The Institute of Economic Affairs (IEA) has called for the UK to set up a regulatory framework to replace UCITS and encourage EU-domiciled funds managed from London to move their domicile out of the EU post Brexit.
In a recent report on financial services regulation post Brexit, authors Shanker Singham and Catherine McBride suggested the UK should develop its own authorised retail investment scheme that could replace EU-domiciled and managed UCITS funds.
UCITS funds are required to be registered and domiciled within the EU as well as comply with all EU UCITS fund regulations, but after Brexit, UK-registered UCITS funds can no longer be called UCITS even if they continue to comply with the UCITS regulations.
As such, the IEA says the UK authorities need to develop a UK-authorised investment scheme that is comparable to UCITS or the US Mutual Fund scheme.
"The UK regulators should also allow the new UK retail funds to be domiciled in non-EU jurisdictions, as Germany has done with Swiss retail funds, provided those jurisdictions meet UK investment regulatory standards," the report said.
According to the European Fund and Asset Management Association (EFAMA) €8,658bn in net assets was held in UCITS funds at the end of 2016, with the UK by far the largest UCITS manager in the EU. However, over 50% of UCITS funds managed in the UK are domiciled outside the UK.
The IEA also warned that if the EU tries to reverse delegation rules - which allow funds to be domiciled and regulated in one EU country while being actively managed and marketed from another - the UK should "actively encourage investment funds presently managed from London, but domiciled in the EU27, to move their domicile either back to the UK or to other financial centres such as the British Overseas Territories and Crown Dependencies".
The think tank also said it would be "impossible" for EU27 investors to comply with the MiFID II 'best execution' requirements if they are not able to access UK or other major third country markets after Brexit, adding that the fallout from MiFID II already includes liquidity concerns.
"A large drop in liquidity in the financial markets is a real risk to investment valuations and can be brought about by ill-informed legislation or overzealous regulations that attempt to tax financial transactions, or protect private investors from market losses or that assume all sales people are unscrupulous," the report said.
"MiFID II prevents stockbrokers from recommending an investment, commenting on market activity or even providing clients with free research on listed companies; all of these issues are predicted to lower the traded volume in individual companies and increase price fluctuations.
"Many investment banks are predicting a drop in the traded volume of small and medium-sized companies because of these regulations restricting 'free' research and see a move towards index-based passive fund investments.
"As only larger and established companies are included in the main stock indices, this will lower the ability of small and medium-sized companies to find initial investors and raise additional capital through the financial markets."
The IEA said the "extensive compliance systems" have driven many smaller speculators into the accounts of the offshore financial betting industry, adding: "It is unlikely that this was the intended outcome of the MiFID regulations".
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