Asset and fund management- At the beginning of June 2017, the Financial Conduct Authority (FCA) sent letters to 20 of Britain’s largest asset management companies asking them to provide details of their Brexit contingency plans.
The FCA’s letter contained 30 questions, including whether or not UK-based companies are planning to relocate staff or operations to the EU, whether their Brexit contingency plans will affect their capital base and IT systems and if they had applied for new licences from foreign regulators.
When asked why the FCA sent out the letters, lawyers advising asset and fund managers told the media that the FCA does not want to discover 12 months into Brexit negotiations that the asset and fund management sector has done nothing to plan for the changes that may come and impact their clients.
In such a highly regulated sector, it is likely that most asset and fund managers have already seriously considered their options and begun making contingency plans for dealing with Britain leaving the EU. A report from the London School of Economics found that a quarter of the £24 billion in assets booked annually by UK asset managers is derived from EU-related business and around £3 billion of this could move outside the UK if required. If Brexit negotiations go badly, or the political situation in the UK destabilises, there is a risk of large capital outflows from funds, like those that occurred following the referendum, leading to asset and fund managers suspending withdrawals or putting in place gating mechanisms.
The main concerns for UK-based asset and fund managers is whether they can service EU clients after Brexit, their ability to hire talent from the EU and whether they will need to relocate staff and/or operations to the EU. But frustratingly, with no clear details being released on how the government plans to negotiate issues such as passporting rights and possible models for UK/EU relationships in the asset and fund management context, creating a solid strategy for dealing with these challenges is difficult to say the least.
The government’s plan to adopt EU legislation
At this stage, the UK government has stated that most of the applicable EU law will likely be adopted directly into UK legislation. This will provide certainty, at least in the short-term, to investors.
UK-based fund or asset managers who do not engage in cross-border activity may, over time, lobby for changes to certain regulations so they are more in tune with the situation in the UK market. However, this will need to be balanced with the requirements of UK-based asset and fund managers who do operate in multiple jurisdictions. Their needs will include having a regulatory regime for key areas that can be awarded ‘equivalency’ status by the European Commission.
The consequences of a ‘hard Brexit’
If the UK leaves the single market and fails to establish a special status, it will become a ‘third country’ for the purposes of EU legislation.
The key issue for all financial institutions in the event of a hard Brexit is the loss of ‘passporting’ rights. The impact of this will depend on the EU Directive which provides the passporting rights.
The Undertakings for Collective Investment In Transferable Securities Directive 2009/65 (UCITS)
This is the main European framework covering collective investment schemes. It creates a harmonised regime for the management of funds. These investment funds cover around 75% of collective investments by small investors in Europe.
To qualify as a UCITS scheme, its object must be to invest capital into transferrable securities and liquid assets, the scheme units/ shares must be redeemable and its headquarters must be based in the EU. Therefore, in the event of a hard Brexit, UK domiciled UCITS risk not be considered as having UCITS status and UK fund managers would be unable to manage UCITS schemes in EU states.
As a solution, the fund can be re-domiciled to an EU Member State, self-managed or managed by an EU management company with the UK manager acting as a delegated investment manager.
Alternative Investment Fund Managers Directive 2011/61 (AIFMD)
The AIFMD directly regulates alternative investment fund asset managers and funds in the European Economic Area.
If the passport system is disrupted or ends with Brexit, managers may need to restructure their business, market on a country per country basis or re-domicile their funds. This is because UK AIFs would become non-EU AIFs and lose their pan-European marketing rights. Local marketing regulations would apply instead. In addition, fund and asset managers would no longer be able to completely manage AIFs based in the bloc.
There is a ray of hope however. The Alternative Investment Fund Managers Directive (Directive 2011/61/EU or AIFMD) makes provision for “third countries” to access the EU’s alternative investment fund market subject to meeting certain requirements.
The European Securities and Marketing Authority (ESMA) has so far assessed twelve different non-EU countries to determine the suitability of granting AIFMD passporting rights to those countries’ AIFMs and AIFs. It gave positive advice to 5 of these so far.
If the UK was to apply for third-country passporting rights under the AIFMD, the ESMA would need to undertake a full regulatory review of the UK regulatory regime which is likely to take a reasonable amount of time.
A review of the AIFMD, involving a public consultation, is scheduled this year. So far, the European Commission has not granted any third-country passporting rights.
Coming into force in January 2018, MiFID II recasts and broadens MiFID (the EU’s Markets in Financial Instruments Directive) in response to the financial crisis. It will change the way asset managers operate and not just in terms of enhanced investor protection. The new rules affecting allocation of costs for research, the impact on the fixed income market, the prohibition on payments to financial advisers and the significantly more onerous reporting requirements are all major issues for the industry players to deal with.
MiFID II effectively allows firms from non-EU member states to access the EU market. The key issue is whether the UK will fall under a harmonised regime for third country access to enable passporting rights following Brexit.
There are options as noted above, but whether these will hinder the fund and asset management sector is yet to be seen.
Abraham Lincoln once quipped “If I had eight hours to cut down a tree, I would spend six hours sharpening my axe.” Preparation and contingency planning will be key for asset and fund managers over the next 18 months.
The prudent approach for UK-based asset and fund management firms at present is to balance day to day business, with some strategic scenario and contingency planning, which may involve considering the re-location of certain staff and services to other EU-based financial hubs.
Saracens Solicitors is a multi-service law firm based in London’s West End. We have dedicated and highly experienced finance law solicitors who can advise on all legal matters relating to asset and fund management. For more information, please call our office on 020 3588 3500.