A new Overseas Funds Regime for the UK – HM Treasury consults

On 11 March 2020, HM Treasury (HMT) published a consultation paper, setting out its proposals for an overseas funds regime (OFR) which would establish a more appropriate basis for recognising overseas funds, including EU UCITS and Money Market Funds (MMFs).

The proposed OFR would comprise two separate new regimes:

• one for retail investment funds
• one for MMFs.

Both regimes would be based on HMT granting equivalence to the country in which a given fund is domiciled, with this then allowing streamlined access to marketing in the UK.

The existing recognition regime under s. 272 of FSMA will not be repealed. Instead, (subject to some minor amendments to make it more efficient for the industry and the FCA) this would continue to be available for individual funds not eligible to be recognised through the OFR because they are not covered by an equivalence determination for retail investment funds.

The consultation period runs until 11 May 2020, following which HM Government will analyse responses received and include the OFR in the Financial Services Bill announced in the Queen’s Speech on 19 December 2019.

The current position – passporting, s. 264 and s. 272 of FSMA

Under the current regime, EU UCITS automatically become ‘recognised’ funds in the UK when notified to the FCA under s.264 of FSMA This allows the fund to be marketed to all UK investors without being subject to the restriction on promotion under s.238 of FSMA.

Non-EEA domiciled funds can also become individually recognised in the UK, through s.272 of FSMA, though this requires an assessment by the FCA to ensure that each fund meets the prescribed tests.

EU managers will be able to passport into the UK (and UK managers into the EU) until the transition period under the Withdrawal Agreement reached between the EU and the UK comes to an end – currently set to be 31 December 2020.

Prior to the UK leaving the EU, the UK established a ‘temporary permissions regime’ (TPR). This allows eligible EU UCITS which have notified the FCA to continue to market in the UK in a very similar way for a limited period after the end of the transition period. For the fund to continue to be recognised in the UK after the end of the TPR, it must apply for recognition under s.272 of FSMA.

Drawbacks to the current regime

The assessment process under s. 272 of FSMA is widely regarded as being time consuming. It is expected that a large percentage of the 8,000 funds (including MMFs) which had notified the FCA by the end of January 2020 that they wish to enter the TPR, will subsequently apply for recognition under s. 272. This would pose an operational challenge for both the FCA and for the funds themselves.

On top of that, doubts have been raised in the past as to whether the s. 272 regime is both proportionate and viable in the long-term, given the importance of EU funds in the UK market.

As a result, HM Government has decided to streamline the recognition process and create a more streamlined OFR. HM Treasury’s consultation paper sets out the key proposals for this.

Money market funds (MMFs)

As well as retail funds, such as UCITS, the intention is that the OFR would include a regime which provides market access for MMFs - a type of fund which invests in liquid assets such as cash, government and corporate debt and which provide an important cash management function for financial institutions, corporations and governments.

The vast majority of MMFs active in the UK (many of which are UCITS) are EU-, rather than UK-, domiciled. Although these can access the UK market through the passporting regime, the ability to passport an MMF into the UK will cease when the transition period ends.

How will an equivalence determination be made and what are the implications?

The two separate equivalence regimes being proposed will establish processes by which HM Government can make an equivalence determination in respect of another country’s regime for (a) retail funds or (b) MMFs.

The effect of making of such a determination means that

• eligible retail funds can be ‘recognised’ for the purpose of Part 17 of FSMA, allowing them to be marketed to all investors in the UK, including retail investors.
• eligible MMFs can gain access to the UK, though the process for this will depend whether the MMF intends to market to retail or professional clients.

Before equivalence is granted, HMT must be satisfied that

• on an outcomes basis, the other country’s regulatory regime:
  • for retail funds achieves at least equivalent investor protection to comparable UK authorised funds
  • for MMFs is at least equivalent to the regulations that apply to UK MMFs
• there are adequate supervisory cooperation arrangements between the FCA and the NCA in the other country, in order to grant equivalence.

Once equivalence has been granted

• retail funds from a country which has been determined to be equivalent and which fall within the specified category of funds in that determination must register with the FCA to become recognised
• MMFs structured as retail funds (such as UCITS) and which wish to market to both retail and professional clients must either:
  • be located in a country with equivalence determinations for both MMFs and retail funds, and register for recognition under the OFR or
  • be located in a country with an equivalence determination for MMFs, and be recognised under section 272 of FSMA
• MMFs from a country with an equivalence determination that wish to market only to professional clients will have to submit a notification under the UK’s National Private Placement Regime (NPPR) to be able to market in the UK.

Funds recognised under the OFR will be subject to a number of obligations that will apply to all overseas funds marketing in the UK – these obligations include matters related to disclosure, the provision of investor facilities in the UK, regular reporting to the FCA, and payment of regulatory fees. These are set out more fully in Chapter 5 of the consultation paper.

Also, after having made an equivalence determination in respect of retail funds, HMT may require a specified category of funds to comply with additional requirements as a condition of being recognised in the UK – any such additional requirements would be based on aspects of the UK framework judged to be important to ensure consistency between overseas funds and those offered in the UK.

Registration under the new regime

(a) Retail funds

Where an equivalence determination is made, retail funds and MMFs marketing to retail clients will have to register with the FCA to become recognised.

The proposed OFR for retail funds would be similar in many respects to the now defunct regime for recognising schemes authorised in designated countries or territories under s.270 of FSMA, although the end result would be something of a hybrid between the s. 270 regime at the level of the home domicile of the fund and the s. 264 regime at the level of the fund. Although the CP gives little firm detail as to the specifics of how HMT would make such determinations, it seems highly likely, for commercial reasons, that the EU’s UCITS regime would be deemed equivalent and so allow such funds to continue to be marketed to UK investors. (It is fair to say, though that the possibility can’t be ruled out that this could be used as a negotiating point in the discussions between the UK and the EU as to the terms of their future relations.)

The retail fund registration process is intended to be simple and straightforward (although it should be noted that it would involve a registration process rather than simply a notification, as currently required under s. 264).

• the FCA will not be responsible for verifying that a fund complies with its overseas regulatory framework - the fact that an equivalence determination has been granted should confirm that funds in the specified category offer equivalent investor protection
• funds registering under the retail scheme will not be required to notify under the NPPR
• the FCA will be expected to rely on funds self-certifying they are eligible for recognition (although the FCA can require supplementary evidence it considers necessary)
• for a new fund requesting recognition, the FCA will ordinarily have 2 months from receipt of a completed registration to either confirm a fund’s recognition or provide reasons it is not eligible (for example, because it fails one or more of the eligibility criteria, is not within the category of funds included in the equivalence determination or does not have a UK address for the service of notices).

HMT accepts that new equivalence determinations are likely to result in a short-term spike in applications under the new regime, so in the early days, the FCA may need longer to consider registrations.

(b) MMFs

Following an equivalence determination

• an eligible MMF to be marketed only to professional clients can notify under the UK’s existing NPPR. This allows a non-UK fund to be marketed into the UK, provided it complies with certain requirements under the UK’s Alternative Investment Fund Managers Regulations 2013.
• an MMF to be marketed to retail clients must also gain recognition for the purpose of Part 17 of FSMA:
  • where the MMF is eligible to be recognised under an equivalence determination for retail funds and is to be marketed to retail clients, it must seek recognition by registering under the OFR for retail funds (see above).
  • where the MMF is in scope of an equivalence determination for MMFs, but not in scope of an equivalence determination for retail funds, it could apply to the FCA for recognition under s. 272 of FSMA.

Amendments to s.272 of FSMA

The OFR and the regime under s. 272 of FSMA will run alongside each other. Funds which are within the scope of an equivalence determination will not be eligible to apply for s. 272 recognition but would have to use the OFR. However, a fund (including, for example, an EU non-UCITS) that does not fall within the scope of an equivalence determination can still apply for recognition under s.272 in order to be able to market in the UK.

To make sure the s.272 process works in a more efficient way, HMT’s consultation paper proposes the following three amendments to the existing s.272

1. FCA assessment of application

   As things stand, when it assesses an overseas fund’s application for recognition, the FCA must have regard not only to any rule of law but also to “any matters which are or could be” the subject of rules.

   HM Government is proposing to amend this requirement so the FCA would only need to consider matters which are the subject of current rules, rather than rules which do not yet exist.

2. Written notice about proposed changes

   Once a fund has been recognised, its operator must give the FCA written notice of any proposed change to the fund’s operation or management so that the FCA can approve the change. This requirement includes immaterial changes of little or no relevance to the FCA.

   HM Government is seeking to amend this so that the FCA can give directions about which changes it needs to approve.

3. Written notice about operator, trustee or depositary

   The current rules require the fund operator to give the FCA a month’s written notice prior to any replacement of the operator, trustee or depositary.

   Noting that this requirement may be impractical in certain situations, (e.g. where it is incompatible with other countries’ regulations, or where an operator suddenly enters insolvency proceedings), HM Government proposes to require the written notification to be made in a manner decided by the FCA and as soon as may reasonably be practicable.