The Overseas Funds Regime – one step closer

The Financial Services Bill - a brief what? and when?

The Financial Services Bill 2020 (the Bill) was introduced to Parliament on 21 October 2020.

The Bill looks at the issue of how the UK wants to regulate financial services in the post-Brexit world. As such, it covers a very wide range of areas, including (but certainly not limited to) benchmarks and LIBOR, PRIIPS, MIFID and financial market infrastructure.

This article concentrates on the UK Government's proposals for an overseas funds regime. A separate Insights article on other aspects of the Bill can be found here.

The Bill has just started its journey through Parliament and will be the subject of much debate. It had its second reading on 9 November and next passes to the Committee stage where it will be scrutinised line by line. Although it is too early to know how far the Commons or the Lords will look to amend its contents, HM Government and the regulators must be hoping that it receives Royal Assent in or around Spring 2021, so some of the reforms it sets out can take effect in the summer.

The Overseas Funds Regime (OFR)

As we reported at the time, in March 2020 the UK Government consulted on changes it was looking to make to the way in which overseas funds can be recognised in a post-Brexit UK.

What's the current position?

Currently, an overseas scheme must be 'recognised' before it is able to be promoted to the general public in the UK.

Non-EEA funds can apply to the FCA for recognition under s.272 FSMA.

EEA funds, on the other hand, can continue to passport into the UK under the relevant EU legislation until the UK's transition period comes to an end on 31 December 2020. So long as they have been duly notified to the FCA, these funds are automatically recognised under s.264 FSMA.

From 1 January 2021, an EEA fund, such as a UCITS, which has notified the FCA of its intention to join the Temporary Permission Regime (TPR), can continue to market in the UK for a limited period (currently to the end of 2023 but this may be extended by one year.) However, when the TPR does finally end, the fund will need to have obtained recognition under s.272 FSMA if it wants to continue to market in the UK.

The Government realised that the s.272 regime was time consuming (even without the influx of applications expected as the TPR comes to an end) and needed to be streamlined if it was to remain viable in the long-term.

In addition, the Government wanted to ensure that Money Market Funds (MMFs) - the vast majority of which are EEA-domiciled - will still be able to access the UK market when the transition period ends (as they will then no longer be able to use a passport).

MMFs are funds which invest in liquid assets such as cash, government and corporate debt and which provide an important cash management function for financial institutions, corporations and governments.

What does the Bill contain?

The Bill introduces a new regime, the OFR, under which overseas funds can obtain recognition.

The OFR will sit alongside s.272 FSMA:

• funds which fall within the OFR would have to use this and will not be able to apply for s. 272 recognition while

• funds that don't fall under the OFR (for example, an EU non-UCITS) can still apply for recognition under s.272 in order to be able to market in the UK.

Looking at the two 'streams' of the OFR:

(a) Retail collective investment schemes

The Bill creates, by means of a new s.271A FSMA, a new power for HM Treasury (HMT) to approve a non-UK country and to specify types of collective investment schemes from that country.

Approval is subject to HMT being satisfied that the protection afforded to UK investors under the laws of the given country is at least equivalent to that offered to the equivalent type of fund under UK law.

In addition, there must be adequate supervisory cooperation arrangements between the FCA and the other country's regulatory authority.

If a scheme is from a country that has been approved and is of a type specified in respect of that country, its operator can apply for recognition to the FCA. Once this is granted, the scheme will be permitted to market in the UK as a recognised fund.

Once recognised, the scheme's operator must give the FCA written notice ("as soon as reasonably practicable") of any proposed changes to the name or address of the trustee, depositary or any UK representative of the operator, so the FCA can then approve this.

Recognition under s.271A can be either suspended or revoked under certain circumstances.

(b) MMFs

Following Brexit, the UK's Money Market Funds (Amendment) (EU Exit) Regulations 2019 (the MMFR) will on-shore the EU's MMF Regulation. Among other things, the MMFR sets restrictions on which funds can be marketed as MMFs in the UK.

The Bill provides an exemption to these restrictions in respect of MMFs authorised in a country that has been approved by HMT.

Approval will depend on HMT having first determined that the law of the relevant country imposes requirements on MMFs which have equivalent effect to those imposed by the MMFR.

Following an equivalence determination:

• an eligible MMF which is 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 which is 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.

Where does that leave s.272?

S.272 FSMA will not be repealed but will, instead, continue to be available for individual retail schemes that are not eligible to be recognised through the OFR because they are not covered by an equivalence determination for retail schemes.

S.272 will also remain for MMFs that still wish to market to both retail and professional investors, and which are assessed as MMF equivalent but not eligible to be recognised under the OFR.

The Bill will, then, make minor amendments to s.272 to make it more efficient, but without changing the fundamental features of the assessments required for schemes accessing the UK market through this route.

Umbrellas and sub-funds

Importantly, the Bill also specifies that the OFR and s.272 FSMA apply both to a collective investment scheme and to a “part” of a collective investment scheme (i.e., to a sub-fund), so recognition under both regimes operates at sub-fund level allowing for the possibility that some sub-funds of an umbrella scheme will satisfy the criteria for an equivalence determination whereas others may not by virtue of the nature of their investment objectives and policy.