UK proposes new regulatory regime for overseas investment funds

The 'overseas funds regime' (OFR) proposed by the UK would incorporate two new sets of rules, one for retail investment funds and one for money market funds (MMFs). The rules would be based on a broad principle of regulatory equivalence, as well as adequate reciprocal supervisory cooperation between the UK's Financial Conduct Authority (FCA) and the national competent authority (NCA) in the jurisdiction seeking equivalence.

Currently, over 8,000 funds authorised under the EU's Undertakings for Collective Investment in Transferrable Securities (UCITS) regime are domiciled in the European Economic Area (EEA), gaining market access into the UK through the passporting regime. The passporting regime will cease to apply in the UK at the end of this year, once the Brexit implementation period ends, although a temporary marketing permissions regime (TMPR) will operate for a limited time to allow funds to seek permanent UK market access.

In contrast, non-UCITS retail investment funds which are domiciled in non-EEA countries must apply to the FCA to become individually recognised in the UK, under the process set out in section 272 of the Financial Services and Markets Act (FSMA). The FCA will only grant recognition to funds which meet several tests in the legislation, and which provide adequate protection to investors.

The proposals set out in the consultation, which closes on 11 May, would apply to overseas funds wherever they are domiciled, not just those domiciled in the EU.

Dublin-based investment funds expert Gayle Bowen of Pinsent Masons, the law firm behind Out-Law, said that early publication of the proposals would be welcomed by managers of Irish funds seeking long-term access to UK capital.

"This development provides some clarity on how asset managers with Irish funds can continue to access the UK market after the end of the temporary permissions regime," she said.

"Given the fact that Irish funds are predominantly used for sale in the UK market, this will be a welcome relief for UK managers with Irish funds. While there is much to do before this is finalised, it appears to be a very pragmatic approach by the FCA," she said.

The new regime as proposed would allow the UK Treasury to grant equivalence to a country in respect of either retail investment funds domiciled there, or MMFs domiciled there. Before doing so, the Treasury would have to be satisfied that the other country's financial services regulatory regime delivers equivalent regulatory outcomes and that there are, or will be, adequate supervisory cooperation arrangements in place between the FCA and the NCA in the other country.

The equivalence test would be slightly different for each type of fund. The other country's regulatory regime for retail funds must achieve at least equivalent investor protection to comparable UK authorised funds. The Treasury would also be permitted to impose additional requirements to retail funds from equivalent countries, something that is not possible under the current regime. The other country's regulatory regime for MMFs must be at least equivalent to the regulations that apply to UK MMFs.

The existing section 272 procedure would be retained for individual retail investment funds that are not eligible to be recognised through the OFR because they are not covered by an equivalence determination. However, the government is proposing some minor amendments to make the process "more efficient" for both the industry and the FCA.

Once finalised, the OFR would be introduced by way of a new Financial Services Bill, as announced in the Queen's Speech in December.

London-based investment funds expert Elizabeth Budd of Pinsent Masons, the law firm behind Out-Law, welcomed the proposals, although she said that further discussion would be needed over questions of investor protection and compensation in respect of overseas funds granted equivalence under the new regime.

"Almost from the outset, there were concerns that the proposed use by the UK of section 272 FSMA to recognise some 8,000 funds which were sitting in the TMPR simply wasn't viable," she said.

"This consultation paper proposes the equivalence of regulatory outcomes. Whilst it might be fairly straightforward to say that EU UCITS are equivalent to UK UCITS funds, a more uncertain area is that of investor protection and compensation. The proposal that the UK's Financial Ombudsman Scheme (FOS) should have compulsory jurisdiction over operators and depositaries of funds within the new regime, or alternative rely on the third country alternative dispute resolution mechanism which may have a lower level of compensation, is likely to lead to some vigorous debate," she said.