The upcoming regime for marketing foreign funds to retail investors in the UK
After the Brexit agreement, the United Kingdom's financial regulators faced a dilemma. In the absence of a specific agreement between the European Union and UK, fund passporting rights would cease. This meant that EU authorised and registered funds, such as undertakings for the collective investment of transferable securities (UCITS), would no longer be automatically authorised in the UK and eligible for marketing to UK retail investors. These funds would need to be individually recognised by the Financial Conduct Authority (FCA). The large number of EU funds sold by UK investors – around 8,000 at present – risked creating a bottleneck, swamping the regulator with applications to be considered.
In addition, Brexit meant that the UK's authorities assumed new powers that had formerly been the preserve of the EU's authorities, including the power to deem third countries' fund regimes equivalent in regulatory outcomes, and to permit non-EU funds to be sold in the UK. The UK Government also voiced its desire for the UK to remain a global investment hub, through an attractive regime for both onshore and offshore investment.
These twin pressures – the need to recognise EU funds and the pressure to be open to international investment – led the UK to the conclusion that the current regime for recognising non-UK funds for sale to UK retail investors is inadequate. The solution is the creation of a new overseas funds regime (OFR) that is streamlined and yet provides for the FCA to have sufficient scrutiny of fund applications. More contentious in the new regime is the political 'overlay' that gives the UK's political authorities wide discretion to decide on country and fund type regulatory equivalence.
Temporary permissions regime
In December 2017, the UK Government announced that in the event of a 'no deal' Brexit, it would introduce a temporary permissions regime (TPR) for inbound passporting European Economic Area (EEA) firms and funds.
Under the TPR, EEA firms that were passporting into the UK could notify the FCA that they wish to make use of a temporary permission to continue to access the UK retail market.
Firms within the TPR are given the opportunity to apply for ongoing recognition in the UK under the new, permanent regime (the OFR) that will succeed the TPR. The TPR therefore is a transitional regime that 'buys' policy-makers time to implement a successor regime, and firms additional time within which to seek permanent recognition or authorisation.
The FCA's deadline to notify funds under the TPR was 30 December 2020, and therefore no further umbrellas can make use of the regime. However, new sub-funds, and material or minor changes to funds within the TPR, are still permitted. Firms may still apply for the recognition of non-UK funds that are not in the TPR via the existing, although very clunky and onerous, s272 process under the Financial Services and Markets Act 2000.
The OFR is envisaged to replace the TPR with a permanent solution that aims to achieve policy-makers' objectives as set out in the introductory paragraphs to this article.
The authorisation or recognition of a non-UK fund under the OFR comprises two stages: a political approval stage and a regulatory approval stage.
First, Her Majesty's Treasury (HM Treasury) will approve a non-UK country and specific types of retail funds authorised in that country based on equivalent investor protection rules and appropriate supervisory arrangements between the FCA and the national regulator in question.
HM Treasury reserves the right to impose additional requirements on approved fund types, a power that does not yet exist, if, for instance, HM Treasury deems it necessary to ensure full parity with UK authorised funds. This reserved power could introduce an element of political consideration into what is otherwise solely a matter of regulatory equivalence (eg, as a tool by which to encourage a positive equivalence determination from the EU).
This power could reduce competitive distortions in the UK funds market. By way of example, HM Treasury could use this power to require non-UK management companies to carry out a value for money assessment (a requirement for UK authorised and regulated funds). However, it might also be used politically as a tool to reach agreements in trade deals between the UK and other countries.
Second, the FCA will consider applications from managers of retail funds from an approved country and of an approved fund type. We understand that there will be no automatic 'grandfathering' of funds from the TPR to the OFR (ie, a new application must be made under the OFR). The general tone from the FCA suggests that not all applications under the OFR will receive authorisation.
The FCA will have a two-month period in which it is required to approve or reject (with reasons given) a fund's application. Asset managers with funds in the TPR will be given 'landing slots' within the next two years to provide a window in which to submit an application under the OFR.
Funds that are not currently within the TPR will be eligible to apply for recognition under the OFR. However, the expectation is that priority will be given to funds within the TPR (if those funds and their home countries receive a positive equivalence determination from HM Treasury).
The implementation timeline
On 29 April 2021, the Financial Services Act 2020 received Royal Assent in the UK. This legislation provides for the OFR, and the UK Government's intention is that the new regime will come into force at the end of 2023 (however, this is subject to a possible extension until the end of 2025).
Overall, the streamlined process under the OFR (termed the s272a process) should be more efficient than the existing s272 process in respect of the approval of funds for marketing to UK investors. However, the overall timelines for the approval of funds under the OFR will depend on: (1) the time taken for the political approval stage noted above; and (2) the 'landing slots' asset managers are allocated within which they are permitted to submit an application.