Covid-19 has achieved what nothing else has managed to do in almost four years by knocking the UK’s departure from the EU out of the news. But UK investors might be mildly reassured that financial market regulators are, however, continuing to work on preparations.
It's not unimportant; some 8,000 or so of the investment funds available to us are actually domiciled in other EU countries, even many of the funds managed by familiar British institutions. Until now, one of the benefits of EU membership has been Ucits (Undertakings for Collective Investment Schemes), which in simple terms is a catch-all name for similar open-ended investment product structures that exist in each country and operate to a common set of standards.
Crossing Borders
One main advantage of Ucits is their easy ability to passport into any or all other EU countries and market to local investors. Since the UK’s exit from the EU at the end of January, a Temporary Marketing Permissions Regime continues to operate and will do so until the end of the transition period on December 31, 2020.
For investors, it dramatically extends choice, while for fund firms, it provides opportunities to operate one range of funds and sell them into multiple countries. Interestingly though, the 2019 fees chapter of Morningstar’s Global Investor Experience Study found that this benefit doesn’t usually translate into economies of scale for investors, with charges often higher than smaller, locally domiciled funds.
While there is already a route for individual funds domiciled in a non-EU country to become recognised in the UK, it entails in-depth analysis of the fund by the Financial Conduct Authority. Such an approach would be impractical given the scale of EU-based funds.
So instead, HM Treasury (HMT) has issued a consultation, open until May 11, on a proposed new Overseas Fund Regime (OFR). The OFR would establish an equivalence regime that HMT would determine on a country-by-country basis, subject to the regulatory regime of each country providing investor protection equivalent to the UK's, and each country satisfying HMT that there will be adequate supervisory cooperation.
Funds domiciled in countries awarded equivalence status will then be able to apply to the FCA for entry into the UK market; the regulator would have two months to approve or decline the application. Importantly, equivalence will not require identical regulatory structures, but rather will be awarded based on outcomes-based assessment – that is to say, that HMT and the FCA are satisfied that despite different rules of engagement, the end result for investors will be comparable.
Different Rules for Money Market Funds
In fact, two separate regimes are proposed: one for retail investment funds and another for money market funds.
The market disruptions caused by Covid-19 have pushed money market funds (MMF) to the front of many investors' minds in light of the problems they experienced during the 2008/9 financial crisis, when the value of their underlying investments dropped.
Since that time, and in direct response to those issues, EU regulators created an MMF Regulation that stipulated strict criteria for any fund that wishes to label itself as an MMF. Almost all MMFs bought by UK investors are actually domiciled in other EU countries, principally Luxembourg and Ireland, and so it’s particularly important that a route is found for continuing investment into money market instruments by UK investors.
Under the proposals, funds that achieve recognised status will also be eligible for inclusion in tax-incentivised products such as Isas (individual savings accounts) and Sipps (self-invested personal pensions).
What Happens if it Goes Wrong?
But unsurprisingly, one of the most common questions asked in the consultation is: "what happens in the event something goes wrong?"
It goes on to discuss the Financial Ombudsman Scheme and the Financial Services Compensation Scheme and if, and how, they could be applied to funds recognised under the Overseas Fund Regime.
The Ombudsman is an independent service for settling disputes between investors and financial services firms and can award compensation up to £350,000. The scheme could potentially be extended to cover non-UK funds, although the Treasury admits that enforcement on such funds might be difficult. An alternative might be available where there is a dispute resolution facility in a funds country of domicile.
The Compensation Scheme, funded by an FCA levy on financial firms, provides protection for investors when they are owed compensation, for example, arising from bad investment advice or negligent investment management. The Treasury is also evaluating how this would apply to overseas funds, though notes that it historically has never been applicable to Ucits and nor has there been an instance where investors have needed it to be.
If the Temporary Permissions Regime expires without a replacement, investors would be left holding units in EU funds that are no longer recognised by the UK and potentially wanting to redeem them at what may be a less than ideal time. With all that's at stake for UK investors and institutions, as well as many EU institutions, there will be a strong drive to resolve these open questions and turn the proposals into legislation between now and the end of the year.
