UK Government and FCA Propose More Streamlined, Nuanced Approach to Regulating Managers of Alternative Investment Funds

The UK government’s April launch of a consultation, along with a related call for input by the FCA, paves the way for further material divergence between the EU and UK models for the regulation of managers of alternative investment funds (AIFs) (and their depositaries). A significant deregulatory streamlining of the UK model would entail a reduction in requirements for the majority of UK AIFMs and rules that are proposed to be better targeted to their size and business models, which should prove welcome to the United Kingdom’s alternative investment fund management industry.

The somewhat bland titles of the UK government’s “Regulations for Alternative Investment Fund Managers” and the Financial Conduct Authority’s (FCA’s) “Future Regulation of Alternative Fund Managers” belie the significance of their content.

Just three days later, UK Chancellor Rachel Reeves confirmed the reappointment of Nikhil Rathi as CEO of the FCA for a second five-year term until September 2030. The timing cannot have been entirely coincidental with the Chancellor noting that "Nikhil Rathi has been crucial in this government’s efforts to reform regulation so it supports growth and boosts investment" and the government noting that "the FCA is continuing to examine the financial services regulatory landscape and working to eliminate any unnecessary rules that hold back growth".

Equally, the government recognises that in the 10 years following the introduction of the Alternative Investment Fund Managers Directive (AIFMD), the UK asset management sector grew by 50% and today the UK is the second largest global asset management hub with around £14 trillion (about $15.6 trillion) in assets under management (AUM). The government concedes that many aspects of the AIFMD are necessary to formalise a global consensus, provide investor protections and mitigate some of the financial stability risks that AIFs can pose. However, neither the government nor the FCA proposes to track the EU AIFMD 2 amendments due to commence in April 2026.

GOVERNMENT CONSULTATION

The main thrust of the government paper is to explore the simplification of the UK AIFMD legacy legislative framework to allow the FCA to establish a more graduated and proportionate approach to regulation in this sector and to change the scope of the regulatory perimeter (ironically by expanding it marginally). For example:

• AIFMD-derived law, in particular, the UK version of the EU Level 2 Regulation, will be replaced with rules developed by the FCA through the required consultative processes, allowing regulation to be tailored to UK markets and capable of agile updating in future;
• Legislative thresholds governing whether AIFMs qualify as "sub-threshold" or "full-scope", which were first baked into law in 2011, [1] are proposed to be removed, in part to avoid cliff-edge risks whereby sub-threshold AIFMs are subject to minimal requirements whereas above-threshold AIFMs undergo a significant increase in requirements which discourages growth. [2] At the point of first transposing the AIFMD into UK law, most UK firms falling within the AIFMD were already required under the UK Financial Services and Markets Act 2000 to be authorised and regulated by the FCA. For those firms qualifying as sub-threshold for AIFMD purposes, the government implemented the Small Authorised Regime, requiring them to be FCA-authorised but not subject to full-scope requirements; and for a minority of firms that had not previously been FCA-authorised, the government decided they would merely be required to register with the FCA under the light-touch Small Registered Regime, which currently covers:
  • managers of UK social entrepreneurship funds and registered venture capital funds—these fall outside the range of the consultation with the status quo continuing for the time being;
  • managers of unauthorised funds that mostly invest in land—it is proposed these will require FCA authorisation and to comply with a proportionate set of rules based on their size; and
  • managers of internally managed companies which do not appoint an external AIFM—it is proposed these will require FCA authorisation.
• The marketing regime for UK AIFMs is proposed to be retained, save for the requirement to notify FCA 20 working days prior to the start of marketing UK funds, which will helpfully allow marketing to begin immediately on notification;
• The UK national private placement regime used by non-UK AIFMs (and UK AIFMs managing non-UK AIFs) to market AIFs in the UK is proposed to be retained;
• The government is considering whether to remove the requirements for full-scope UK AIFMs and above-threshold non-UK AIFMs to file notifications with the FCA in relation to the acquisition of control of unlisted companies and issuers by their AIFs; and
• The liability in law of external valuers to the AIFM for any losses caused by the valuer being negligent or intentionally failing to perform its tasks is proposed to be removed, which should foster growth in the market for such services.

The government considered whether closed-ended investment companies admitted to the Official List and traded on the Main Market of the London Stock Exchange (LCICs), a popular UK investment structure accounting for around 30% of the FTSE 250, should be removed from the scope of the regulatory perimeter, which would revert to the pre-AIFMD status quo. The government has decided that LCICs should remain in scope to ensure continued financial stability and that consumer protections apply. Further, the government proposes that internally managed LCICs currently qualifying as "sub-threshold" would be rendered into scope for the first time.

FCA CALL FOR INPUT

The FCA is committed generally to streamlining the regulatory regime for UK asset managers, with respondents to its 2023 Discussion Paper "Updating and improving the UK regime for asset management" stating that the rules for AIFMs should be less complex, more proportionate and better tailored to the varied types and investment activities of UK AIFMs. There was no call for wholesale change. Fast forward to now and FCA sees a strong case for retaining—but substantially adapting—the current regime. It is still early days, although the call for input indicates a direction of travel in line with which FCA will later develop rules and guidance for consultation in 2026.

UK asset managers responsible for managing about £2 trillion in alternative assets will find it refreshing to read that the FCA:

• Recognises that clearer rules, better tailored to AIFMs, could create efficiencies and support economic growth and competition;
• Wants smaller AIFMs to grow without having to implement abrupt and significant changes;
• Envisions a new coherent and consistent regime, more proportionately applied to smaller and growing AIFMs;
• Where appropriate, aims to achieve current regulatory outcomes but with less prescription;
• Acknowledges that the UK market includes many specialist and boutique AIFMs many of which are required to operate as full-scope AIFMs despite not having the same level of market presence or posing the same level of risk as the larger full-scope ones; and
• Acknowledges that some rules currently apply to all AIFMs even though they were designed to address AIFMs undertaking specific activities (such as trading in liquid financial instruments where the rules largely derive from the rules applicable to UCITS (Undertakings for Collective Investment in Transferable Securities) fund managers) and the rules could apply more clearly to different categories of firms based on their investment activities, for example, managers deploying venture capital, growth capital and/or private equity strategies and LCICs.

The key structural change canvassed by the FCA is to set clear requirements for AIFMs of different sizes, with:

• Large AIFMs (with net asset value under management (NAV) of £5 billion (about $6.6 billion) or more) being subject to a regime like the current one for full-scope AIFMs but with "unnecessarily burdensome rules" removed for all AIFMs and certain rules applicable dependent upon the activity being regulated; [3]
• Midsize AIFMs (with NAV of more than £100 million to under £5 billion) being subject to a regime consistent with that for large ones but with the requirements in the UK version of the EU Level 2 Regulation removed except where "necessary" (and the FCA will make clear the outcomes it wants to see but leave flexibility as to how AIFMs achieve those outcomes, thus reducing costs for some AIFMs and improving their efficiency and promoting more competition); and
• Small AIFMs (with NAV of under £100 million) being subject to baseline standards "essential" for maintaining appropriate levels of consumer protection and market integrity and having greater flexibility.

AIFMs moving categories would be required simply to notify the FCA rather than prepare and file a detailed application for a variation of permission.

On the depositary front, the FCA sees no immediate need to make “radical changes” to the depositary framework relating to how asset safekeeping and AIF oversight should be carried out for large and midsize AIFMs. Generally, the FCA does allude to being open to some relaxations where the AIF contains no retail investors and would welcome input on whether it should explore proportional alternatives that meet global regulatory standards. The FCA confirms that it does not propose to extend the depositary requirements beyond the current scope. Put another way, small authorised AIFMs and full-scope AIFMs that manage non-UK domiciled AIFs that are not marketed in the UK will continue to be out of scope.

The call for input does not address other issues that the FCA plans to address separately, such as:

• Prudential rules;
• Regulatory reporting under the AIFMD;
• Requirements around disclosure, distribution and marketing to retail investors;
• Remuneration; and
• The AIFM business restriction originating from article 6(4) of the AIFMD.

We are closely monitoring this area and will keep you up to date on material developments.