There have not been many upsides to Brexit, as far as I can see. But the ability to rewrite inherited EU UCITS rules without asking Brussels for permission might just be one.
This week, I have written extensively about the failures of the current UCITS rules. Specifically, I have reported how the industry is pushing back against rules requiring active funds to adhere to a 5/10/40 portfolio restriction.
It means they can only hold up to 10% in one individual stock and can hold no more than 40% in companies with a weighting above 5% – a rule that is relaxed significantly for passive funds.
Brought over from Europe and implemented by the FCA, these regulations restrict active managers. As Fabiana Fedeli, chief investment officer of equities, multi-asset & sustainability at M&G, said: “We do not see a clear rationale for applying different concentration caps to active UCITS and passive strategies.”
Some may point to diversification – if an active fund owns more than 10% in a stock, it is taking on a bet that is too concentrated. If this is the case, surely the same logic must stand for passive funds. The solution: either up the active limits or lower passive ones. Only one of those figures can truly be right.
Additionally, we already allow some portfolios to invest however they like. Investment trusts have no caps. Just look at Scottish Mortgage, which at one point had 25% in Elon Musk’s SpaceX.
Others may suggest that looser rules will encourage bad actors. What is to stop fund managers from taking huge short-term bets to improve performance?
Yet no fund group would risk their reputation to allow one individual to do whatever they choose – and few would argue that this was an acceptable level of risk.
And if we are concerned about how the rules could be exploited by boutique groups, I would question how the current UCITS regime protected investors in 2019 from Neil Woodford, a saga that left the then-FCA chief executive Andrew Bailey to tell the Treasury Committee “we will see about UCITS, frankly”.
He wasn’t arguing for more restrictions either, noting that the UCITS regulations were “excessively rules-based”.
But the issues are not just a problem for active funds. There are real quirks in the system that need addressing, in my view, when it comes to passives too. For example, unless using full replication (buying every stock at the index weight), passive funds can find themselves under active rules, as Invesco’s Matt Tagliani told Trustnet this week.
There are also oddities surrounding quant funds (or passive plus), which may not be able to index weight positions because they are treated as active funds. The solution here could be a third tranche of rules centred around benchmark weightings.
Of course, the rules may be perfectly acceptable. It may be that what we have right now is genuinely the best solution for the world we live in and that the current restrictions in place are the right ones for retail investors.
I am not saying there is a right answer. But I think given the groundswell of support already shown this week by asset managers such as Fidelity, Invesco, Schroders and Aberdeen, now is the time to look at these rules.
I didn’t vote for Brexit. I wasn’t a big fan then of leaving the European Union and I remain unconvinced that it was the right decision.
But there could be one thing that comes from it that makes the investment world a better place: the ability to change arbitrary, restrictive EU UCITS laws.
UCITS started as an EU directive. After Brexit it was on-shored into the FCA's handbook, but there is nothing that states we have to keep them identical to those imposed on the continent.
There's no Brussels sign-off required, no EU negotiation, no external blocker to rewriting the rules. The FCA holds the pen and can wield it however it so chooses.