International Funds Legal Update | February 2025

Custody and service providers receive 'Dear CEO' letter from UK regulator

The Financial Conduct Authority (FCA) has published a "Dear CEO" letter to firms providing custody and fund services. These types of firms are responsible for overseeing £15 trillion of assets under custody, which has caught the regulator's attention and come under its focus. The FCA has now taken steps to review a sector that has not otherwise been subject to the same amount of scrutiny as fund managers.

The letter has been sent to firms acting as third-party custodians, depositaries (including for non-retail funds) and third-party administrators, who often provide fund accounting and transfer agency services.

As part of its supervisory strategy, the FCA has identified a number of outcomes it will be assessing. It will consider the associated risks in light of these assessments. The FCA will scrutinise compliance with the regulatory requirements and its expectations within the following areas:

• Operational resilience
• Cyber resilience
• Third-party management
• Change management
• Market integrity
• Depositary oversight
• Protection of client assets

Each firm's chief executive officer has been asked to discuss the letter with their governing bodies and executive committees and to take the necessary steps to make sure the legal requirements and expectations of the regulator are met.

The FCA is seeking to maintain high standards in the service providers that support the UK asset management industry. In the long term, both fund managers and investors will likely benefit from this enhanced scrutiny. However, in the short term, fund managers may be drawn into the engagement process with the regulator.

Improvements to service providers' systems and processes will likely have knock-on implications for fund managers. There is also a risk for some specialised funds that, if meeting the regulator's expectations is perceived as burdensome, service providers might raise their costs – or step back from providing their services altogether.

Connect user guide published for overseas funds regime

The overseas funds regime (OFR) provides a streamlined gateway for overseas investment funds to be sold to UK retail investors. The FCA has now updated its OFR webpage adding a user guide for the Connect online system about the notification of material changes to a recognised collective investment scheme (CIS) or sub-fund of a CIS subject to the OFR.

This means that, at the point that a CIS or sub-fund is recognised under the OFR gateway, its operator will need to notify the FCA of certain subsequent changes affecting its status. This notification must be submitted through a material change notification form on the Connect system.

FCA changes diversification rules for UK UCITS

The FCA has updated the provisions in the Collective Investment Schemes Sourcebook relating to concentration limits for UK retail funds, known as UCITS (undertakings for collective investment in transferable securities), as published in the Handbook Notice 126 made by the board of the FCA on 30 January 2025. 

The instrument makes changes to an existing rule that limits the ability of a UCITS scheme to hold units of other CISs and to reinforce appropriate risk diversification in a UCITS fund of funds. This clarifies how the rule applies to sub-fund structures and disapplies the rule in situations where the investing UCITS and second scheme are managed by the same firm.