Open for business: Proposal for a streamlined UK regime for overseas funds post Brexit

• United Kingdom

• Financial services and markets regulation

24-03-2020

Cross-border fund marketing arrangements into the UK are poised to be significantly amended when the current post-Brexit ‘transition or implementation period’ (“TIP”) comes to an end on 31 December 2020.  Retail funds’ ‘passporting’ rights under the Undertakings for Collective Investment in Transferable Securities Directive (“UCITS”, or the “Directive”) will fall away at the end of the TIP.  The ‘temporary marketing permissions regime’ (“TMPR”), which will come into force on 1 January 2021, is only available to existing funds which have applied to participate in it and is time limited to a maximum of three years.  A new, standalone regulatory architecture will be required to regulate overseas UCITS’ post-Brexit marketing rights to UK investors (both retail and professional) and the necessary Financial Conduct Authority recognition processes, with money market funds (“MMFs”) a particular concern.  On 11 March HM Treasury published a consultation paper, Overseas fund regime – a consultation (the “Consultation”) to consider how the regime might look.

The proposed regulatory structure is to be known as the ‘overseas funds regime’ (“OFR”), which will provide for a streamlined recognition of funds domiciled in jurisdictions which HM Treasury (“HMT”) has determined to have financial regulation that delivers equivalent outcomes to UK regulation.  Awareness of the development of the OFR will be crucial for EU UCITS and MMFs wishing to market to UK investors after the end of the TIP.

The proposed approach is very welcome for, as the law currently stands, funds would otherwise need to be individually recognised under section 272 of FSMA 2000 after the end of the TMPR, a process which is recognised to be onerous and time consuming.

Replacement of UCITS passporting and the TMPR

UCITS currently benefit from ‘passporting’ rights under the Directive. UCITS funds acquire an automatic pan-European marketing right in respect of retail and professional investors in any European Economic Area (“EEA”) state, once they are authorised by the national competent authority (“NCA”) in the EEA state in which they are domiciled.  This ‘passporting’ right ensures automatic recognition in the UK once the FCA is notified of a fund’s overseas authorisation by its NCA.

Any UCITS fund exercising its passporting right to market to UK investors before the end of the TIP can apply to participate in the TMPR under which that fund will be permitted to continue to market into the UK after the end of the TIP.  Funds in the TMPR will be given a landing slot, during which they will be expected to obtain formal FCA authorisation.  Funds in the TMPR which choose not to apply for formal authorisation or which are rejected by the FCA will have to wind down their UK business before the end of the TMPR.

Overview to the proposed overseas funds regime (reviving section 270 of FSMA 2000) and Section 272 FSMA 2000

The OFR will be similar in many respects to its precursor under Section 270 of FSMA 2000.  It provides for the recognition by HM Treasury of other countries’ regulatory frameworks for funds (including EU UCITS and MMFs) for the purposes of marketing.  Section 270 provided automatic authorisation of certain funds located in certain prescribed jurisdictions – Jersey and Guernsey for example – based on the FCA’s assessment of those jurisdictions’ regulatory regimes for funds.  

The OFR will operate on the principle of ‘equivalence’, which HMT proposes to determine on an ‘outcomes basis’.  Once a jurisdiction is found to be equivalent, new funds regulated in that jurisdiction will be able to request recognition from the FCA.  Ordinarily the FCA will have 2 months, following receipt of a completed registration form, to either confirm a fund’s recognition or provide reasons why the fund is not eligible.

The OFR will provide for two separate regimes supervised by the FCA: one in respect of MMFs; and one in respect of retail funds.  Currently, the vast majority of MMFs operating in the UK are passported in from an EU27 country, and the vital role they play for UK investors has prompted the proposed new regime.

The Consultation proposes that Section 272 FSMA 2000 be retained in an amended form as a mechanism recognition of individual overseas funds domiciled in jurisdictions which HMT has not determined to be equivalent.

Equivalence frameworks

The OFR will comprise two separate ‘equivalence’ frameworks for retail funds and MMFs.  HMT will have the power to make equivalence determinations in respect of other jurisdiction’s regulatory regimes.  Once equivalence is found, overseas funds from that jurisdiction can then obtain FCA recognition for the purposes of Part 17 of FSMA 2000.  That recognition will confer the right to market to UK retail and professional investors.

In practice, an equivalence determination will be subject to two express conditions (as well as being guided by FCA advice):

• for retail funds, the regulatory framework of the overseas jurisdiction must afford investor protections at least equivalent to those provided by UK regulation for comparable UK authorised retail funds (the question will how equivalence is judged, against the detailed requirements of COLL, such as the value for money rules)
• In respect of MMFs, the regulatory framework of the jurisdiction must be equivalent to that which applies in the UK
• HM Treasury must be satisfied that there are, or will be, sufficient supervisory co-operation arrangements between the FCA and the regulator in the overseas fund’s domicile, which in practice will require the agreement of a suitable memorandum of understanding between the FCA and the equivalent regulator(s) in the relevant jurisdiction.  There are already precedents in place for this eg the Memorandum of Understanding (“MoU”) in place with the Hong Kong regulator, the Securities and Futures Commission

‘Outcomes-based’ equivalence: how might this concept operate in practice?

An outcomes based equivalence determination takes as its end goal whether an overseas jurisdiction’s regulatory framework provides ‘equivalent investor protection’.  Accordingly, when assessing the regulatory framework of an overseas jurisdiction, HMT will look to the substance rather than precise form of such regulation, which will permit a far greater flexibility in determining ‘equivalence’ than ESMA and the Commission are afforded under their rules.

Discrepancies between the regulation of an overseas jurisdiction and that of the UK regulation will not necessarily prevent a determination of equivalence. For instance, an overseas regulatory regime which does not require a fund’s management company to be in a separate legal group from its depositary (which would not be acceptable under current UK regulation) would not necessarily be a bar to HMT making a finding of equivalence, provided that the regulations of the overseas jurisdiction requires the depositary to be sufficiently independent in function and substance.

Where there are discrepancies, the FCA may impose additional requirements on overseas funds to ensure that they offer investor protections more consistent with those available under UK regulation.

HMT will also have the ability to modify or withdraw an equivalence determination.  For example, in response to material changes in the regulatory regime in either the UK or the overseas country, and where the supervisory cooperation arrangements and dialogue between the two countries have not been able to find a way to reconcile those changes in the context of outcomes-based equivalence.

FCA powers under the OFR regime

As overseas funds are already subject to the supervision of regulators of their domicile, the FCA will be given limited supervisory tools and powers in respect of the OFR.  Those powers will be exercised in conjunction with co-operation arrangements with such domestic regulators.  Such powers will encompass:

• registration of overseas funds
• refusal of recognition
• suspension or revocation of recognition
• requiring the provision of information.

Further, certain obligations will apply to all overseas funds marketing in the UK.  The nature of these obligations will very much depend on whether funds are marketing to retail or professional clients.

Retail funds recognised under the OFR will be subject to obligations such as those on:

• alternative dispute resolution (“ADR”): the government is considering two policy options, namely to expand the Financial Ombudsman Service (“FOS”) to cover funds recognised under OFR, or that a requirement for equivalence is that UK investors have access to an appropriate ADR facility in the overseas jurisdiction
• financial compensation: the government is considering whether the Financial Services Compensation Scheme (“FSCS”) should be expanded to include funds recognised under the OFR
• tax incentivisation: under the OFR, recognised retail funds will also become eligible for inclusion in tax wrappers such as an Individual Savings Account (“ISA”), a personal pension scheme or Self-Invested Personal Pension (“SIPP”).  These tax wrappers were available to recognised funds (ie those under section 272 and 264) and will continue to be available under the TMPR.  HMRC authorised ISA and pension scheme managers will be expected to comply with all relevant UK tax regulations.

Amendments to Section 272 FSMA 2000 to streamline the process

Section 272 will be the residual recognition mechanism for overseas funds domiciled in jurisdictions which are not found equivalent for the purposes of the OFR.  In anticipation of a substantial increase in the number of applications, the Consultation proposes three amendments to streamline the administrative process:

• variation of the written notice obligation on a fund operator in respect of proposed fund changes, so that the FCA can give precise directions about which changes require its approval
• for the FCA to have regard only to matters which are the subject of current rules (rather than future rules) in assessing an application for recognition
• to prevent incompatibility with an overseas fund’s domestic regulatory obligations, make the requirement for a fund operator to give written notice to the FCA prior to the replacement of the operator, trustee, or depositary capable of being waived at the FCA’s discretion

Next steps

The Consultation will run until 11 May and responses can be sent either by email to overseasfundsregime@hmtreasury.gov.uk or by post to Personal Finances & Funds, 1 Blue, HM Treasury, 1 Horse Guards Road, London, SW1A 2HQ.

The OFR will be included in the Financial Services Bill announced in the Queen’s Speech.

How Eversheds Sutherland can help

To navigate the significant changes to the process, provisions, and mechanics of cross-border funds marketing by overseas funds to UK investors which the Consultation indicates, Eversheds Sutherland can leverage its market-leading strength and depth of experience in retail funds to guide any queries you may have. Since June 2016, our lawyers, consultants and International Funds Net (FundsNet) team have advised various institutions passporting into the UK from EU27 Member States and passporting from the UK into the EU27 on Brexit planning and Brexit related issues.

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