UK government launches a review of the UK funds regime

Introduction

The review of the UK funds regime is intended to build on the work of the Government’s Asset Management Taskforce and the UK Funds Regime Working Group established by the Investment Association.

One potential opportunity identified in the Call for Input is to leverage the reputation and history of the UK’s legal and regulatory systems and global reputation for investment management to promote the use of UK funds in international markets – something that, to date, has largely been the preserve of the offshore centres. 

Underlying the review are other key Governmental policy objectives, especially stimulating investment into carbon neutral and green technology, infrastructure and other long term investment.  Also clearly at the forefront of the Government’s thinking is to ensure that there are sufficient suitable investment opportunities to support defined contribution pension schemes and as alternatives to annuities to properly service the needs of the retirement income and drawdown market following the pension freedom reforms.

The Call for Input highlights specific areas where the Government welcomes views, but also includes an invitation for the submission of suggestions on other fund-related topics. 

The Government recognises that, notwithstanding the wide range of the review, it cannot do everything at once, so invites comment on what its top three priorities ought to be.  While understandable, this suggests that not every proposal in the Call for Input will be taken forward. 

Taxation

A coherent approach to tax is fundamental to any successful funds regime.  The Government acknowledges that achieving tax neutrality must be the ultimate goal, although it can be difficult in practice.  It invites comment on how successful the Government’s fund taxation reforms over the last ten years have been at keeping the UK competitive. 

The Call for Input floats the idea of introducing tax exempt unauthorised funds to invest in alternative assets, including real estate. These funds could be in the form of companies, partnerships or contractual schemes. A difficulty with a tax exempt fund is that this may impact on the ability to access existing UK tax treaty benefits.  However, we expect that a tax transparent structure, such as a contractual scheme or unit trust, which is unauthorised and allows interests to be freely transferable, would be a welcome alternative to Jersey unit trusts for investment in UK real estate. Any fundamental changes to the UK’s approach to fund taxation would need to be considered carefully and the UK government is looking for evidence to support the likely attractiveness of any new fund structure.

Specific mention is made of potential changes to the current REIT regime, including some changes already trailed in the Government’s on-going Asset Holding Company consultation which may permit “private” REITs owned by institutional investors, together with some additional suggestions, including the potential to make the holding of overseas property by REITs more attractive.

The Call for Input also asks whether there are any specific barriers to the use of investment trusts, especially for investment in long term assets, and what steps might be taken to support their use. 

Besides direct taxation, the Call for Input acknowledges the impact of VAT on fund formation and domicile decisions, especially the imposition of VAT on the supply of management services to some funds and notes that leaving the EU makes simplification (and, potentially, rationalisation) of the existing regime easier.  The Call for Input states that the Government is committed to reviewing the VAT treatment of fund management fees and will take this forward in 2021. 

The Call for Input also notes a decline in use of UK-domiciled limited partnerships in recent years and limited interest in private fund limited partnerships and questions whether new partnership taxation rules might help.  While this is a valid question to ask, it would not seem to be a significant priority and the reason for the comparative success of fund partnership structures in other jurisdictions, especially Luxembourg, probably has more to do with non-tax reasons, such as for example legal and regulatory flexibility and simplicity when seeking to make a new fund attractive to EEA-based professional investors. 

Regulation

The Call for Input includes a section on the UK’s approach to fund regulation.  While almost all funds formed in, managed from or marketed in the UK are subject to some UK regulation and oversight, the Call for Input focuses on funds that are required to be authorised by the FCA rather than fund regulation more generally. 

The questions flagged by the Call for Input include the speed to market for authorised funds, especially qualified investor schemes (or QISs - the closest that the UK currently has to an approved professional investor fund product) and some of the specific rules applicable to QISs. 

It is also noted that the review will take account of the on-going work of the FCA and others on liquidity mismatch in authorised funds, in particular the concerns around real estate investment by open ended funds.

Fund structures

The Call for Input cites with approval the forthcoming authorised long-term asset fund, or LTAF, proposed by the UK Funds Regime Working Group as a way to facilitate more confident investment in illiquid assets.  Front of mind here will be the recent highly public concerns raised by some concerning authorised open-ended structures holding real estate and other illiquid assets.  The Financial Conduct Authority is due to consult on setting up a framework for LTAFs during 2021, but the Call for Input states that the Government will also be considering the direct and indirect tax structure for LTAFs, as well as noting that the fund administration ecosystem will need to ensure that appropriate dealing and notice periods for investment in LTAFs are supported. 

The Call for Input also acknowledges the numerous proposals that have been made to the Government for new unauthorised, or “light-touch” authorised fund vehicles.  The notion of a “light touch” authorisation appears to receive short shrift but the Government otherwise appears sympathetic to considering introducing a new structure for an unauthorised professional investor fund to invest in alternative assets, including real estate and infrastructure. 

Fund administration

The Government is clearly keen to explore if significant UK employment opportunities could be generated by growing the UK’s fund administration capabilities, especially outside London.  No potential changes in law, regulation or taxation accompany this objective, nor are any probably required, save for those that would make the UK a more attractive jurisdiction for fund domiciles. Many offshore service providers have developed significant technical expertise in fund administration in the past ten years so, regardless of needing to be competitive on cost as well, there will certainly be plenty of catching up to do if the UK is to compete on equal terms.

What the review doesn’t cover

The Government includes an express statement that the review will not consider changes to the UCITS Directive or AIFMD as they are currently incorporated into UK domestic law following Brexit.  Therefore, the existing EU funds framework will remain in place in the UK for the foreseeable future.  While this might disappoint some Brexiteers, it is perhaps unsurprising given the focus on the UK achieving an agreement on financial services equivalence with the EU.  The Call for Input does include an express statement that the Government remains “completely committed” to supporting investment management portfolio delegation from and to the UK, potentially anticipating some tension with the EU. 

The Call for Input makes no mention of the PRIIPS Regulation or the MiFID product governance and client reporting requirements.  Apart from the limited changes to the PRIIPS KID already contemplated by the Financial Services Bill, it also seems unlikely, for the same equivalence reasons, that the Government is contemplating significant change here too, including as a result of the review. 

The Call for Input does not mention the complexities of the existing financial promotion regime as it applies to different types of fund products, proposed investors and FCA authorised firms.  The financial promotion and approval rules, which include a number of complex and difficult to apply requirements developed by the FCA in response to numerous abuses, could well benefit from some rationalisation in connection with any wider review of the distribution of funds in the UK.

Next steps

The Call for Input is open until 20 April 2021.

Hogan Lovells is planning to respond to the consultation and we are also involved in contributing to the responses being prepared by various industry bodies, such as the British Property Federation and the Association of Real Estate Funds.

If you would like to know more or would like our assistance in ensuring that your views are taken into account in the responses to the consultation, then you should contact the authors or your usual Hogan Lovells contact.

Authored by Jonathan Baird, Nicholas Holman, and Elliot Weston