Shaping the future of the UK funds regime - HMT seeks views

On 26 January 2021, HM Treasury (HMT) published a public consultation, "Review of the UK funds regime: a call for input". 

The aim of the Call for Input is to find ways of making the UK a more attractive location in which to set up, manage and administer funds, (and one which supports a wider range of funds). This also requires considering what tax reforms would be needed to support such a framework while remaining compatible with the UK's international commitments.

This note gives a summary of what the Call for Input says in respect of funds. See here for our note on the tax issues which HMT is considering. 

The period for feedback closes on 20 April 2021 - Simmons & Simmons will be developing a response, covering all aspects of the matters being consulted on. We will also be holding meetings with clients, trade associations and relevant governmental and regulatory bodies in order to put forward our views.   

HM Government (the government) will analyse responses to the Call for Input and will consult again on specific proposals for reform.

Our overview

A person is stopped in the street and asked for directions to a well-known landmark. They scratch their head and think long and hard before replying, 'well, I wouldn't start from here'.

There's something similar about the Call for Input. No doubt about it, it offers an excellent opportunity for a wholesale rethink about what the future should look like in terms of onshore funds.

This is a wide-ranging review and, with the political and economic backdrop of 2021, represents a genuine opportunity to shape the future

But ... if the government is going to achieve its goal of making the UK a significantly more attractive location for funds, it is absolutely crucial that all elements are considered holistically - speed to market, eligibility of investments, investor confidence in regulatory oversight and, perhaps more important than all that, 'getting the tax right'.

And while the underlying aims are laudable, it may be that a somewhat blanker canvas would have been better - the questions being posed may not necessarily be the 'right' ones and might inadvertently restrict respondents when putting forward their thoughts and proposals.  

What's the background to this?

For a consideration of many of the areas examined in this Call for Input, in particular, the issue of access to illiquid assets, see our note on the Democratisation of Private Assets.

In its 2020 Budget, HMT announced that it would carry out a review of the UK funds regime to consider reforms which might enhance the UK's attractiveness as a location for asset management and for funds in particular.

As well as the current Call for Input, the review encompasses two separate workstreams:

• the government's March 2020 consultation on the tax treatment of asset holding companies (AHCs) in alternative fund structures, which led to a second consultation, published on 15 December 2020 (see our Insights note here); and
• a review of the VAT treatment of fund management fees, which the government intends to take forward in 2021.

HMT highlights that the UK funds regime has an important role in both providing a source of capital into the economy (not least to fund the post COVID recovery, to invest in infrastructure and to help the transition to a carbon neutral economy) and meeting the needs of defined contribution (DC) pension schemes.

HMT's proposals take account of recent and ongoing work on investment in illiquid assets, including:

• changes to the FCA rules on permitted links - see our note here
• new rules for Non-UCITS Retail Schemes (NURSs) investing in illiquid assets - see our note here
• the Financial Policy Committee joint review of 'liquidity mismatch' in open-ended funds, which the FCA and the Bank of England are currently undertaking.
• the Productive Finance Working Group (co-sponsored by HMT, the Bank of England and the FCA), looking at how to channel capital into long term productive investment.
• the FCA's consultation CP20/15 'Liquidity mismatch in authorised open-ended property funds' - see our note here

The Call for Input also builds on the recommendations of the UK Funds Regime Working Group, which made a series of recommendations in its report to the Asset Management Taskforce in 2019.

The outcome of a Department for Work and Pensions consultation on making it easier for DC schemes to invest in long-term assets will be published in Spring 2021 alongside regulations to increase investment by pension schemes in 'illiquid' assets. This, in turn, builds upon the government's Patient Capital Review and the work now being taken forward by the Productive Finance Working Group, formed by the Bank of England, HMT and the FCA.

Where does the government see scope for change?

The government believes that:

• there are gaps in the range of fund structures available in the UK, particularly to facilitate investment in long-term, illiquid assets and to meet the needs of professional investors; and
• there are elements of regulation relating to existing fund structures and the broader funds environment which could be enhanced.

Fund authorisation

Asset managers marketing funds to professional investors and sophisticated retail investors, who could otherwise invest in unauthorised collective investment schemes, still often prefer to use authorised products - this might be particularly true for funds targeted at DC pension schemes.

The government wants to understand the factors that lead firms to choose authorised or unauthorised fund structures when creating fund products - in particular, why some firms creating fund products targeted at professional investors consider authorised fund structures most appropriate.

Speed to market

The government recognises that the ability to launch an authorised fund quickly, with clarity on the timelines involved, can be a factor in determining where to set up a fund - particularly in the case of Qualified Investor Schemes (QIS).

Although, strictly, the FCA has six months in which to determine an application for authorisation for a QIS or a Non-UCITS Retail Schemes (NURS), it aims to process complete applications for QIS within one month and for a NURS within two months - it met these targets for 92% of applications in 2019/2020.

The government considers that a one month target is an appropriate timeframe for QIS applications, but that statutory flexibility is required for this timeline to go above one month on occasion. However, it is keen to identify opportunities where the authorisation processes could be refined further and where further clarity on timelines could be provided.

Looking at the UK funds landscape

The Call for Input reviews a number of existing fund types, along with proposals for new ones.

These include:

Qualified Investor Scheme

• an authorised fund structure, with flexibility on the legal form - a QIS can be a unit trust, open-ended investment company (OEIC), or authorised contractual scheme and is an AIF for the purposes of AIFMD.

• it has considerable flexibility on its permitted investments compared to UCITS schemes and NURSs.

• like unregulated collective investment schemes, the QIS is a non-mainstream pooled investment and is intended to be marketed to professional investors and sophisticated retail investors - no minimum investment is prescribed for a QIS.

The government and the FCA are keen to understand the limitations of the QIS - specifically, the detail of impediments that prevent certain products from being launched within this structure, and why the QIS (rather than, for example, an unauthorised fund) would be the preferred UK structure

Investment Trust Companies

• funds constituted as closed-ended companies with a fixed share capital traded on the secondary market at market value - as listed companies, their shares are generally available to all types of investors, including retail

• management of ITCs is regulated under AIFMD (unless under the threshold for small AIFMs, in which case they are regulated but only to a limited extent)

• not authorised by the FCA but must comply with UK Listing Rules and company law.

Closed-ended structures avoid the liquidity mismatch that has been the focus of the Bank of England and FCA's joint review into open-ended funds, and some consider that closed-ended funds may be more appropriate vehicles for investing in certain illiquid assets.

The government is not aware of any specific barriers for ITCs investing in long-term assets but is keen to understand what steps could be taken to support the use of the ITC structure.

Long-Term Asset Fund (LTAF)

• a proposal for a new authorised open-ended fund structure

• designed to enable investors - particularly DC pension schemes - to invest in illiquid assets with greater confidence than in existing fund structures

• the government "strongly supports" the delivery of an LTAF and the Chancellor of the Exchequer has made public his wish to see the first established in 2021

• the FCA will consult early in 2021 on plans for an LTAF

• however, the 'wider ecosystem' for funds will also need to change - the distribution infrastructure will need to support dealing at different intervals as well as notice periods and there are currently impediments to investment in long-term assets

• the Call for Input also seeks views on the tax implications of the LTAF structure, including the likely adoption of the current rules for authorised investment funds, and consideration of access to any tax reliefs.

Professional Investor fund

The government believes that there is a gap in the UK's unauthorised fund range for new, flexible, tax-efficient unauthorised fund structures.

While unauthorised funds offer greater investment freedom than authorised funds, they are more limited in the types of investors they can be sold to (and - other than investment companies - are not accessible to retail investors in general).

When unauthorised funds are of a sufficient size, their managers require authorisation as AIFMs. The funds themselves, though, do not require authorisation by the FCA.

Proposals have been made for funds which would be:

• aimed at professional investors

• unconstrained in terms of eligible asset classes and investment strategies

• able to take multiple legal forms - open-ended or closed-ended, listed or unlisted.

The government considers that such vehicles could have strong international appeal and could support the work on facilitating investment in long-term and productive assets.

In particular:

• the UK Funds Regime Working Group Report and the AIMA have proposed a fund which might be either an entirely unauthorised collective investment scheme, or subject to a new 'light-touch' form of authorisation.

  It would be structured as either a corporate or as a limited partnership.

  The corporate model would be established outside the existing ICVC regime

  The new unauthorised limited partnership structure could use existing limited partnership legislation (although stakeholders may prefer it to be established separately)

• the Association of Real Estate Funds (AREF), supported by the UK Funds Regime Working Group, has also suggested a fund structured as a contractual scheme

  This could offer an onshore alternative to fund managers looking to service pension funds' as well as other, professional investors' investments in underlying UK real estate assets without the additional layer of regulation that comes with the current authorised ACS structure.

  The unauthorised contractual vehicle could be created as a version of the existing Co-ownership Authorised Contractual Scheme.

  This contractual structure would be closed ended and would not be listed, though it would have tradable units.