WIREDGOV

The Financial Services Authority (FSA) recently set out further progress on allowing UK retail consumers to invest in funds of hedge funds and other alternative investments authorised in the UK.

A Consultation Paper confirms the policy of introducing retail-oriented Funds of Alternative Investment Funds (FAIFs) into the FSA’s regulatory regime. It also initiates a further round of consultation on a number of important issues which have been raised by fund managers and other interested parties during consultation, and which require resolution before the final regime is introduced.

Dan Waters, FSA Director Retail Policy and Themes and Asset Management Sector Leader, said:

"Permitting consumers access to a wider range of innovative investment strategies through authorised onshore vehicles will allow more choice and a better opportunity for risk diversification, while maintaining consumer protection through our proportionate rules on the operation of the product. We aim to make the final adjustments to the new regime before the end of the year, including the additional areas on which we are consulting today.

"As we have previously stated, there are a number of difficult tax issues involved in the operation of onshore FAIFs regime. Following constructive discussions with the Treasury on tax issues we welcome the publication today of their tax framework, setting out a new elective regime which aims to allow FAIFs to operate competitively within the UK retail market.”

To avoid any regulatory regime being used to gain unintended tax advantages the FSA also propose to include a ‘genuine diversity of ownership’ condition in its rules. This condition is similar to those proposed in the Property Authorised Investment Funds discussion paper issued by the Treasury in December 2007.

The new consultation will close on 22 May 2008. The FSA will then finalise the draft rules in light of the responses and publish a Policy Statement giving feedback towards the end of the year. This will set out the finalised rules for FAIFs as whole and the date on which they will come into effect.

Notes for editors

1. CP08/4 'Funds of Alternative Investment Funds' is available on the FSA website.

2. The Treasury’s proposed framework can be found on their website.

3. CP07/6 'Funds of Alternative Investment Funds', published in March 2007, is available on the FSA website.

4. FAIFs will be introduced into the existing Non UCITS Retail Schemes (NURS) regime by:

   • relaxing the existing NURS rules that restrict investment in unregulated collective investment schemes from 20% allowing up to 100%;
   • removing the prescription of the 15% rule that prohibits circularity of investment within NURS and to extend this to the Qualified Investor Scheme (QIS) regime; and
   • applying due diligence criteria to the investment manager where they invest more than 20% into unregulated collective investment schemes.

5. The additional areas for consultation in CP 08/4 relate to:

   • whether the existing repayment standards for NURS need to be altered to take account of the time required for funds of funds to obtain valuations of their assets held in the underlying funds;
   • allowing a FAIF (and NURS more generally) to act as “feeder funds” into one master fund; and
   • strengthening the due diligence rules and guidance for fund managers who operate FAIFs.

6. Retail investors in the UK are already able to get exposure to hedge funds and other alternative products in a variety of ways, including structured products. The FSA believes that it is right to allow the development of retail-oriented Funds of Alternative Investment Funds within its regulatory regime. This would bring substantial structural and operational safeguards including the requirement to have an independent depositary and the application of key Collective Investment Scheme Sourcebook rules e.g. leverage limits and risk spreading even when the FAIF is a feeder fund.

7. A key element in the FSA's approach is its requirement that the fund manager will operate with ‘due diligence’. This sets out the FSA’s expectations in a more principles based way using a mixture of both rules and guidance for the fund manager in the matters the FSA believes he needs to consider in making, and maintaining, significant investments into unregulated schemes.

8. The term 'FAIF' does not indicate the FSA is introducing a new type of retail product. On the contrary, FAIFs will be Non-UCITS Retail Schemes (NURS), which already exist in FSA rules and are allowed to be widely marketed to retail consumers in the UK. The term FAIF denotes a NURS that invests more than 20% of its scheme property into unregulated collective investment schemes.

9. UCITS schemes are regulated under an EU Directive. UCITS schemes (unlike NURS) are given an EU "passport", enabling them to be sold cross border throughout the EEA without re-authorisation in any host state.

10. Qualified Investor Schemes (QISs) are schemes that are authorised by the FSA, but which can only be sold to limited classes of sophisticated investor.

11. The FSA regulates the financial services industry and has four objectives under the Financial Services and Markets Act 2000: maintaining market confidence; promoting public understanding of the financial system; securing the appropriate degree of protection for consumers; and fighting financial crime.

12. The FSA aims to promote efficient, orderly and fair markets, help retail consumers achieve a fair deal and improve its business capability and effectiveness.