The Financial Services Authority (FSA), the UK regulator, has today issued its long awaited consultation paper (CP 185) on new approaches to the regulation of UK mutual funds, such as unit trusts and OEICs. But the changes it advocates have positive implications for hedge funds.
Under the new regime proposed in CP 185, retail investors will have access to a wider range of investment opportunities and product features, together with better information about the progress of their investments, while schemes available only to professional investors will benefit from a reduction in regulation.
“Our current ‘one size fits all’ approach to fund regulation does not take sufficient account of the fact that investors have differing degrees of experience and expertise,” says Michael Folger, Director of Conduct of Business Standards for the FSA. “Our proposals recognise changing consumer needs and market developments. They should give the industry more operational flexibility, whilst safeguarding investors’ interests.”
The FSA proposes that a new category of “non-retail” funds, restricted to investment by institutional and expert investors only, be introduced. These funds will be subject to lighter product regulation than retail schemes, on the basis that the investors will know what they are doing. The rules governing them will, however, be robust enough to distinguish them from unregulated schemes. The FSA adds that investors in such schemes will not have access to private customer protections.
The current eight distinct categories of retail scheme will be rationalised into two broad types. The first will be UCITS funds, which are governed by European rules on the spread and quality of assets they can hold, and eligible for sale throughout the European Union. The second will be non-UCITS funds, which will be able to invest in a wider range of assets, including real estate, an asset class that currently lies outside the UCITS Directive definitions.
On the sensitive and contentious subject of fees and charges, the FSA proposes to align the rules for unit trusts with those for OIECs. Performance fees will be allowed for both products, bringing the UK in line with most other European Union markets. However, the FSA proposes up-front disclosure to investors of examples of how performance fees would operate.
The new non-retail fund category is of obvious interest to hedge funds. If the proposals are adopted, it means hedge funds can be sold to anybody who can prove they know what they are doing. Funds will have to report to investors semi-annually but can also charge performance fees. Acceptable asset classes will include securities, derivatives, cash, money market instruments, other funds, gold, real estate, precious metals and commodities contracts traded on a recognised exchange. Short selling will be permitted and fund will be allowed to gear up to 100 per cent of NAV. Redemption rights can be limited too. The FSA is understood to be in discussions with the UK Inland Revenue concerning the taxation of these new funds.
The FSA is also arguing that investors should receive better information about specific events affecting funds – over and above what they are required to send – and in a format that suits different types of investor. Under the new regime proposed by the FSA, fund managers will have to send short-form reports to customers in place of long-form reports and accounts. The full prospectus will also have to be more user-friendly than existing prospectuses, as outlined in the FSA’s recent Key Facts document for packaged products.
The requirement that funds be open to redemption at all times is to be limited in some non-UCITS schemes, notably those where, for example, the investments are relatively illiquid (such as real estate). The FSA also proposes to permit redemption days to be up to six months apart.
The FSA is ken to present the new measures as deregulatory, while increasing protection for consumers – its primary concern. The regulator estimates that, by removing prescriptive material from the current rules, the 500-page Collective Investment Schemes Sourcebook will be reduced by two fifths. “The main consequence of the proposed changes would be to shift the balance in the way authorised CISs are governed to put more weight on the fund documentation and somewhat less on the regulator’s rules,” says the FSA.
The FSA, which is always obliged to cost its proposals, estimates that the total cost to firms of updating documentation will be around 10 million. It says this sum will be more than offset by the savings to be expected from streamlining annual and six-monthly reporting requirements.
Firms will also be offered an extended transitional period to February 2007. As this is the date when the rules implementing the UCITS product directive come in to force, the FSA says it is a good opportunity for existing funds to amalgamate the costs of both sets of changes.
The consultation period on these proposals runs until 31 October 2003. The FSA plans to make final rules in early 2004, at which point they will be available for use by existing UK schemes. They will apply to all UK schemes from February 2007.