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Authorised or regulated

Jonathan Gain of Stellar AM explores the differences and benefits of unregulated investment schemes.


It should not be like that. Firstly, some background; all UK fund management firms are authorised by the Financial Services Authority (FSA) which will enable them to carry out regulated activities such as establishing, managing and promoting various types of funds.

Typically these funds will either be authorised collective investment funds such as investment trusts or Undertakings for Collective Investments in Transferable Securities (UCITS) or unregulated funds such as Unregulated Collective Investment Schemes (UCIS).

Authorised funds will have their scheme documentation reviewed and approved by the FSA ahead of publication and will be required to follow specific rules on matters such as the spread of assets, dealing frequency, cash reserves and limitations on borrowings.

As we have seen in recent months these rules do not mean that the product is any less risky as those exposed to Keydata and Arch Cru will sadly testify.

Unregulated funds are traditionally set up for those asset classes where the investment activity may preclude regular dealing or wish to have higher levels of gearing. These funds have typically been used for property transactions.

The overwhelming majority of funds, be they authorised or unregulated, will be managed or operated by an FSA regulated company.

There are however unfortunate exceptions and it is possible for companies not regulated by the FSA to promote unregulated schemes. These companies can either be incorporated in jurisdictions where the regulations are less stringent or rely on exemptions in the UK legislation around introducers.

The recent report by the FSA into UCIS and their sales and promotion uncovered some issues at a small number of advisory firms and it is the regulation around this type of product that needs to be clarified. The responses on various websites show that there is a sense of confusion. The reaction should not lead to a cessation of advice in this area as many have mooted.

Why use unregulated products or UCIS?

Firstly, the FSA is not in any way stating that UCIS are fundamentally wrong structures; their regulations determine that any fund which does not meet the criteria of a collective investment scheme or CIS must therefore be a UCIS fund and therefore they impose a restriction that they cannot be promoted to the general public in the UK.

However, they can be promoted to certain categories of investors who are either high net worth or sophisticated investors who are able to understand the risks involved.

UCIS have typically been used for less mainstream investment activities such as property, forestry and film schemes. The rationale for this is that as the assets are more illiquid it makes regular dealing virtually impossible and therefore they are normally closed ended vehicles such as partnerships. These funds also fall foul of the asset diversification rules and may only acquire one or two properties; others have higher levels of gearing which obviously increases their risk profile.

Does this mean they are unsuitable schemes?

There will always be good and bad investment strategies and as we have noted earlier it does not really matter if you are an authorised fund or not, investors still have investment risk and some strategies will fail.

However, all advisers are well aware of the need to undertake client suitability assessments and the advice they give does not differ for either an authorised or unregulated fund. The FSA will require evidence of both know your customer and attitude to risk fact finds.

Compensation and complaints

The Financial Services Compensation Scheme (FSCS) is available on the default of the fund manager or operator regardless of whether it is a UCIS or an authorised fund. The manager or operator clearly has to be a participant and the FSCS applies at the firm level rather than at the underlying investment level. Therefore advisers should be checking with the manager or the FSA whether they participate.  However, investors must understand that if the fund itself fails then they will not get a return from the FSCS unless the manager or operator is at fault.

The ability to complain to Financial Ombudsman Scheme will also apply to UCIS in the same way as it would for an authorised fund.  It is important to note that if the investor has been categorised as a professional client then they will not be able to complain to the Financial Ombudsman Scheme.  Again any manager’s or operator’s participation in the scheme will need to be checked.
Professional Indemnity (PI) policies usually provide cover in the event that a third party claims to have suffered loss as result of the policyholder’s professional negligence, omission or error. You would expect a standard PI policy to provide cover if a firm has negligently advised its customers to invest in UCIS in contravention of the FSAs regulatory requirements. Naturally if there has been a deliberate breach then the policy is unlikely to respond. 

As with most things, the FSA has not made matters easy for either fund managers or advisers as to how the risks of both authorised and unregulated funds are indentified and managed. We will never be able mitigate investment risk either but good fund managers with sensible strategies will never go out of fashion. UCIS fulfil a necessary function and enable investors to obtain exposure and portfolio diversification they would not ordinarily achieve in authorised funds alone. They are not for everyone but structured correctly with a regulated manager or operator they do provide attractive opportunities in an investor’s portfolio and some even come with attractive tax benefits.

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