HM Treasury has published their “Review of the UK funds regime: a call for input” seeking comments from stakeholder regarding what reforms should be taken in order to improve the UK fund regime.

The consultation is wide-ranging, covering direct and indirect tax and relevant areas of funds regulation and includes chapters on:

  • The UK’s approach to funds taxation;
  • The UK’s approach to funds regulation; and
  • Opportunities for wider reform.

This update we will focus on the “UK’s approach to funds regulation”.

Recent Reform

There have been a number of recent and ongoing work by UK regulator to reforms to the UK’s fund regulation regime. These include:

  • October 2014: Launch of the Innovation Platform
  • April 2017: Creation of a new type of limited partnership for investment funds: PFLPs.
  • June 2017: Asset Management Market Study which aimed to improve the value offering for investors and included improvements to how fund managers disclose fund objectives and describe their use of benchmarks.
  • October 2017: Launch of the Asset Management Authorisation Hub
  • March 2020: Changes to the FCA rules on permitted links
  • August 2020: The Financial Policy Committee joint review of ’liquidity mismatch’ in open-ended funds
  • August 2020: The FCA’s consultation CP20/15 ’Liquidity mismatch in authorised open-ended property funds’
  • September 2020: New rules for Non-UCITS Retail Schemes (NURSs) investing in illiquid assets
  • November 2020: Productive Finance Working Group work on how to channel capital into long term productive investment.

Scope for Change

The scope for changes section of the call for input and corresponding questions largely fall within the following sections:

  • Fund Authorisation
  • Speed to Market
  • Qualifies Investor Scheme
  • Operational efficiency

Fund Authorisation

UK funds marketed to the general public in the UK, including retail investors, must generally be authorised. However, the government is conscious that 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. It has been suggested that this might be particularly true for funds targeted at DC pension schemes. In order to shape the government’s enhancements to existing fund structures and to establish where there are gaps, the government are interested in understanding the driving factors behind why firms creating fund products choose authorised or unauthorised fund structures. In particular, they would like to understand why some firms create fund products targeted at professional investors consider authorised fund structures most appropriate.

Speed to market

Stakeholders have emphasised to the government the importance of being able to launch authorised funds quickly, and of having clarity on the timelines involved. Firms have suggested that they value speed and predictability in the fund authorisation process and that this features in their considerations on where to set up funds. It has been suggested that this is particularly important for Qualified Investor Schemes (QISs).

Legislation requires the FCA to process complete UCITS scheme authorisation applications within 2 months. For other types of authorised funds, the FCA has a statutory target for the authorisation of new schemes within 6 months of receiving a complete application or within 12 months of receiving an incomplete application. This includes QIS and NURS. The FCA also has voluntary service standards for processing complete applications for authorisation of a NURS within 2 months and a QIS within 1 month, and reports against these targets each year. In 2017/18 and 2018/19 the FCA responded to 100% of all applications within these timeframes. In 2019/20 it responded to 92% of applications within the timeframes.

The government considers that the FCA’s 1-month target for authorisation of QIS applications seems an appropriate timeframe given the rigour of the process demanded by the complexity of the product, its availability for sophisticated retail investors, and the standards associated with FCA authorisation. The government also recognises the fact that at a minimum statutory flexibility is required for this timeline to go above 1 month on occasion given that formal rejection of an application if required takes longer than 1 month. However, the government is keen to identify opportunities where the authorisation processes set out in legislation could be refined further and where further clarity on timelines could be provided.

Qualified Investor Scheme

The QIS was launched in the UK in 2004. It is an authorised fund structure and the regulations allow flexibility on the legal form; a QIS can be a unit trust, open-ended investment company (OEIC), or authorised contractual scheme. A QIS is an AIF for the purposes of AIFMD. It has considerable flexibility on its permitted investments compared to UCITS schemes and NURSs. Therefore, like unregulated collective investment schemes, the QIS is defined in FCA rules as a non-mainstream pooled investment and is intended to be marketed to professional investors and sophisticated retail investors. While this investor scope is more limited than UCITS schemes and NURSs which are open to all categories of investor, it is broader than offshore vehicles often cited as international comparisons, which in some cases have high minimum investment thresholds (the rules do not prescribe a minimum investment for a QIS)

Stakeholders have suggested to the government and the FCA that the QIS can be made more attractive, and this was an area of focus in the UK Funds Regime Working Group proposals. These included recommendations to remove requirements for distribution of income and allowing QISs to distribute capital and carry over income.

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

The government is aware of several proposals in this area already. The UK Funds Regime Working Group recommendations included expanding the range of QIS permitted investments, and other stakeholders have suggested to the government that these should include loan origination and investment in a wider range of other funds. Stakeholders have also recommended increasing the 100% cap on borrowing and highlighted the constraints on derivatives exposure. The government and the FCA would welcome further detail from stakeholders on how these proposals would expand the types of investment products that can be delivered within the QIS structure and specifically how this would improve the attractiveness of the vehicle.

The government has also received comments from stakeholders suggesting that there is room to further optimise the QIS sub-fund structure and the protection provided for the segregation of assets between sub-funds. Specifically, while the segregation of assets between sub-funds in OEIC QISs is specified in legislation through the OEIC Regulations’ Protected Cell Regime, in other forms of QIS it is achieved through contractual means. It has been put to the government that the UK approach to segregation provides less certainty for investors than in other jurisdictions where this segregation is specified in legislation. The government would value further information on this issue and on whether and how any further clarity in this area, via legislation or rules, would be helpful.

The government notes that the investor scope of the QIS is distinct from some vehicles generally considered as international comparisons, and that its availability to sophisticated retail investors justifies the FCA in imposing requirements beyond those set out in the AIFMD. The government and the FCA are interested on how any changes to the QIS should take into account these considerations and the risks which additional complexity could create for the attractiveness of the regime.

Operational efficiency

The UK Funds Regime Working Group report put forward a proposal for an optional ‘Direct2Fund’ investor dealing model. This would offer an alternative to the model operating in the UK whereby Authorised Fund Managers deal in units as principal with investors. This alternative model would give investors the option to transact directly with funds and remove the Authorised Fund Manager as a counterparty to the investor deal, in-line with the approach in other jurisdictions. There has been close engagement between the FCA and industry on the steps which would be needed to implement this proposal, and that work will continue.

Click here for our article on the list of questions contained in the Call for Input.

Click on the above link for further information.