With Brexit firmly back in the news headlines, it is worth revisiting this thorny subject and focus on the impact on asset managers and their respective products. Since the initial vote, Brexit has been a storyline fraught with ambiguity, uncertainty, and fast-paced changes and as the end of the Brexit transition period and no deal cliff edge approach — this time for real — many asset managers are rightfully already contemplating the post-Brexit landscape. But even when Brexit officially happens, unfortunately the complexity and uncertainty around it will likely remain.
The Change Over/Change Up
One of the instant effects of the UK leaving the European Union is that UK-based firms cannot act as UCITS management companies. Further, UK domiciled funds who previously were authorized as UCITS instantly become non-EU alternative investment funds (AIFs), as there is no third-country regime for UCITS.
Before we address the points of ambiguity and uncertainty, let’s be crystal clear: as of January 1st, 2021, no UK fund or management company will have UCITS authorization status. Only funds or management companies domiciled in an EU member state are eligible under UCITS and can avail of its passporting permissions.
From an EU perspective, all UK UCITS instantly become non-EU third country Alternative Investment Funds (AIFs): because no “passport” has been switched on for non-EU AIFs (including for UK funds after 1st January), sales and distribution of such funds into the EU will be subject to relevant member state national private placement rules.
While most recent talk has been about UK divergence from EU rules and laws, from a UK funds market perspective, the FCA has already moved to implement some EU exit regulations which in effect "freeze" and retain certain EU laws for funds in the UK for the time being, one of which is retain the UCITS rulebook for UK domiciled funds who currently are authorized as UCITS.
Same, but different
In turn, this has created a rather unhelpful new fund label (“UK UCITS”), to refer to existing UK domiciled UCITS funds or future funds which may launch in the UK under the “onshored” UCITS regime. It is understandable why the UK funds wish to retain this ruleset as it ensures continuity for investors already in the UK UCITS funds and its brand recognition is already strong in the UK market, however it remains quite confusing since there will now be two types of “UCITS” available in the UK funds market. The two versions are:
1. UK UCITS. These are UK domiciled funds which carry the name but are not part of the pan-European UCITS ecosystem and cannot be distributed cross border under the UCITS regime
2. UCITS. These are funds domiciled in an EU country that can be sold on a cross border basis across all EU member states and may also continue to be sold into the UK market under the Overseas Fund Regime (OFR)
The continued use of the term "UK UCITS" is also commercially driven as the UK industry looks to maintain a degree of equivalence with EU. The term also creates positive branding by association for UK funds as industry looks to export UK funds into other markets through mutual recognition agreements and memorandum of understandings (MOUs) with other non-EU financial centers. It should be noted that historically UK funds have not exported well even when they had actual UCITS designation. It is still unknown whether the EU retains a trademark for the UCITS designation or if they will take action if certain UK UCITS attempt to leverage the UCITS name to market against EU UCITS in markets throughout Asia for example where the UCITS brand recognition is very strong. It is also far from clear what, if any, powers the EU holds to stop the UK from calling the funds in question UCITS.
NURS uncertainty remains
The other driver to retain the UCITS designation for certain funds is that a fund in the UK market known as Non-UCITS Retail Schemes (NURS) remains under regulatory scrutiny. The scrutiny is primarily due to liquidity concerns within certain retail property funds and carry over from events in connection with Neil Woodford’s fund. This is causing some managers to question whether they should look to have their NURS re-constituted to become a UK UCITS with the Financial Conduct Authority (FCA). This step further avoids oncoming additional FCA liquidity scrutiny that NURS will be subjected to soon.
The retention of the UCITS moniker for UK funds shows how successful the brand has been and the trust it instils in investors. Even without the distribution and passporting benefits that EU UCITS benefit from, it will be interesting to see how well the UK UCITS versions do when it comes to attracting inflows. The strength and trust in the UCITS brand are such that the UK has consciously retained it even after leaving the EU. On the other hand, having two versions of UCITS in the UK market and generally will very likely generate some confusion down the line. It truly does raise the question when is a UCITS not a UCITS?