In the early days of the Brexit period Trade and Cooperation Agreement (TCA), we take a look at the shape of the new UK regime for regulation of funds and the asset management industry. The aspirations to preserve a single market in Western Europe for funds and asset management have been trumped by mercantilism. The UK’s intention to maintain continuity with the inherited EU regime is increasingly overshadowed by proposals for change. And the world has still to master the pestilence that has disrupted commerce.  So 2021 looks set to bring plenty of challenges and, no doubt, opportunities.  

On the surface, the new regulatory framework looks like a return to the dark ages of cross border business between the UK and the EU27, as we engage with the complexities of national private placement regimes under the TCA. The new terminology will be confusing for a while. UK UCITS become AIFs and UCITS become AIFs in the UK. The UK transitional regime will provide a limited respite to adapt to the new state of affairs. Similar regimes may appear on a piecemeal basis in the EU27, as the limitations of the new deal for financial services become apparent. We focus in particular on market access now that the EU AIFMD, UCITS and MiFID II Directives cease to themselves form part of UK law and related passporting rights cease to apply. We offer two Case Studies to contextualise our thoughts.

We hope that this guide to the changes that we see as important in the regulatory regime for funds and asset management will be helpful in getting to grips with the new dynamic.  

UCITS Directive

The Collective Investment Schemes (Amendment) (EU Exit) Regulations 2019 (UCITS EU Exit Regulations) have been adopted to adapt the regime for UCITS funds post Brexit. The regulations contain amendments to the Financial Services and Markets Act 2000 (FSMA) and to the UCITS Regulations 2011. The UK Financial Conduct Authority (FCA) has taken over all responsibility for UCITS technical standards. Updates to the COLL Chapter of the FCA Handbook reflect the changes under the new regime.

The UCITS EU Exit Regulations create the designation of "UK UCITS", and a new regulated activity under the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (ROA) of "managing a UK UCITS".

The objective of the UCITS EU Exit Regulations was to re-create the previous, EU-law-based rules as far as possible, and so the previous investment rules for UK UCITS remain unchanged. Under the UCITS EU Exit Regulations, UK UCITS retain the ability to book cash in accounts opened with any EEA credit institution, meaning that funds are not required to move their settlement accounts as part of the Brexit transition. In order to minimise disruption to UK UCITS investing in EEA assets, the classes of eligible assets will be defined to include both UK and EEA assets, meaning investment powers remain functionally unchanged.

The UCITS EU Exit Regulations establish a Temporary Permissions Regime (TPR) and Temporary Marketing Permissions Regime (TMPR) for firms and funds. More generally, the temporary regimes were created by the FCA to enable relevant firms and funds that had passported into the UK to continue operating in the UK as the passporting regime fell away, provided relevant notifications to the FCA had been made. The TMPR includes provisions which allow EEA UCITS to continue to be treated as recognised schemes in the UK for a period of three years from the end of the transition period, with the possibility for a further year's extension by HM Treasury (and see proposals for further extension below). This allows EEA UCITS to continue to be marketed to the public in the short term and makes it easier for advisers to continue to recommend these funds. Other than under the TMPR, EEA UCITS will only be able to market into the UK under the same conditions as other third country funds. Further detail on the TPR and TMPR are set out below. To take advantage of the temporary regimes, the FCA would require to have been notified of the intention to do so prior to the expiry of the Brexit transition period.

As noted above, the previous UCITS passporting system, which allowed UCITS to be marketed to retail investors across the EU (including the UK), ceased at the end of the transition period. As it stands, at the end of the TMPR, a fund would need to apply under section 272 of FSMA to become "recognised" in order to market to retail investors in the UK. Concerns were raised as part of the Brexit onshoring process about whether section 272 offered an appropriate regime for recognising funds. Following a period of consultation, the UK government proposes to create two separate equivalence regimes for overseas retail funds and money market funds (MMFs). An equivalence determination under the retail funds regime allows eligible funds to gain recognition and be marketed to retail investors. Under the MMF regime, an equivalence determination allows eligible funds to gain access to the UK. This new "overseas funds regime" (OFR) is expected to be introduced via The Financial Services Bill 2019-21. The Bill (the date for the House of Commons report stage for the Bill has not yet been announced) will introduce a new section 271A of FSMA to create a retail fund equivalence regime. The Bill also extends the TMPR from three years to five years to ensure sufficient time for the OFR to be established.

There is scope for new UCITS sub-funds to be marketed in the UK using the TMPR. To use the regime, a sub-fund will need to satisfy the following conditions:

• the new sub-fund becomes authorised by its home state regulator on or after 31 December 2020;
• when the new sub-fund becomes authorised by its home state regulator, at least one other sub-fund of the new sub-fund’s umbrella scheme must be a recognised scheme in the TMPR;
• after the new sub-fund becomes authorised by its home state regulator and while at least one other sub-fund of the umbrella scheme continues to be so authorised, the operator of the new sub-fund must notify the FCA that they wish the new sub-fund to enter the TMPR;
• the notification must be given before the start of the period specified by us directing the umbrella scheme to apply for individual recognition under section 272 of the Financial Services and Markets Act 2000 (or presumably via the OFR once the Financial Services Bill 2019-21 has been enacted).

Unless operating within the TPR, the depositary, trustee, operator and manager of a UK authorised fund has to meet certain domestic requirements, depending on the legal form the fund takes. In summary, those entities will each need to be a body corporate incorporated in the UK and have a place of business in the UK. This is a significant change, especially for depositaries and managers from an EU member state who operated using a UK branch arrangement. Although the TPR can be used initially, functions may need to move to a new entity that complies with the UK requirements.

The UCITS EU Exit Regulations also remove the possibility of cross-border mergers between UCITS, though mergers between UK UCITS will still be possible.

UK UCITS will be treated as third country AIFs from an EU perspective, on which more below.

Alternative Investment Fund Managers Directive (AIFMD)

The Alternative Investment Fund Managers (Amendment) (EU Exit) Regulations (SI 2019/328) (AIFMD EU Exit Regulations) have "onshored" the previous AIFMD regime, creating a domestic UK regime for alternative investment fund managers post Brexit. As onshored, an AIF for the purposes of the AIFMD EU Exit Regulations is an investment fund that is not authorised as a UCITS in the UK. Responsibility for making technical regulations and reporting obligations in a UK context has switched from the European Securities and Markets Authority (ESMA) to the FCA. The FUND Chapter of the FCA's Handbook remains the core part of the Handbook of relevance to UK and overseas fund managers.

The central tenets and concepts enshrined in AIFMD survived the onshoring process. Indeed, the very objective of that process (as with the UCITS Directive discussed above) was to ensure as little disruption as possible as a consequence of Brexit. The main changes to the onshored Regulation, compared to the regime we have been used to, relate to market access following the UK's departure from the political bloc. 

The AIFMD EU Exit Regulations created their own TMPR and the TPR was open to managers providing services in the UK via AIFMD passporting rights. The TMPR enables EEA AIFMs to continue to market certain AIFs in the UK. Importantly, this was subject to the AIFM notifying the FCA of their intention to do so prior to the expiry of the transition period. An EEA fund manager can continue to manage a UK AIF for a limited period, provided it has made the necessary notifications under the TPR. 

Existing funds which had not been passported into the UK were not eligible to enter the TMPR. This included EEA AIFs managed by UK AIFMs and third country AIFs or EEA AIFs which are feeders for a third country master AIF, managed by EEA AIFMs. The FCA is to apply the Temporary Transitional Power (TTP) in relation to the provisions which govern how such AIFs can now be marketed in the UK after the end of the transition period. The onshoring process means that there are some areas where the requirements on firms and other regulated persons have changed. To help firms adapt to their new requirements, the Treasury gave UK financial regulators the power to make transitional provisions to financial services legislation for a temporary period. This is known as the TTP. As a result, these funds will be able to be marketed in the UK on the same basis as they were before the end of the transition period for a temporary period of 15 months, expiring on 31 March 2022.

UK and EEA AIFMs marketing new AIFs in the UK are unable to use the marketing passport under AIFMD or the TMPR. Such AIFMs will need to market those new funds in the UK via its national private placement regime (NPPR). US managers, for example, or those advising them, may already be familiar with the NPPR – it is not itself a new regime but it will have much broader application following Brexit, given it will apply to EEA funds and managers too.

Interestingly, the onshored version of the UK AIFMD Regulations grant HM Treasury the power to specify the date on which the UK's own third country (i.e. non-UK) passport may come into force in the UK. This provision would allow the UK to consider the regulatory and supervisory regimes that apply in other jurisdictions to be suitable, such that non-UK managers can access the UK market in a more frictionless manner than currently. The equivalent third country passport regime has never been activated under the AIFMD itself to permit access to European markets by managers based in jurisdictions outside the European project. One would have thought that permitting EEA managers third country passports to access the UK would be high on the priority list, but it will be interesting to see if other territories are keen to engage and what political considerations might apply.

There is no equivalent to the TPR/TMPR available to funds and their managers on an EU-wide basis and, therefore, subject to any rules in a specific member state, UK fund managers will not be able to act as fund manager of EEA funds post Brexit (although acting as delegated portfolio manager in most cases will still be permitted (see Case Study 2 below)), and will not be able to market their funds in the EEA except under the NPPR in the relevant member state (and those rules are quite restrictive in a number of those member states).

Markets in Financial Instruments Directive (MiFID II) and Markets in Financial Instruments Regulation (MiFIR)

MiFID II and MiFIR are adapted for UK law through a number of instruments and new regimes, including the Investment Exchanges, Clearing Houses and Central Securities Depositaries (Amendment) (EU Exit) Regulations 2019 and the Markets in Financial Instruments (Amendment) (EU Exit) Regulations 2018 (MiFID II EU Exit Regulations), as well as updates to FSMA and various chapters of the FCA Handbook.

The MiFID II EU Exit Regulations transfer ESMA's functions under MiFID to UK equivalents, including the FCA, the PRA and HM Treasury, and replaces the information-sharing obligations with a discretionary regime.

The TPR applies in relation to MiFID II on the basis of substituted compliance, which allows EEA firms using the TPR to operate legally in the UK for the period of that regime if they can show that they are in compliance with the EU regime. An EEA portfolio manager or investment adviser passporting into the UK prior to the expiry of the Brexit transition period can continue to do so under TPR post Brexit (if it has notified the FCA).

As noted in the context of AIFMD, there is no equivalent of the TPR in the opposite direction (i.e. into the EEA) operating on a pan-European basis. Case Study 2 below provides insights on how delegation arrangements may be preserved/adopted in order to allow UK service providers to continue to provide services in the EEA absent passporting rights.

Temporary Permissions Regime, Temporary Marketing Permission Regime and Financial Services Contract Regime

The preceding discussion will evidence the immediate importance of the TPR and TMPR in preserving market stability and mitigating client disruption. It is therefore worth looking at the arrangements in more detail. 

The TPR will allow inbound firms to continue operating in the UK within the scope of their current permissions for a limited period after exit day, while seeking full UK authorisation. The TMPR will also allow funds previously marketed in the UK via a passport to continue marketing in the UK temporarily.

The TPR/TMPR is available to:

1. firms authorised in EEA states which benefited from passporting rights to offer certain products or services in the UK;
2. firms authorised in EEA states which were authorised to carry out business in the UK through the exercise of Treaty rights (Treaty firms);
3. electronic money, payment institutions and registered account information service providers which made use of passporting rights under the Electronic Money Directive or the Payment Services Directive;
4. UCITS schemes; and
5. Alternative Investment Funds.

Note that the FCA has indicated that it will only consider granting UK authorisation to firms that establish a branch in the UK. This is a significant restriction for EEA firms that have been relying on a services passport with no UK branch. Subject to this restriction, by making use of the TPR and TMPR, firms and funds will be able to continue their business in the UK with minimal disruption for a limited period of time, provided they have notified the FCA of their intention to do so prior to the deadline. It is intended that, during this time, they will be able to apply for the necessary permissions which they will need to have in place once the TPR expires.

Firms making use of the TPR will be allocated a time period known as a "landing slot" within which they will need to submit their application for UK authorisation. These slots are expected to be around two to three months in length and will be confirmed after exit day. The TPR is intended to be in place for three years from exit day, during which time firms and funds will be required to obtain authorisation or recognition in the UK, if required. Please see the commentary above under the UCITS Directive in the context of a desire to extend the period required for authorisation in order to allow the new overseas funds regime to be implemented.

The government has also introduced a financial services contracts regime (FSCR). The FSCR will enable firms who do not enter the TPR to wind down their UK business in an orderly fashion. The FSCR will automatically apply to EEA passporting firms that do not submit a TPR notification, but have pre-existing contracts in the UK which would need FCA permissions to service. The FSCR has its own FCA notification requirements to which relevant firms should adhere. The FSCR is time-limited depending on the type of regulated activity being performed. It will apply for a maximum of 15 years for insurance contracts, or five years for all other contracts. The Treasury can extend these periods, if necessary, based on a joint assessment by the FCA and the PRA.

Case Study 1: Forgot your passport? Does it matter?

We have come across examples where firms have made the relevant notifications to allow them to manage funds in other jurisdictions in the EU via a passport, but actually the spread of regulated activity means that the passport is not in fact necessary. This observation could be helpful to managers who are recognising that their existing passport (to manage UK funds) will be unavailable from 31 December and are considering whether they need to make alternative arrangements.

A person manages an AIF when such person performs risk management or portfolio management on its behalf. If a person manages an AIF and also carries on one or more additional activities for an AIF, or in connection with or for the purposes of the management of that AIF, those additional activities are included in the regulated activity of managing an AIF. Those additional activities include certain administration activities, marketing activities and activities related to the assets of the AIF. It is important to test that fund management activities connected to the AIF are actually being performed in the UK and under the regulatory permissions of the AIFM.

PERG 16.8 (Question 8.1) provides that the activity of managing an AIF is generally carried on where the place of business of the AIFM from which the activity is carried out is located. If the activity is carried on from a number of locations, some in the UK and some not, the activity is treated as being carried on in the UK if there is some continuity or regularity of provision within the UK of activities which are a significant part of managing an AIF. PERG guidance provides that, when deciding whether a company is managing an AIF in the UK if it splits the work between an office in the UK and one outside, one should take into account any of the additional activities described that an AIFM may perform in the course of managing an AIF.

Section 418 of the FSMA extends the territorial scope of FSMA by deeming, in certain cases, activities that would otherwise be carried on outside the UK to be carried on in the UK. This includes when each of the stages that make up a regulated activity (such as managing investments) takes place in different countries – for example, a person's management is in country A, the assets are held by a nominee in country B, all transactions take place in country B or country C, but all decisions about what to do with the investments are taken from an office in the UK. Given that the investments are held, and all dealings in them take place, outside the UK, there may be a question as to where the regulated activity of managing investments is taking place. For the purposes of FSMA, it is carried on in the UK.

In our Brexit scenario, where the manager has relevant permissions in the UK, this provision is helpful. Of course, advice would need to be obtained in all relevant jurisdictions.

Case Study 2: Delegation arrangements post Brexit

It is very common for EU AIFMs to delegate portfolio management services to a manager in the UK. What happens to these delegation arrangements when the UK becomes a third country for the purposes of the Directive?

From a European regulatory perspective, it is clear that it is possible for EU fund managers to delegate portfolio management services to a service provider in a third country. AIFMD contains two requirements for this route: (i) the third country delegated portfolio manager must have a licence for asset management in its own country, and (ii) there should be a cooperation agreement between the regulator of the EU fund manager and the regulator of the third country delegated portfolio manager. The FCA has entered into Memoranda of Understanding (MoUs) with ESMA and EU regulators in February 2019 to satisfy (ii) above. Provided the portfolio manager satisfies limb (i), the delegation arrangements should be able to survive Brexit. 

All good? Perhaps not…

First, the EU fund manager also needs to be satisfied that it can objectively justify the delegation to the particular delegate, and that it can direct and control its delegate. These principles are well-established under the ESMA Brexit opinions issued in 2017 (one of which set out general principles on supervisory convergence and another focused specifically on the investment management sector). For existing delegations, satisfying these requirements should be reasonably straightforward, but will come under more scrutiny from European regulators now that the delegation is to a third country. Also, the EU's current AIFMD review is focusing attention on the existing delegation rules, so these rules may be tightened further in time. [Marketing team: link to our AIFMD article here?]

Secondly, while, from the perspective of the EU fund manager, it should be able to continue to justify the delegation to a UK portfolio manager who is regulated to manage investments in the UK, this is not necessarily the whole story from the perspective of the UK portfolio manager. It is possible that the home member state of the EU fund manager considers that the UK portfolio manager is, by way of the delegation, conducting regulated activity in that EU member state which would require it to maintain a licence there. 

Positively, two major EU fund jurisdictions (Luxembourg, as most recently confirmed in a circular published by the CSSF in July 2020, and Ireland, under its MiFID II safe-harbour) have confirmed that they would not seek to license the delegate in this scenario on the basis (in summary) that investment services provided by a third country firm on a cross-border basis to per se professional clients in Luxembourg/Ireland are deemed not provided in Luxembourg/Ireland and, therefore, fall outside MiFID II. 

However, for EEA funds and fund managers in other countries, or if the UK portfolio manager has operations in the relevant country, the situation may not be so simple, and local advice should be sought.

This case study is also a reminder that, although the AIFMD is intended to apply a standard fund management regime across the EU, member states do interpret concepts differently. For example, this is also true for the rules on "reverse solicitation", whereby services provided by a third country firm that have been solicited by a client in a particular member state may (or may not) be provided without requiring to be licensed in that member state. 

Local advice is therefore always recommended. The Dentons Asset Management and Investment Funds team across Europe is well equipped to help you navigate these issues, whether in particular countries or across the EEA.

Dentons' global Asset Management & Investment Funds group is a team of more than 200 asset management-focused lawyers led from key management jurisdictions within the world's largest law firm, whose dominant focus is investment funds work, both transactional and advisory. Through our unrivalled global coverage, clients can be sure that wherever they have assets, make investments, do business or see opportunity, we can assist.