able to market to UK retail investors via the OFR:
- its home jurisdiction must have been granted an equivalence determination by HM Treasury; and
- the fund must then apply to the FCA for recognition.
HM Treasury will be able to grant equivalence for categories of retail funds in an overseas jurisdiction if it is satisfied that:
- its regulatory regime provides investor protection which is at least equivalent to the investor protection provided by UK retail funds; and
- there are adequate supervisory cooperation arrangements in place between its regulator(s) and the FCA.
HM Treasury will seek advice from the FCA before making such equivalence determinations.
Overseas funds need not be subject to the same regulatory requirements as UK FCA authorised funds in order for a jurisdiction to be judged “equivalent”. The consultation paper emphasises that there will be an “outcomes based” comparison. For example, within the UK, the management company and the depositary of a fund must be separate legal entities. However, a jurisdiction which does not have this requirement may still be judged to provide “equivalent investor protection” as long functional separation is maintained and other rules (such as prudential requirements relating to depositaries) are met.
The equivalence determination will be made on a country-by-country basis, by statutory instrument (SI). These SIs will also specify whether certain categories of funds in a particular jurisdiction must also meet additional requirements (above and beyond their home jurisdiction’s obligations) in order to register with the FCA under the OFR.
Once equivalence has been granted to its home jurisdiction, an overseas retail fund will then need to register with the FCA to become “recognised” under the OFR.
The registration process is intended to be simple and straightforward. The FCA will not be responsible for verifying that any fund seeking recognition complies with its overseas regulatory obligations. The FCA will be able to rely upon funds “self-certifying” that they are eligible for recognition – although it will be entitled to ask for evidence of funds’ authorisation in their home jurisdiction.
The FCA will be more involved where a jurisdiction’s equivalence determination states that a category of retail funds must adhere to additional requirements. Here the FCA may ask additional questions and/or require evidence to ensure that these additional requirements have been met.
The FCA will ordinarily have two months to consider applications for recognition. This may vary in the early days of the OFR when there will be many funds transferring across from the TMPR.
Will overseas funds be subject to FCA supervision?
The FCA will not act as a supervisory or enforcement body to funds recognised under the OFR – however, it will have powers of enquiry to ensure that such funds are adhering to UK law and regulation, such as FSMA and any additional requirements specified in relevant SIs.
In particular, the FCA will have the power to require information from all overseas funds accessing the UK market via the OFR and will have the power to suspend or revoke access where a fund does not comply.
In addition, such funds will be subject to notification requirements; they will be expected to inform the FCA where they make changes that might impact on their eligibility for recognition; and will be expected to immediately notify the FCA where they breach an OFR related requirement or another requirement under FSMA.
The UK Government is considering whether it will require managers of overseas funds to confirm on a regular basis that they still meet the requirements of the OFR.
The FCA will have the ability to require funds recognised under the OFR to pay fees in order to cover its additional costs. The FCA is likely to set registration and periodic fees for this purpose.
What additional obligations are under consideration?
The UK Government is also considering whether additional requirements should attach to funds recognised under the OFR.
Currently EEA UCITS funds which are marketed in the UK under the passporting regime are not subject to the jurisdiction of the UK’s Financial Ombudsman Scheme (FOS), nor are they covered by the UK’s Financial Services Compensation Scheme (FSCS).
However, UK investors do potentially have access to complaints resolution and to the compensation scheme of the fund’s home jurisdiction. Additionally, they may also have access to the UK schemes where they purchase units in funds via a UK distributor (such as a UK platform).
The consultation paper asks whether the jurisdiction of the FOS should be extended to cover funds which are recognised under the OFR. It also asks whether the FSCS should be extended to such funds. This would represent a significant change to the current position and would require all funds which are currently passported to review their prospectus disclosures prior to entering the OFR.
There will also be changes to funds’ ability to make financial promotions in the UK. Currently fund operators of UCITS passported into the UK are able to issue their own financial promotions in the UK. Under the OFR, overseas fund operators will need to put procedures in place to ensure that a UK authorised person makes, or approves, any financial promotion relating to the fund (unless the promotion falls within the scope of an exemption). Many of these funds are currently promoted exclusively by UK distributors and platforms in any event.
HM Treasury are currently seeking feedback from stakeholders on a number of key issues. The consultation is currently open until 11 May 2020.
A response to the consultation is expected to be published later in the year and the UK Government have confirmed its intention to publish a new Financial Services Bill in due course which will include the necessary legislative provisions to implement the OFR.
If you require further information about anything covered in this briefing, please contact Jessica Reed, or your usual contact at the firm on +44 (0)20 3375 7000.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, April 2020