Prior to Brexit more than 8,000 EEA-domiciled funds and sub-funds accessed the UK retail market via the “passporting” mechanism enshrined in the UCITS directive. This regime ended at the end of 2020. Whilst many EEA funds still access the UK via the temporary marketing permissions regime (TMPR), options for new retail funds wishing to access the UK market are currently limited.
This is set to change following the introduction of the UK’s Overseas Funds Regime (OFR), which will allow certain overseas funds formed under “equivalent” regulatory regimes to be marketed to retail clients in the UK.
However, a number of steps lie ahead before the new regime is operational. In this briefing we look at the new framework for retail investment funds and how the new regime may work in practice.
What is the current position?
There are currently two ways in which non-UK funds may be marketed to retail investors in the UK:
- EEA UCITS which were passported into the UK before the end of the Brexit transition period were able to apply to enter the TMPR. Currently some 160 standalone funds and 8270 sub-funds access the UK retail market in this way. The TMPR is now closed to new applications and was always intended to be a temporary fix, however the regime has now been extended until the end of 2025, in order to facilitate an orderly transition across to the OFR.
- Other non-UK funds 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 four stand-alone funds and 26 sub-funds currently being marketed in the UK.
What is the Overseas Funds Regime?
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 currently using the TMPR. The UK Government has therefore put in place legislation to allow for a more streamlined regime for overseas funds to gain UK marketing permissions. This is known as the Overseas Funds Regime or OFR.
The OFR for retail funds is now set out in Sections 271A to 271S of the Financial Services and Markets Act 2000. Funds recognised under the OFR will therefore be known as “Section 271A schemes” for UK regulatory purposes. However, although these provisions are now in force, the regime itself is not yet operational.
Once it is operational, the OFR will potentially be open to overseas retail funds from any countries whose regulatory regimes are judged “equivalent” – it will not be limited just to EEA funds. During its consultation, the Treasury stated that the 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:
- The fund’s home jurisdiction must have been granted an equivalence determination by the Treasury.
- The fund must be of a specific approved regulatory type.
- The fund’s operator must have applied for, and been granted, an order by the FCA granting recognition to the fund.
The Treasury will grant “equivalence” on a jurisdiction-by-jurisdiction basis. However, is only empowered to grant equivalence for categories of retail funds in a particular overseas jurisdiction where it is satisfied that:
- Its regulatory regime of that overseas jurisdiction provides investor protection which is at least equivalent to the investor protection provided by comparable UK retail funds; and
- There are adequate supervisory cooperation arrangements in place between the FCA and the regulators of that overseas jurisdiction.
The Treasury will seek advice from the FCA before making such equivalence determinations. As at the date of writing no such determinations have yet been made.
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 UK Government has emphasised 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 for each jurisdiction will be made 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. In imposing these conditions, the Treasury must keep in mind requirements imposed on comparable UK authorised funds.
Once equivalence has been granted to a fund’s home jurisdiction, the operator of the overseas retail fund will then need to register with the FCA to become “recognised” under the OFR.
The registration process is intended to be 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 the operators of 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, the operators of 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 FCA will have the ability to require operators of funds recognised under the OFR to pay fees to cover its additional costs. The FCA is likely to set registration and periodic fees for this purpose.
We are also waiting to see whether the FCA will require ongoing confirmations from operators overseas funds – for example, whether the FCA will require operators of overseas funds to confirm on an basis that their fund(s) continue to meet the requirements of the OFR.
Will UK retail investors be able to access the FOS or FSCS protection?
Currently EEA UCITS funds in the TMPR 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). This reflects the pre-Brexit position.
HM Treasury has now confirmed that this position will not change under the OFR. UK investors will 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 FOS or the FSCS where they purchase units in funds via a UK distributor (such as a UK platform).
It is likely that the FCA will mandate disclosures to ensure that UK investors understand that investment in an overseas fund will not provide them with the same UK regulatory protections as UK authorised funds.
Will operators of funds in the OFR be able to make financial promotions to UK investors?
There will also be changes to funds’ ability to make 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.
Will funds still be able to be marketed to UK investors under the s.272 route?
Yes, the s.272 route will remain available, but funds which are capable of being recognised under s.271A will not be able to use s.272.
This regime is currently being amended further to enhance its efficiency. However, there will be no changes to the fundamental features of this route, which will still require an overseas fund to undergo an in-depth assessment by the FCA and notification requirements.
With effect from 1 January 2023, fund operators will need to provide written notice of any proposed alteration to the fund only if it amounts to a “material alteration”. The FCA is currently consulting on the type of changes which could constitute a “material alteration” (see CP22/17).
At the time of writing, the FCA’s regulatory initiatives grid still note that the FCA is “working on operationalising the OFR” as it has been for some time. The FCA intends to consult on various aspects of the handbook rules to ensure OFR funds are appropriately captured. We await the first substantive consultation.
We also await an announcement from the Treasury regarding the first jurisdictions which may be deemed equivalent under the regime. Such an announcement will surely sound the starting gun to the implementation of the OFR and the phasing out of the TMPR.
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, October 2022