FCA consults on implementing the Overseas Funds Regime

At a Glance

• The FCA has consulted on implementing the Overseas Funds Regime (OFR) for non-UK funds wanting to market to UK retail investors following an equivalence decision. There is a separate regime for money market funds (MMFs) which the FCA will consult on at a later date.
• Funds seeking recognition under the OFR will need to start assessing what actions they will need to take and what strategic decisions they will need to make early – while the Temporary Marketing Permissions Regime (TMPR) does not expire until the end of 2025, in order to process the large volume of applications expected, the FCA will give funds a landing slot which could be well before the end of 2025.
• Funds seeking recognition under the OFR should expect scrutiny of their costs and charges – the FCA will assess whether these are clear, transparent and do not expose investors to harm from undue costs. The FCA will pay particularly close attention to any promotional payments to third parties. It remains to be seen whether the UK Government will impose any additional value assessment requirements when granting an equivalence decision.
• Funds seeking recognition under the OFR can expect to have to comply with the UK Sustainability Disclosure Requirements (SDR), and to need a UK-authorised firm with appropriate competence and expertise in the investment to communicate or approve financial promotions. The FCA also proposes to require more prominent disclosures on funds being outside the scope of the Financial Ombudsman Service (FOS) and Financial Services Compensation Scheme (FSCS) – firms may consider joining the FOS’s Voluntary Jurisdiction to give potential investors peace of mind.
• There are still some important details to be clarified – including when any equivalence decisions will be granted, whether additional requirements will be imposed alongside equivalence decisions, the timing of the landing slots that will be allocated following an equivalence decision, the shape of the future UK retail disclosure regime, and details on the OFR regime for MMFs. However, this consultation gives firms enough information to start considering their approach and taking “no regret” actions.
  

Overview

The FCA has consulted on implementing the OFR and aims to finalise the rules in H1 2024. The OFR introduces two new equivalence regimes: one for retail investment funds and one for MMFs. These regimes allow non-UK funds to be marketed in the UK once the UK Government has deemed their jurisdiction to be equivalent and the fund has been recognised by the FCA. MMFs wanting to market to UK retail investors will need to apply under both regimes.

No equivalence decisions have yet been made, but the Government is currently considering the equivalence of EEA UCITS funds. Equivalence assessments are based on whether the non-UK regime gives at least equivalent investor protection on an outcomes basis, and whether adequate supervisory cooperation arrangements are in place. As part of an equivalence decision, the Government can specify additional requirements for a category of retail funds to give consistency to UK retail investors and to ensure a level playing field with UK funds. Additional requirements cannot be applied to non-retail MMFs.

The consultation sets out the information that the FCA would need to obtain from retail scheme operators to inform its decision to recognise a fund under the OFR, and the rules that would apply to OFR funds. The TMPR for existing EEA UCITS funds will expire at the end of 2025. There are currently 109 standalone UCITS funds and 8190 UCITS sub-funds in the TMPR, so there are expected to be a lot of applications for the FCA to process before the end of 2025. To manage the volume, once an equivalence decision has been made, the FCA intends to give firms landing slots in which to apply for recognition. Firms will need to ensure that they are ready for their landing slot, which could be well before the end of 2025.

This consultation does not cover the information the FCA would need to grant recognition to non-UK MMFs. The FCA is separately consulting on a transitional provision which would allow EU MMFs which are currently or were previously marketing under the TMPR to continue to be established, managed or marketed in the UK until the end of 2027 before needing to transition to the OFR. However, since retail MMFs need to be recognised under both equivalence regimes, they will still need to apply under the retail regime before the end of 2025.

Funds domiciled in jurisdictions without an equivalence decision can still market to UK retail investors under section 272 of FSMA – however, this is significantly more expensive and time-consuming than marketing under the TMPR or the OFR. Non-retail funds can market to professional investors under the UK’s national private placement regime.

Costs and charges

The FCA proposes to require firms to submit information about all the cost and charges associated with the fund – including ongoing charges, initial and exit fees, performance fees and payments to a sponsor - so that it can assess whether the fees are clear, transparent and do not expose investors to harm from undue costs. The FCA shows a particular interest in any payments that are being made to third parties, including sponsors and fund promotors – noting that UK rules prohibit promotional payments being made from the fund to third parties and that it has seen several instances in the past where UK investors may have borne undue costs in relation to promotional payments to third parties.

The FCA does not include any proposals to require overseas funds to submit a value assessment similar to that required for UK funds under the Assessment of Value rules or the Consumer Duty. However, the UK Government will be able to impose additional requirements when granting an equivalence decision, so it remains to be seen whether value assessment requirements may be imposed via this route. UK distributors may already expect information about the value a fund delivers to be provided to them so that they can meet their obligations under the Consumer Duty. We set out our perspective on how EU firms can leverage the EU undue costs rules to provide such information here. However, if more formal value assessment requirements are imposed then EU firms may need to carry out more detailed assessments. In future, there may also be synergies with value assessments conducted under the EU’s retail investment strategy.

Sustainability

The FCA wants to bring OFR recognised schemes into the scope of the SDR and will work with HM Treasury to understand the options for achieving this. The SDR consists of several requirements including a “sustainable investment label” regime, several product and firm level disclosures, marketing restrictions, rules for distributors and a stand-alone anti-greenwashing rule.

Firms managing OFR recognised schemes will need to consider carefully how they comply with the FCA’s anti-greenwashing rule, which requires firms to communicate sustainability-related claims in a “clear, fair and not misleading” manner. This is made more complicated by the broad, technical and largely undefined sustainability lexicon, and (typically) by firms lacking consistent in-house definitions of sustainability related terms. We set out our perspective on how firms can prepare for this here.

Firms managing OFR recognised schemes will also need to consider whether they want to use any of the FCA’s sustainable investment labels – these allow firms to market their funds as sustainable but will require firms to ensure they have credible evidence to back up their sustainability claims. The UK rules are different from the EU rules, so funds classed as sustainable in the EU will not automatically meet the FCA’s sustainable investment labels.

Financial promotions

The FCA proposes that financial promotions relating to units in an OFR recognised scheme will need to be communicated or approved by a UK authorised firm, unless a financial promotion exemption applies. This differs from the current position for EEA UCITS in the TMPR which are able to communicate financial promotions themselves. An exemption applies to firms that approve financial promotions for unauthorised firms within their own corporate group – so groups where the operator of the non-UK scheme delegates investment management to a UK portfolio manager will generally be able to use this exemption. Where no exemption applies, non-UK funds will need to find a UK firm which can communicate or approve the financial promotion – the FCA has recently strengthened its rules to require this firm to have appropriate competence and expertise in the investment to which the financial promotion relates.

Investor disclosures

OFR recognised schemes will need to produce investor disclosures under the UK rules, which currently require a key investor information document (KIID) and a prospectus. However, these rules are currently under review, and the FCA is expected to consult on the new regime in 2024.

The FCA proposes that OFR recognised schemes would be required to provide additional disclosures about the fact that they are outside the scope of the FOS and the FSCS. They would be required to disclose this in financial promotions, in the prospectus and in supplementary information provided alongside the KIID – subject to any changes in the new retail disclosure regime. In the prospectus and the supplementary information alongside the KIID, they must also disclose whether investors would be able to access a redress or compensation scheme in another jurisdiction – however this would be omitted from financial promotions to avoid information overload. Given that information about the lack of FOS coverage will become more prominent, non-UK funds may wish to consider joining the FOS’ Voluntary Jurisdiction, which will incur costs for the firm but may give potential investors more peace of mind.

Conclusion

This consultation provides helpful clarity on a number of the requirements that will be applicable to retail schemes seeking recognition under the OFR. However, there are still some important details to be clarified – including when any equivalence decisions will be granted, whether additional requirements will be imposed alongside equivalence decisions, the timing of the landing slots that will be allocated following an equivalence decision, the shape of the future UK retail disclosure regime, and details on the OFR regime for MMFs. Nevertheless, this consultation provides enough information for firms to start assessing what actions they are likely to need to take before submitting an application under the OFR, considering what strategic decisions they may need to make, and taking “no regret” actions. This will help them to move quickly once the rules are finalised and equivalence is granted.

“No regret” actions that firms can take now include:

• reviewing their costs and charges (and especially any promotional payments to third parties) to ensure that these are clear, transparent and do not expose investors to harm from undue costs;
• considering whether they want to use any of the SDR sustainable investment labels, and ensuring that any sustainability-related claims are communicated clearly and backed up by credible evidence;
• where a fund does not have a UK authorised firm to approve their financial promotions and no exemption applies, starting to look for potential approvers with the required expertise; and
• considering the costs and benefits of joining the FOS’ Voluntary Jurisdiction.