Key Features of the Overseas Fund Regime for UCITS Marketing post Brexit
- When analysing the implications of Brexit, the most emphasis has always been placed on the outward limitations relative to the lost access to European markets for UK investment firms. After Brexit occurred, a different narrative gained momentum about the barriers to entry the UK fund market for UCITS funds.
- The new process for recognition of UCITS under the Overseas Fund Regime promises smooth transition from the temporary marketing permission regime to a UK permission for the vast majority of UCITS grandfathered after Brexit. This is also due to some concessions made especially in terms of the guarantees on investor protection.
- Whilst the UK FCA consultation on the Overseas Fund Regime bodes well relative to the expectations of granted equivalence for EEA UCITS, the related process remains highly politicised and will be carried out by the HM Treasury in the UK. UCITS authorised to market in the UK under the new regime will have to have the marketing communications approved by an authorised UK investment firm and continue to offer local facilities.
In anticipation of Brexit, the most emphasis was posed on its so-called outward implications. These refer to the loss of access to the single market in Europe for UK investment firms. The fact that there were also consequences in the opposite scenario – relative to the access to UK markets – was something that became of concern only after Brexit eventually materialised.
The UK has a longstanding tradition of being a global market. Its regulatory framework for financial services already has avenues to allow for recognition of overseas funds. These avenues were historically used for the recognition of a small number of funds from certain selected overseas domiciles. As part of this process, UK regulators carry out a thorough assessment of the scheme and the legislative regime of its country.
Whilst rules on the Overseas Fund Regime were introduced already in February 2022, these require an equivalence assessment to be fully operative. A recent consultation from the UK FCA on this topic seems to suggest that the Overseas Fund Regime will be a reality in the near future.
The New Realities of Brexit
Brexit did create a new reality overall. A vast amount of UCITS domiciled in the EEA, authorised under the passport regime to market in the UK, were grandfathered on Brexit day. UK authorities introduced an ad hoc regime for the purpose – the temporary marketing permission regime. This regime was based on a legal fiction that the UK was still part of Europe. Under the regime, UCITS already authorised before Brexit were allowed to continue to market in the UK on a temporary basis. They could also add new sub-funds to the temporary regime.
The Overseas Fund Regime was conceived to deal with a set of different issues, not only technical in nature. Grandfathered UCITS were required to transition their legacy European marketing authorisation to a UK marketing permission at the end of the temporary marketing permission regime. Whilst an avenue for recognition of foreign funds in the UK did exist under article 272 FSMA, the related process was not designed to deal with such a high number of applications. At the same time, the UK saw in this conversion exercise, linked to the broader issue of maintaining access to its internal markets for European firms, an opportunity to gain some more leverage in Brexit related negotiations. With the Overseas Fund Regime UK authorities have introduced their own equivalence assessment, to counterbalance the corresponding equivalence assessment in Europe.
Sustainability Disclosure Requirements
The Overseas Fund Regime intersects with a set of parallel regulatory initiatives affecting the UK financial services industry. One of these relates to the introduction of the Sustainable Disclosure Requirements (SDR).
Whilst not tackled into great details in the FCA consultation, the issue of compliance with SDR for UCITS to be authorised for marketing in the UK under the Overseas Fund Regime seems straightforward in principle. Similar to what happens in Europe, authorisation for marketing in the UK will likely trigger compliance with the UK SDR rules. The additional compliance burden for European fund houses, active also on the UK market, will very much depend on the degree of homogenisation between the rules to be introduced under SDR in the UK and the second iteration of SFDR currently underway in Europe.
Whilst indeed a new requirement, part and parcel of Brexit, we cannot exclude that the second iteration of SFDR in Europe will come closer in principle to the UK SDR rules. This could result in a lessen burden for those international fund houses actively marketing their UCITS both in Europe and in the UK.
The Issue of the UK Financial Promotion Regime
The authorisation for marketing of EEA UCITS in the UK under the Overseas Fund Regime will also trigger a new requirement relative to the local regime on financial promotions. To have a better understanding of the implications of this new requirement, it helps to make a reference to the broader discussion on the revamp of the UK financial promotion regime.
In the UK, a financial promotion is a concept that covers a broad range of marketing communications of financial products. To be considered as such, a financial promotion shall be made in the course of carrying out a business activity and capable of having an effect in the UK. Financial promotions need to be approved or communicated by an authorised firm or person in the UK. Until the introduction of the new rules on UK financial promotions, any authorised firm in the UK could have approved a financial promotion of a non-authorised firm or person. The tightening of the UK financial promotion regime comes as a consequence of some recent wrongdoings which lead to losses for retail investors in the UK. Under the new regime, authorised firms who intend also to approve financial promotions of third parties will have to seeks a specific authorisation to do so with the UK authorities.
Zooming in on the marketing of UCITS in the UK, under the temporary permission regime UCITS were considered fictitiously as authorised persons themselves, hence allowed to communicate financial promotions autonomously and independently. Under the Overseas Fund Regime, UCITS will have to seek approval for their financial promotions. This additional requirement will weight differently depending on the actual circumstances of UCITS managers. UK authorised investment firms who wish to approve financial promotions for unauthorised persons part of their group will be able to avail themselves of an exemption. All firms that are not authorised in the UK will instead have to find third party authorised firms to approve their financial promotions. There will be a premium to pay in these cases we believe because authorised firms that can approve third party financial promotions will have to undergo a separate approval process with the UK FCA and will be monitored accordingly.
We expect that a market for the approval of financial promotions in the UK will develop quite quickly in response of both the revamp of the related rules and the introduction of the Overseas Fund Regime.
Seeking Redress for Complaints
One of the most important keywords of the UK regulatory system is retail investor protection. This starts from dealing with complaints about the activities of an authorised firm established in the UK all the way through actual compensation for claims. There are two specific acronyms in this realm – FOS (Financial Ombudsman Service) and FSCS (Financial Services Compensation Scheme).
All UK authorised firms must have procedures in place to deal with complaints from retail investors. Should a complaint not be resolved to the satisfaction of an investor, redress is offered free of charge in the form of an independent review of the case offered via the FOS. Some investors are also protected in case an authorised firm is unable to pay claims against it. The FSCS acts as a backstop for protected claims against authorised firms when these cannot meet their liabilities towards customers.
The existence of similar redress mechanisms and facilities came into play already in the evaluation process of foreign schemes before the introduction of the Overseas Fund Regime already. It was worded more generally as equivalent investor protection under the recognition mechanism provided for under article 272 FSMA. It revolved around the existence in the home state of the foreign scheme of redress mechanisms similar to the ones available in the UK, including the compensation scheme. Across Europe, the concept of Ombudsman is realistically not unknown. That is not the same for what concerns compensation schemes. In the very few European member states where there might ultimately be a compensation of sort available to investors in local UCITS, the extent of it is not comparable with what is currently on offer in the UK. The need for equivalent investor protection acted as a showstopper for all the attempts made to obtain retail marketing authorisation in the UK for new UCITS after Brexit using the avenue provided under article 272 FSMA.
The approach adopted under the Overseas Fund Regime takes into account the uniqueness of the UK financial services regulation for what concerns investor protection. Accordingly, UCITS and other funds recognised for offer to the UK retail market will be operating outside of the FOS and FSCS. The issue moves from one of equivalence to one of disclosure. Looking at the journey of a retail investor through the fund market, the first point of contact with a specific investment product is represented by financial promotions. It is proposed that financial promotions for UCITS authorised to market under the Financial Promotion Regime shall contain statements at least to the effect that the fund is not eligible under the FOS and FSCS. Both the prospectus and the retail disclosures shall instead contain more detailed information on the actual redress, if any, that is available to UK investors relative to that specific product. UCITS KIIDs will have to accommodate for the additional disclosure, for as long as new retail disclosure will be rolled out as planned in the UK.
Digitalising the Local Facilities
One of the other main obligations imposed by UK regulations on UCITS marketed in the UK has been relative to offering local facilities in the UK. The role of the UK facilities agent is not at all dissimilar to the corresponding local facilities under UCITS. Accordingly, the local facilities in the UK is the place where local investors go to obtain copies of offering documentation of the UCITS, information on NAV prices and corporate actions, as well as to have facilitated both the handling of complaints as well as other types of interactions with the UCITS itself, like redemptions, subscriptions and conversions of existing participations.
The requirement to offer a local facilities agent in the UK will stay also under the Overseas Fund Regime. At inception, there will be no significant change compared to the current situation under the temporary marketing permission regime. The facilities agent in the UK will have to have a physical presence in the UK. That is to cover for instances where investors have not expressed a preference to use exclusively means of electronic communication for what concerns their interaction with the overseas UCITS. As digitalisation takes over also in the UK, the regime will transition to a digital version of the local facilities in the UK.
The consultation from the UK FCA on the technical aspects of the Overseas Fund Regime does not represent the last step in the process to formalise the opening of the UK retail fund market to UCITS again. This is only the last step in the preparatory work of the infrastructure and process that will govern the authorisation of UCITS funds for marketing to UK retail investors.
There is one last crucial step that is represented by the equivalence assessment to be made by HM Treasury on the EEA as equivalent. This is the last step required considering that official rules were introduced already in 2022 and now the UK FCA is consulting on the mechanics of the approval process. As and when the EEA will be deemed equivalent, the UK FCA will notify existing UCITS of their landing slot to proceed with the new recognition. UCITS that have never been authorised for marketing in the UK before, will also be able to apply for such recognition using the new process. Whilst the consultation on the mechanics of the Overseas Fund Regime bodes well in the general context, the process of granting equivalence remains nevertheless highly politicised.