The ICLG to: Public Investment Funds Laws and Regulations

Public Investment Funds Laws and Regulations UK 2024

ICLG - Public Investment Funds Laws and Regulations - United Kingdom Chapter covers common issues in public investment funds – including registration, regulatory framework, marketing of public funds and tax treatment.

Published: 04/04/2024

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1. Registration

1.1        Are funds that are offered to the public required to be registered under the securities laws of your jurisdiction? If so, what are the factors and criteria that determine whether a fund is required to be registered?

For UK purposes, a collective investment scheme (“CIS”) is defined very widely under s.235 Financial Services and Markets Act 2000 (the “FSMA”) as essentially being arrangements, the purpose of which is the sharing of profit or income by the participants in circumstances where the participants do not have day-to-day control over the management of the property in question.

It is important to be aware that not all “public funds” are CISs for UK purposes.  In particular, the UK Alternative Investment Fund Managers Regime (the “UK AIFM Regime”) extends to certain types of closed-end corporate funds that are specifically excluded from the CIS definition.  Where such corporate funds are listed, they can be regarded as an alternative to an authorised CIS for retail investors; however, the requirements relating to such funds are beyond the scope of this note.

The relevance of the CIS definition for marketing purposes is that s.238 FSMA restricts the promotion of CISs by authorised persons (as defined in FSMA) to the general public in the UK, except in relation to the following types of CIS established in the UK:

  1. an authorised unit trust scheme (“AUT”), being a CIS under which the property is held on trust for the participants, and which has been authorised by the Financial Conduct Authority (“FCA”) pursuant to s.243(1) FSMA;
  2. an authorised contractual scheme (“ACS”), being a specific type of tax-transparent CIS introduced under the Collective Investment in Transferable Securities (Contractual Scheme) Regulations 2013 and which may take one of two forms: (a) a co-ownership scheme; or (b) a limited partnership scheme; or
  3. a scheme constituted by an authorised open-ended investment company (“OEIC”), being an open-ended investment company incorporated under the Open-Ended Investment Companies Regulations 2001 (the “OEIC Regulations”) or equivalent prior legislation.

An overseas CIS may only be promoted to the general public in the UK by authorised persons under s.238 where it is a recognised scheme under either s.271A (schemes authorised in approved countries) or s.272 (individually recognised overseas schemes).

Prior to the end of the Brexit transition period (11pm (GMT) on 31 December 2020), an Undertaking for the Collective Investment in Transferable Securities (“UCITS”) scheme constituted in an EEA State that satisfied certain requirements under s.264 FSMA could be promoted to the general public in the UK by authorised persons under s.238 FSMA.  However, following Brexit, UCITS schemes constituted in an EEA Member State will need to be individually recognised by the FCA under either s.271A or s.272 FSMA where they have not entered the UK’s Temporary Marketing Permission Regime.

1.2        What does the fund registration process involve, e.g., what documents are required to be filed?

An application for authorisation of a UK CIS must be made to the FCA as follows:

  1. in relation to an AUT by the manager and trustee under s.242 FSMA;
  2. in relation to an ACS by the operator and depositary under s.261C FSMA; and
  3. in relation to an OEIC by the authorised corporate director and depositary under regulation 12 of the OEIC Regulations.

In addition to the completed application form, various documents need to be provided when the application is submitted, including a draft copy of the Trust Deed (for AUTs), Co-ownership or Partnership Deed (for ACSs), Instrument of Incorporation (for OEICs), a solicitor’s certificate stating that the CIS’s constitutional document complies with applicable laws and regulations, the draft prospectus and related checklist, the draft Key Investor Information Document (“KIID”) or NURS-KII (as and where applicable) and a model portfolio.

Following Brexit, the EU UCITS regime has been onshored into English law by the creation of a UK-specific UCITS regime.  An application for an authorisation order must propose that the scheme be either: a “UK UCITS”; a Non-UK UCITS Retail Scheme (“NURS”); a Qualified Investor Scheme (“QIS”); or a Long-Term Asset Fund (“LTAF”).  QISs are authorised funds that are only intended for professional clients and certain categories of retail clients (subject to various conditions).  They are categorised as non-mainstream pooled investments (“NMPIs”) and are subject to restrictions in their promotion accordingly.  As such, QISs have a more relaxed set of rules governing their operation and, in particular, their investment powers than UK UCITS or NURS.

When LTAFs were first launched, they were also treated as NMPIs and subject to similar restrictions regarding their distribution and promotion.  However, in June 2023, the FCA published its final rules on broadening retail access to the LTAF, under which a unit in an LTAF was recategorised as a restricted mass market investment (“RMMI”) extending their distribution to a broader range of retail investors and pension schemes to appropriately access the LTAF while ensuring they understand the risks involved.  LTAFs are specifically designed to enable wider access to investors in assets such as infrastructure and private companies that are not regularly traded and need to be held over the longer term.

The FCA must determine applications for authorisation of new UK UCITS schemes within two months and has six months to process applications for authorisation of a NURS, QIS or LTAF.  However, on its website, the FCA states that it aims to approve: (i) NURS applications within two months of receiving a complete application; and (ii) QIS applications within one month of receiving a complete application.  The FCA encourages firms that are considering launching an LTAF to engage with it prior to submitting an application.

Where the CIS is not a UK UCITS, it will be an alternative investment fund (“AIF”) for the purposes of the UK AIFM Regime and the AIF manager will need to make certain additional notifications to the FCA, including a marketing form. 

Non-UK CIS

S.271A schemes

The overseas funds regime (the “OFR”) is intended to help streamline the regime for marketing overseas investment funds to UK retail investors.  The OFR created two new equivalence regimes based on the principle of “outcomes-based equivalence” for retail investment funds and money market funds.  Under these regimes, HM Treasury has the power to determine that another country’s regime for investment funds is equivalent, in terms of the protection afforded to participants, to the UK regime.  Once HM Treasury has made an equivalence determination, an investment fund of a specified description that is domiciled in that country can apply to the FCA for recognition in the UK.  In January 2024, HM Treasury confirmed that it had found EEA States (including EU Member States) to be equivalent under the OFR by reference to EU UCITS (not including UCITS that are also money market funds).  In its determination of an application, the FCA will consider, among other things, whether the following requirements are satisfied:

  • the scheme is authorised in a country or territory that is approved by HM Treasury under s.271A (i.e. the equivalence regime);
  • the scheme is of a description of scheme specified in the regulations; and
  • adequate arrangements exist for co-operation between the FCA and the overseas regulator.

The OFR effectively came into force in February 2022 as a result of HM Treasury commencement regulations permitting themselves to issue regulations recognising funds authorised in designated countries as being capable of being marketed in the UK.  The FCA issued a consultation paper in December 2023 regarding implementing the OFR; however, at the time of writing, the OFR is not yet operational, as the full requirements and procedures are yet to be finalised.

S.272 schemes

The s.272 regime has remained in place alongside the OFR and can be used for individual funds that want to market to UK retail investors but do not fall within the scope of an equivalence determination.

In this case, the operator of the CIS may apply to the FCA to make an order declaring the scheme to be a recognised scheme.  In determining whether to make such an order, the FCA will consider, among other things, whether the following requirements are satisfied:

  • adequate protection must be afforded to participants in the scheme;
  • the arrangements for the scheme’s constitution and management must be adequate;
  • the power and duties of the scheme’s operator and, where applicable, trustee or depositary must be adequate;
  • the operator and, where applicable, trustee or depositary must have permission or otherwise be fit and proper to act as such and must be able and willing to co-operate with the FCA by the sharing of information and in other ways; and
  • the purposes of the scheme must be reasonably capable of being successfully carried into effect.

In relation to s.271A and s.272 schemes, additional notifications may also be required under the UK AIFM Regime.

Brexit

At 11pm (GMT) on 31 December 2020, the post-Brexit transition period ended.  During the transition period, the UK continued to be treated as part of the single market and EU law continued to apply.  However, now the transition period has expired, passporting rights under EU single market directives (including UCITS and the AIFMD) have been withdrawn.

In order to mitigate the loss of passporting rights and to provide certainty for EEA firms carrying out business in the UK, the UK government introduced a Temporary Permissions Regime (the “TPR”) and a Temporary Marketing Permissions Regime (the “TMPR”) in 2019.  The TPR allowed EEA firms that previously passported into the UK to continue to operate in the UK for a maximum of three years, within the scope of their current permissions.  The TMPR allows certain EEA-based funds that were passporting into the UK at the end of the transition period to continue to be marketed in the UK, in the same manner as they were before the transition period ended, for a maximum of six years (the TMPR was originally scheduled to end at the end of 2023 but this has been extended by an additional three years to ensure sufficient time for the OFR to be established).  

The window for notifying the FCA of an intention to use the TPR or TMPR closed on 30 December 2020.  However, if new sub-funds of EEA UCITS are authorised by the relevant home state regulator after the end of the transition period, and form part of an umbrella scheme that had notified for the TMPR before the end of the transition period, they may be added into the TMPR so that they can be marketed to the general public, including retail investors.

The TPR ended on 31 December 2023.  The TMPR remains in force until 31 December 2026.

1.3        What are the consequences for failing to register a fund that is required to be registered in your jurisdiction?

Where a CIS that has not been authorised or recognised by the FCA (as outlined in question 1.1 above) is promoted to the general public (and such promotion does not fall within a specific exemption), the consequences will differ depending on whether the promotion was made by an authorised person or an unauthorised person.

Promotion by an unauthorised person will, in the absence of an exemption, amount to a contravention of the financial promotion restriction under s.21 FSMA.  Under s.25 FSMA, a person who contravenes s.21 FSMA will be guilty of a criminal offence and liable on conviction to a maximum term of two years’ imprisonment or a fine, or both.  In addition, s.30 FSMA provides that agreements resulting from unlawful communications are unenforceable by the guilty party, and the recipient is entitled to recover any money or other property paid or transferred by him under the agreement and compensation for any loss sustained by him as a result of having parted with it.  However, the court may allow the agreement or obligation to be enforced, or money or property paid or transferred under the agreement to be retained, if it is satisfied that it is just and equitable in the circumstances of the case.

Promotion by an authorised person will, in the absence of an exemption, amount to a contravention of the restriction under s.238 FSMA outlined in question 1.1 above.  Under s.241 FSMA, such contravention is actionable at the suit of a private person who suffers loss as a result of the contravention, subject to the defences and other incidents applying to actions for breaches of statutory duty.  The FCA also has wider powers to impose sanctions on the relevant firm and/or individuals for breaches of its rules.

1.4        Are there local residency or other local qualification requirements that a fund must meet in order to register in your jurisdiction? Or are foreign funds permitted to register in your jurisdiction?

As indicated above, a foreign fund may currently only be marketed to the general public in the UK where it is a recognised scheme under either s.271A or s.272 FSMA.  Additional notifications may also be required under the UK AIFM Regime.

2. Regulatory Framework

2.1        What are the main regulatory restrictions and requirements that a public fund must comply with in the following areas, if any? Are there other main areas of regulation that are imposed on public funds?

i. Governance

As outlined above, each type of UK-authorised fund has its own constitutional document, which, together with the prospectus and applicable FCA rules, will set out the operating rules of the fund. 

Responsibility for the governance of the fund is divided between the segregated duties of the fund’s manager and its depositary.  The manager is responsible for the day-to-day operation of the fund in accordance with the above requirements, including: arranging for the issue and cancellation of units; valuing the scheme property; calculating the price of units; maintaining the register of unitholders; and ensuring that investment decisions are made in line with the fund’s investment objectives, policy and investment and borrowing powers.  The depositary oversees the manager’s performance of certain key functions (including unit pricing, dealing, valuations and compliance with investment and borrowing restrictions) and is also responsible for safeguarding the fund’s assets. 

Both the manager and the depositary have fiduciary duties to the fund’s investors and must act in the best interests of such investors.  The FCA regulates the governance of authorised funds and has powers to fine or require investor compensation for breach of the governance rules.  Although the manager and depositary are permitted to delegate certain activities to third parties, they retain regulatory responsibility for the performance of such activities.

As a consequence of a market review carried out by the FCA, significant governance-related measures were introduced for UK-authorised fund managers in 2019, including the introduction of a yearly assessment on the value for money at fund level and a minimum number of non-executive directors on fund manager boards.

In July 2022, the FCA set out final rules and guidance for a new Consumer Duty, which came into force on 31 July 2023 for new and existing products or services that are open to sale or renewal.  The Consumer Duty is intended to create a significant shift in the culture and behaviour of many firms (including fund manufacturers and distributors) and to ensure that the focus on acting to deliver good outcomes is at the centre of firms’ strategy and business objectives.  Specific examples of governance requirements under the Consumer Duty include; requiring firms to publish an annual board report on its compliance with the Consumer Duty; holding senior managers accountable for delivering good consumer outcomes under the Consumer Duty; and requiring that firms appoint a non-executive director as a Consumer Duty Champion to ensure that the Consumer Duty is regularly discussed and raised in all relevant discussions.  The Consumer Duty is discussed further below.

The most senior personnel (such as executive directors) and those who perform certain required functions (such as compliance oversight) within authorised firms must be approved as “Senior Managers” by the FCA before they can undertake these functions.  Senior Managers must provide the FCA with a written Statement of Responsibilities setting out their areas of responsibility and firms must allocate certain Prescribed Responsibilities to those Senior Managers.  Senior Managers will be personally liable if they fail to take reasonable steps to prevent a regulatory breach in an area for which they are responsible.

Other senior staff who are not Senior Managers but perform a role that could cause significant harm to the firm or its customers, must be certified by the firm on an annual basis as fit and proper to perform that role.

In addition, to drive a culture of personal responsibility and good conduct, the regulator has imposed a set of Conduct Rules, which apply to all staff within authorised firms (apart from certain ancillary roles such as security or catering).  The Conduct Rules include an obligation to act with integrity and to treat customers fairly.  The Conduct Rules are supplemented by an additional Rule to act to deliver good outcomes for retail customers, as part of the Consumer Duty.  There are also additional Conduct Rules for Senior Managers.

ii. Selection of investment adviser, and review and approval of investment advisory agreement

As outlined above, the fund manager is responsible for the day-to-day management of the authorised fund, including investment decisions relating to the scheme property.  The FCA rules permit the fund manager to delegate the performance of its duties to a third party, subject to certain conditions.  For example, a mandate in relation to managing investments of the scheme may not be given to any other person operating from an establishment outside the UK unless such person is: (a) authorised or registered in such country for the purpose of asset management; and (b) subject to prudential supervision in such country.  In addition, where the proposed delegate is not a UK firm, there must be co-operation arrangements in place between the FCA and the overseas regulator of the delegate.

There are also certain requirements relating to the content of the agreement under which investment management services are delegated, including that: the fund manager must be permitted to give further instructions to the delegate and to withdraw the mandate with immediate effect when this is in the interests of the unitholders; and the mandate must not prevent the effective supervision of the fund manager and must not prevent the fund manager from acting, or the scheme from being managed, in the best interests of the unitholders.

iii. Capital structure

There are no prescribed capital requirements at the level of the authorised fund itself, although the FCA raises queries as part of the fund authorisation application (and in relation to any application to terminate or wind up a fund) around the minimum size for the fund to be considered viable.  However, fund managers are subject to certain capital requirements, including the requirement to hold eligible capital of at least one-quarter of their fixed overheads for the preceding year.

The FCA’s Investment Firm Prudential Regime (the “IFPR”) for FCA regulated investment firms came into force on 1 January 2022.  The intention of the IFPR was to streamline and simplify the prudential requirements for investment firms, and to refocus away from risks firms face to managing the potential harm firms can pose to consumers and markets.

The rules (in the FCA’s MIFIDPRU sourcebook) apply to any UK MiFID investment firm authorised and regulated by the FCA as well as collective portfolio management investment (“CPMI”) firms (UK UCITS managers and AIFMs who also have FCA permission to manage investments) and their UK parent entities.  UK UCITS managers and AIFMs without such permission continue to be subject to the prudential requirements in the FCA’s IPRU-INV 11 chapter.  CPMI firms must comply with the relevant provisions of both MIFIDPRU and IPRU-INV 11.

iv. Limits on portfolio investments

The FCA rules impose limits on the type of investments in which an authorised fund can invest and the proportion of the fund’s capital property that may be invested in particular assets.  Different restrictions apply depending on whether the fund is a UK UCITS or NURS, with greater flexibility generally being given to NURS.  In each case, however, it is the fund manager’s responsibility to ensure that the fund provides a prudent spread of risk for investors.  The following examples on limits to portfolio investments are non-exhaustive and given by way of illustration:

  1. Approved transferable securities and money market instruments: A UK UCITS may not invest more than 5% of its assets in transferable securities and/or money market instruments issued by a single body, although this limit can be increased to 10% per single body, provided the total value of such holdings over 5% does not exceed 40% of the fund’s total value (referred to as the 5/10/40 Rule).  A NURS may not invest more than 10% of its assets in transferable securities or money market instruments in a single body.
  2. Unapproved securities: A UK UCITS may invest up to 10% of scheme assets in unapproved securities, subject to the above maximum of 5% of scheme assets being issued by a single body.  A NURS may hold a maximum of 20% of the fund’s assets in unapproved securities.
  3. Derivatives: Both UK UCITS and NURS are permitted to use derivatives for efficient portfolio management and for investment purposes to the extent appropriate to meet the scheme’s objectives and subject to maximum permitted exposure limits for a UK UCITS and NURS respectively.
  4. Direct investments in property, gold and unregulated collective investment schemes (“UCIS”): UK UCITS may not invest directly in property, whereas NURS are permitted to do so subject to certain concentration restrictions and other requirements.  A NURS may also invest in other types of investment that may not be held directly by a UK UCITS, including gold (up to 10%) and UCIS (up to 20% or otherwise 100%, in respect of a NURS structured as a fund of AIFs).
  5. Borrowing: UK UCITS and NURS must not borrow in excess of 10% of the total value of the scheme’s assets.  In addition, for UK UCITS, any borrowing may only be on a temporary and infrequent basis.

In contrast, a QIS (which may only be marketed to certain categories of investors) is subject to very few investment restrictions (for example, a QIS is prohibited from direct lending with private entities), although the fund manager still needs to ensure the fund provides a spread of risk for investors.  An LTAF has even greater flexibility in its investment powers than a QIS, although the manager must ensure the fund aims to provide a prudent spread of risk rather than just a spread of risk.  The FCA expects the investment strategy of an LTAF to be to invest at least 50% of the value of the scheme property in unlisted securities and other long-term assets, such as interests in immovables or other CISs investing in such securities or long-term assets.

v. Conflicts of interest

The UK regime requires a fund’s manager and depositary to be independent of each other.  This is designed to assist in limiting and managing the potential for conflicts of interest.

In addition, UK-authorised fund managers and depositaries are required to comply with the FCA’s rules on managing conflicts of interest, including the following requirements:

  • to take all appropriate steps to identify and prevent or manage conflicts of interest between (i) the firm and its clients, and (ii) clients of the firm;
  • to maintain and operate effective organisational and administrative arrangements with a view to taking all reasonable steps to prevent conflicts of interest from adversely affecting the interests of its clients;
  • to disclose the risk to investors where a firm’s arrangements are insufficient to ensure, with reasonable confidence, that risks of damage to the interests of a client will be prevented; and
  • (in the case of UK UCITS fund managers and depositaries) to keep and regularly update a record of conflicts of interest that have arisen or may arise and to establish, implement and maintain an effective conflicts of interest policy in the form prescribed by the FCA (further requirements apply to AIFMs).

vi. Reporting and recordkeeping

In the UK, there are requirements for authorised funds to provide investors with regular reports on performance and other matters.  Fund managers are required to prepare and make available/provide the following:

  • Annual Reports on the fund’s performance comprising reports from the fund manager, depositary and auditor, accounts for the annual accounting period and comparative information for evaluation purposes.
  • Half-Yearly Reports containing interim (unaudited accounts) and a manager’s report for the period.
  • Notifications on certain changes to the fund are required to be sent to investors depending on the materiality of the change.

Fund managers are required to maintain appropriate records, both to comply with and demonstrate compliance with the FCA rules.  The FCA rules contain, amongst others, specific requirements for records to be held of any minutes of investor meetings, the issue and cancellation of any units and all portfolio transactions (for UK UCITS).

As of 1 January 2022, large UK fund managers (with over £50 billion in assets under management (“AUM”)) are also subject to climate-related disclosure obligations as set out in the FCA’s ESG sourcebook.  These UK fund managers are required to make annual disclosures at both entity level and at product level.  At entity level, the firm is required to publish a Taskforce on Climate-related Financial Disclosures (“TCFD”) entity report on its website setting out how it takes climate-related matters into account in managing or administering investments.  At product level, the firm must provide a separate TCFD product report that discloses how its products take into account climate-related matters by reference to a set of core metrics recommended by the TCFD.  As of 1 January 2023, these requirements also apply to smaller fund managers (above a £5 billion AUM threshold).

As noted above, a firm’s board should review and approve an assessment of whether the firm is delivering good outcomes for its consumers that are consistent with the Consumer Duty, at least annually.  This assessment should include: the results of the monitoring that the firm has undertaken to assess whether its products and services are delivering expected outcomes in line with the Consumer Duty and whether there is any evidence of poor outcomes; an overview of the actions taken to address any risks or issues; and how the firm’s future business strategy is consistent with acting to deliver good outcomes under the Consumer Duty.

vii. Other

In October 2021, the UK government published its “Roadmap to Sustainable Investing”, which sets out the government’s ambition to green the financial system and align it with the UK’s net-zero commitment.  The paper sets out the first phase of this plan, which focuses on ensuring that decision-useful information on sustainability is available to investors.  As part of this initiative, the government announced the introduction of new Sustainability Disclosure Requirements (the “SDR”) as well as a UK green taxonomy.  The SDR creates an integrated framework for disclosures on sustainability and will work alongside the taxonomy (which is currently in development), which will set out the criteria that specific economic activities must meet to be considered environmentally friendly.  Consequently, new requirements will be introduced for fund managers to disclose both how they take sustainability into account as well as to report on their products’ sustainability impact.  The product-related disclosures will form the basis of a new sustainable investment labelling regime to help consumers better determine the sustainability of a product.  The FCA released a consultation on these proposals, CP22/20, in October 2022 and issued its resulting policy statement, PS23/26 on 28 November 2023.  PS23/26 sets out the FCA’s final regime in respect of the SDR and investment labels, building from the UK’s economy-wide implementation of the TCFD.  The final package of measures includes:

  • an anti-greenwashing rule for all FCA-authorised firms to reinforce that sustainability-related claims must be fair, clear and not misleading;
  • four investment labels that firms can apply to their funds that seek to achieve positive sustainability outcomes (labels include Sustainability Impact, Sustainability Focus, Sustainability Improvers and Sustainability Mixed Goals);
  • naming and marketing rules for funds not using labels, to ensure the use of sustainability-related terms is accurate;
  • consumer-facing information to help consumers understand the key sustainability features of a product;
  • detailed information in pre-contractual, ongoing product-level, and entity-level disclosures, targeted at institutional investors and consumers seeking more information; and
  • requirements for distributors to ensure that product-level information is made available to consumers.

The anti-greenwashing rule applicable to all FCA-authorised firms comes into force on 31 May 2024.  From 31 July 2024, firms can start to use an investment label provided they comply with the relevant rules.  The broader naming and marketing restrictions come into force on 2 December 2024.

2.2        Are investment advisers that advise public funds required to be registered and/or regulated in your jurisdiction? If so, what does the registration process involve?

As outlined in question 2.1, ii. above, the fund manager is responsible for investment decisions relating to the scheme property.  The fund manager is typically required to be an FCA-authorised entity.  In addition, investment management functions may be delegated by the fund manager to a third-party investment adviser, subject to certain requirements, including, where the delegate is not a UK firm, the existence of co-operation arrangements between the FCA and the delegate firm’s regulator.  Subject to such requirements, such a delegate would not need to be authorised by the FCA, provided they are not carrying out regulated activities in the UK. 

Applications for authorisation (also known as Part 4A permissions) are made to the FCA through Connect, the FCA’s online application portal.  The process is designed to assess whether the applicant meets the FCA’s required threshold conditions and will be tailored according to the nature of the activities, which require authorisation.  Information regarding the applicant’s proposed activities, its business plan, senior management and ownership, as well as IT systems, will need to be provided.  Application fees can range considerably, depending on the complexity of the application.  A decision on complete applications will be given within six months of submission (and within 12 months for incomplete applications).

2.3        In addition to the requirements above, are there additional regulatory restrictions and requirements imposed on investment advisers that advise public funds? 

FCA-authorised managers will be subject to extensive requirements, including in relation to conduct of business, senior management, systems and controls, financial requirements and other rules relating to the operation of the fund.

2.4        Are there any requirements or restrictions in your jurisdiction for public funds investing in digital currencies?

Digital currencies are not currently a recognised investment in and of themselves for the purposes of the UK regulatory regime applicable to public funds.  Consequently, the requirements or restrictions applicable to public funds investing in digital currencies must be considered on a case-by-case basis according to how the digital currency would be characterised under the regime (for example, whether it would be regarded as a form of derivative or unit in a CIS) and the requirements or restrictions applicable to such instruments or securities must then be applied. 

2.5        Are there additional requirements in your jurisdiction for exchange-traded funds?

UK exchange-traded funds can be structured as UK UCITS, in which case they will be subject to the requirements of the UK UCITS Regime.  In addition to complying with the requirements of the UK UCITS Regime (where applicable), the exchange-traded fund will also need to comply with the requirements of the exchange on which it is listed.  There are specific FCA requirements that need to be satisfied for an exchange-traded fund to be listed on a UK stock exchange.

3. Marketing of Public Funds

3.1        What regulatory frameworks apply to the marketing of public funds?

These are referred to in questions 1.1 to 1.4 above, in particular:

  1. The financial promotion restriction in s.21 FSMA, which prohibits an unauthorised person in the course of business communicating an invitation or inducement to engage in investment activity except where: the content of the communication has been approved by an authorised person in accordance with the FCA rules; or the communication is covered by an exemption.
  2. The restriction on promotion in s.238 FSMA, which prohibits an authorised person from communicating an invitation or inducement to participate in a CIS, except in relation to an authorised or recognised CIS as referred to in question 1.1 above, unless the communication is covered by an exemption. 
  3. Where the promotion relates to an authorised or recognised CIS (or is otherwise permitted under an exemption), the authorised person will need to comply with the FCA’s rules on communicating with clients (including financial promotions) set out in Chapter 4 of the Conduct of Business Sourcebook (the “COBS”) of the FCA Handbook and the overriding principle to communicate information to clients in a way that is fair, clear and not misleading.
  4. In addition, where a fund is being distributed by an FCA-authorised firm, it will be subject to certain additional requirements under the UK regulatory regime.  These include certain governance requirements around identifying a target market for each fund and ensuring the fund is only distributed to that target market. 

Where the CIS is not a UK UCITS, it will be an AIF for the purposes of the UK AIFM Regime, and the AIF manager will need to make certain additional notifications to the FCA, including a marketing form.  In addition, the AIF manager will need to ensure that it makes available to investors, before they invest, certain prescribed information and any material changes to it.

As outlined in question 2.1, vii. above, the anti-greenwashing rule, requiring all sustainability-related claims to be fair, clear and not misleading, comes into force on 31 May 2024.

3.2        Is licensure with a regulatory authority required of persons (whether entities or natural persons) engaged in marketing activities? If so: (i) are there commonly available exceptions that may be relied on?; and (ii) describe the level of substantive regulation applied to licensed persons.

As above, an unauthorised person may only make a financial promotion where the communication has been approved by an authorised person or the communication is covered by an exemption.  In relation to the latter, a number of commonly available exemptions can be relied on in order to make certain types of financial promotion (e.g. to high-net-worth individuals) subject to the conditions of the relevant exemption being met. 

The FCA authorisation process and ongoing level of regulation on authorised persons is referred to at a high level in question 2.3 above. 

3.3        What are the main regulatory restrictions and requirements in the following areas, if any, that must be complied with by entities that are involved in marketing public funds? 

i. Distribution fees or other charges

In 2006, the Financial Services Authority (the predecessor body to the FCA) launched the Retail Distribution Review (the “RDR”) with the aim of making the retail investment market work better for consumers.  One of the key outcomes of this review was to improve the transparency of charges being levied against consumers by those involved in the lifecycle of retail investment products.  Measures included a ban on the payment of commission from fund managers to financial advisers or platforms for recommending or selling their products.  Such advisers and platforms can now only be paid by charging the client a direct fee.

In addition, under the FCA’s inducement rules, there are very limited circumstances in which a firm may pay or accept any fee or commission, or provide or receive any non-monetary benefit to or from a third party in relation to any regulated business carried on for a client.

The Consumer Duty (mentioned above) includes rules relating to the price and value of products, whereby fund manufacturers must both (i) ensure that their products provide fair value to retail customers in the target markets for those products, and (ii) carry out a value assessment of their products and review that assessment on a regular basis.  Consideration of distribution methods and channels by fund manufacturers is required for these purposes.  Fund distributors must then not distribute a product unless their distribution arrangements are consistent with the product providing fair value to retail customers.  The rules include obligations on both fund manufacturers and distributors to work together to ensure that the fair value obligations are met throughout the distribution chain.

ii. Advertising

The most relevant requirements are covered above, including the rules in COBS 4 applicable to authorised persons as referred to in question 3.1 above.

iii. Investor suitability

Where a firm advises a client or manages their investments, it will need to take reasonable steps to ensure that its advice or decision to trade is suitable for the client.

For other services, firms are required to carry out an “appropriateness test” where a non-advised sale relates to a product that is “complex” for the purposes of the UK regulatory regime.  In the FCA’s view, NURS funds are neither automatically non-complex nor automatically complex and need to be assessed against certain specified criteria accordingly.

As outlined above, fund manufacturers and distributors are subject to certain product governance requirements, which seek to ensure sufficient systems and controls are in place to design, approve, market and manage products.  For product manufacturers, these include:

  1. ensuring their products are designed to meet the needs of an identified target market;
  2. ensuring the strategy for distribution of the product is compatible with the identified target market; and
  3. taking reasonable steps to ensure that the product is distributed to the target market.

Fund distributors are also subject to product governance requirements, including to: understand the products it is distributing; assess the compatibility of the products with the needs of its clients; and ensure that the products are distributed only when it is in the best interest of the clients.

Under the Consumer Duty mentioned above, fund manufacturers and distributors must also comply with additional rules relating to the products and services they provide.  These rules are intended to ensure that all products and services sold to consumers are fit for purpose and designed to meet consumers’ needs as well as targeted at the consumers whose needs they are designed to meet.  This includes requirements to identify vulnerable customers within the target market and mitigating associated risks with these customers.  The extent to which these Consumer Duty rules apply to fund manufacturers and distributors depends on the extent to which they comply with existing FCA rules and guidance (in particular under PROD 3).

iv. Custody of investor funds or securities

The depositary of the fund is responsible for safeguarding the fund’s assets.  All of the depositaries in the UK-authorised fund market are subsidiaries or divisions of large banking groups, although there is no regulatory requirement to this effect.  It is not uncommon for the depositary to delegate the custody function to a third-party custodian; however, the depositary is effectively subject to a strict liability regime under UK UCITS and UK AIFM Regimes, respectively, in respect of any fund assets held in custody that are lost.

3.4        Are there restrictions on to whom public funds may be marketed or sold?

As outlined above, complex products may not be sold in an execution-only capacity to retail investors.  This may potentially include NURS (and structured UK UCITS) depending on the level of complexity of the fund in question and whether it meets the relevant criteria.

In addition, regardless of whether a fund is considered complex, the product manufacturer and distributor/s will be required to comply with UK regulatory product governance requirements outlined above (including in respect of the proposed target market). 

3.5        Are there other main areas of regulation that are imposed with respect to the marketing of public funds?

The Consumer Duty includes additional rules that are designed to improve consumer understanding and consumer support.  In the case of the former, fund managers and distributors must ensure that their communications (i) meet the information needs of retail customers, (ii) are likely to be understood by retail customers, and (iii) equip retail customers to make decisions that are effective, timely and properly informed.  The rules require firms to undertake testing of their communications, amongst other requirements.  The consumer support rules require firms to provide a level of support that meets consumers’ needs throughout their relationship with the firm.  The rules require firms to improve their customer service so that consumers are able to realise the benefits of the products they buy and ensure they are not hindered from acting in their own interests.

As outlined above in question 2.1, vii., in addition to the general anti-greenwashing rule applicable to all FCA-authorised firms, the FCA is introducing investment labels for products meeting certain criteria as well as naming and marketing rules for investment products restricting the use of sustainability-related terms unless certain conditions are complied with.

4. Tax Treatment

4.1        What are the types of entities that can be public funds in your jurisdiction?

Authorised UK funds comprise AUTs, OEICs and ACSs as outlined in question 1.1 above.

4.2        What is the tax treatment of each such entity (both entity-level tax and taxation of investors in respect of allocations of income or distributions, as the case may be)? 

Tax treatment of the fund

The UK tax treatment of each type of authorised UK fund is broadly as follows:

  1. An AUT (each sub-fund as a sub-fund of an umbrella fund will be treated as a separate taxable entity) is subject to corporation tax on any taxable income at the basic rate of income tax for the year of assessment.  As such, the normal corporation tax rates do not apply to AUTs.  Any capital gains made by AUTs are generally exempt from the taxation of chargeable gains.
  2. An OEIC is taxed on the same basis as an AUT.
  3. Neither form of ACS is a taxable entity.  As such, they are not within the charge to direct taxes, and may generally be regarded as “tax-transparent” (although special rules, discussed below, apply to investors in ACSs that are co-ownership schemes).  Taxes on income and gains are generally applied, instead, at the level of the investor.  However, where stamp taxes are payable on acquisitions, then the operator of the ACS will generally account for these.

Tax treatment of the investors

The following applies to UK tax-resident investors and is a general summary only.  Special rules can apply, e.g. for certain categories of investors, such as traders or registered pension schemes, and the investor’s particular tax treatment may depend on their circumstances. 

Interest distributions from an AUT or OEIC are taxed as interest, either under the loan relationship rules for corporates or as income for individual investors. 

Dividend distributions from an AUT or OEIC are taxed as dividends.  Individuals will generally pay tax at the relevant dividend rates.  Corporate investors are generally charged to corporation tax on the unfranked part of the dividend distribution (with a credit for a deemed deduction).

Upon disposal of an interest in an AUT or OEIC, investors may be subject to a charge to capital gains tax or corporation tax on chargeable gains. 

Investors in an ACS that is structured as a partnership are taxed on their share of income and gains as they arise (e.g. on the disposal of or changes to assets within the fund). 

Investors in co-ownership ACSs are taxed on their share of income as it arises.  However, because a holding in a co-ownership fund is treated as an asset for tax purposes, investors are only subject to tax on chargeable gains (if any) when they dispose of their interest in the fund (rather than upon disposals of underlying assets held in the fund).

Funds review

The UK government is considering ways of improving the tax treatment of UK funds as part of a wider review that commenced in 2021.  As part of this review, it was stated in February 2022 that (amongst other things) the government is considering options to improve the tax efficiency of UK-authorised funds and, in particular, multi-asset funds.  Additionally, it was also stated that following the launch of the LTAF regulatory structure in October 2021, the government is continuing to assess the case for any further changes to the way LTAFs are taxed.  There have been no published timeframes in relation to the next steps on these two issues.

4.3        If a public fund, or a type of entity that may be a public fund, qualifies for a special tax regime, what are the requirements necessary to permit the entity to qualify for this special tax regime?

In certain cases, a “genuine diversity of ownership” (“GDO”) condition must be met in order for relevant tax rules to apply.  In addition, certain types of authorised UK funds may be subject to special tax regimes.  For example:

  • Certain authorised investment funds (AUTs or OEICs) that meet certain conditions can apply to HM Revenue & Customs to join the “tax elected fund” (“TEF”) regime.  Broadly, investors are taxed as if they held the underlying assets of the fund directly.  The TEF regime was introduced to remove tax drag within multi-asset funds; it has not been widely used and may be reformed as part of a wider government review.   
  • AUTs and OEICs that invest more than 50% of their assets in non-reporting offshore funds (or that make a valid election for the rules to apply) are within the regime for funds investing in non-reporting offshore funds (the “FINROF”).  Income gains are then taxed on the investors (rather than at the fund level).
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