UK regulated fund managers and asset managers should bear in mind that, while the Brexit vote has occurred, this does not bind the UK Parliament. As of the date of writing (6 July 2016), the process of withdrawal under Article 50 of the Lisbon Treaty has not yet started. Although the timetable for withdrawal under Article 50 limits negotiations to two years, this may be extended by agreement. During this hiatus period, it will be business as usual because the UK will remain a member state of the EU.
There are three potential options for the future relationship between the UK and the EU:
- The Norway model: the UK will join the European Economic Area (EEA) and the European Free Trade Association (EFTA), thereby giving it access to the single market and subjecting it to EU standards and regulations, without much ability to influence them.
- The Swiss model: the UK will join the EFTA and negotiate bilateral agreements governing UK access on a sector-by-sector basis.
- The FTA model: the UK will sign a free trade agreement with the EU, which would include in its terms arrangements concerning asset management.
The EU asset management regime The key pieces of EU legislation impacting the asset management industry include the Alterative Investment Fund Managers Directive (AIFMD), the Markets in Financial Instruments Directive (MiFID) and the Undertakings for Collective Investment in Transferable Securities Directive (UCITS). In addition, over-the-counter derivative transactions entered into by asset managers are regulated under the European Market Infrastructure Regulation (EMIR).
If the UK ultimately joins the EEA regime, post-Brexit UK authorised fund and asset managers will be able to continue to operate as they do now, by passporting their EEA domiciled funds and services into EEA member states, or by using private placement for non-EEA domiciled funds under AIFMD.
If, however, the UK does not join the EEA, UK managers will become ‘third country firms' and will cease to be entitled to benefit from the passporting regimes under MiFID, AIFMD and UCITS, until the UK has been granted a third country equivalence passport (or, in the case of UCITS, a third country equivalence passport is introduced). They will instead be required to comply with the national private placement regimes of each EEA member state, where these exist. Where they do not exist, marketing of funds into certain EEA member states may no longer be permitted by UK managers. As the UK has implemented the AIFMD, UCITS and MiFID, the UK’s existing laws should be fully equivalent to those of the EU, but may cease to be equivalent in the future if EU laws change.
Brexit will not impact UK authorised fund and asset managers whose activities are restricted to managing assets or funds in the UK; marketing funds only into the UK; or providing segregated portfolio management or investment services to only UK clients. These activities will be governed by English law, or by the current regime in the event that the UK becomes an EEA contracting country.
Pan European business UK authorised asset managers currently providing portfolio management, advisory or fund management services on a passported basis into the EU, or marketing EU domiciled funds into the EU, will be most affected by Brexit if the UK does not join the EEA regime and thereby loses its EU passporting rights.
The EU and the UK could, of course, conclude an extra-EEA arrangement that provides passporting rights while avoiding free movement of workers, although this proposal has to date been rebuffed by the EU.
AIFMD, funds and fund managers As far as the AIFMD is concerned, the UK will become a ‘third country’. This means that UK AIFMs will not be able to market AIFs in the EEA under the AIFMD passport until the UK successfully receives a third country equivalency passport. Without a third country passport, UK AIFMs will be required to make notifications to each member state regulator and be subject to the national private placement regimes of each member state.
Another option might be to rely on ‘reverse solicitation’ where possible, although this cannot be a marketing strategy in itself. Hopefully by the time the UK needs it (October 2018 at the earliest, assuming Article 50 is triggered promptly following the appointment of a new prime minister), the EU will be ready to issue third country passports.
Assuming that there are no material changes to the UK regulatory regime, we do not anticipate any difficulty in establishing equivalence given that the UK has already implemented AIFMD. The UK may relax the AIFMD passporting regime as it applies to the UK to attract investment into the UK, but this will not of itself affect equivalency for the purposes of the third country passport. The UK legislature may also elect to waive the depositary appointment requirement for UK managers marketing AIFs into the UK only, which may assist start-up managers from a costs/performance perspective.
If the UK is a third country when it exits the EU, EU AIFs will not be able to use UK banks as depositaries and one would expect the UK to pass equivalent legislation in relation to UK AIFs. Lobbying should take place in order to avoid this scenario, as this is not in the interests of the pan-European nature of service providers that provide depositary services.
In addition, EU AIFMs may need regulatory approval to use UK asset managers as delegates (as they will not be EU firms). However, if the UK is assessed as equivalent, then they may readily obtain approval.
Brexit will, of course, adversely affect EU managers for the same reasons, subject to any agreed grandfathering provisions or relaxation of requirements by the UK.
UCITS funds and managers Unless a third country equivalency passport is introduced like we have under the AIFMD, UK UCITS will no longer have a UCITS passport. This means that they will be classified as a UK non-UCITS retail fund and EU marketing will be subject to the national private placement regimes of each EU member state where these exist. Please note that many EU member states restrict or do not permit at all marketing of non-UCITS to local retail investors.
Lobbying should be undertaken to introduce a third country equivalency passport into the UCITS Directive, similar to the AIFMD regime.
If UCITS third country equivalence is not introduced, EU UCITS funds will need to reassess their investment mandates if they invest in UK UCITS, because a maximum of 30 per cent of the assets of a UCITS fund may be invested in non-UCITS funds. Again, lobbying should take place to amend the UCITS Directive accordingly.
Absent amendments to the UCITS regime, UK banks will be unable to act as depositaries for EU UCITS and presumably the UK will take the same position for UK domiciled retail funds. Similarly, UCITS managers delegating to UK asset managers may require regulatory consent to the delegation. Without any material changes to the UK regulatory regime, we can expect such consent to be granted.
MiFID services – investment advisory and portfolio management business UK authorised MiFID asset managers should be able to rely on third country equivalency provisions in MiFID II (which is coming into force on 3 January 2018, within the two-year negotiation period for EU exit) to provide cross-border services which would be accessed through an application to ESMA itself. The need for an EU branch, requiring the local regulator’s approval, will need to be factored in where this is required by the relevant EU member state. It is hoped that a branch office requirement will only be required by most EU member states to access retail investors.
If there is an intervening period between the UK leaving the EU and MiFID II implementation, then the only routes to EU markets will be through the establishment of an EU branch or becoming regulated by an EU regulator, because MiFID does not contain third country equivalency provisions.
Methods of maintaining access to the single market
The EEA and the Norway option As alluded to above, the EEA agreement would be the simplest accession mechanism, although the emphasis implied by the result of the UK referendum on limiting immigration would not be compliant because free movement of workers is enshrined in the EEA agreement. Aside from immigration, accession would require the consent of the other EFTA members, who may have concerns at admitting the UK given the smaller size of their economies.
While EFTA states have no right to vote on proposed EU legislation, EFTA members do get to put questions to their EU counterparts via the EEA Joint Parliamentary Committee. The EEA Joint Committee, comprising the EU and EFTA members, meets monthly to assess which EU legislation needs to be transposed into the laws of the EEA signatories.
The EEA regime therefore incorporates much of the EU framework, while removing the right to vote on forthcoming EU law.
On the financial front, each EEA state is required to make a financial contribution to the EU based on the size of its economy, as a function of the economies of all EEA states.
Norway is, of course, a member of the EEA and is therefore required to pay into the EU budget to gain access to the single market alongside the other EEA states. It also has bilateral agreements with the EU and is viewed in some UK quarters as the best model to maintain sovereignty while accessing the single market. Norway’s annual financial contribution to the EU via the EEA agreement and bilateral arrangements is almost €1 billion, according to the Norway Mission to the EU.
Political views aside, Norway remains bound by the EEA agreement and its bespoke involvement in shipping and fisheries policy is unlikely to be replicated by the UK in the financial services sector.
Bilateral agreements – the Swiss model? While Switzerland is a member of EFTA, it is not an EEA signatory and so does not benefit from automatic EEA passporting rights.
Instead, it has concluded multiple bilateral agreements with the EU (120 at the last count) and agreed at the outset to free movement of workers. The EU Parliament has commented that this complex web of agreements does not incorporate monitoring, automatic implementation or dispute resolution. To this end, the EU has been in negotiation with Switzerland since 2014 to create an institutional framework that incorporates dispute resolution.
There is also an added complication: in a referendum on 9 February 2014, the Swiss public voted to place a quota on immigration and to favour Swiss nationals in the national job market (50.3 per cent in favour). The EU has refused to budge on free movement of workers and has commented that the current framework is not workable and is therefore unlikely to be repeated.
Given that it has taken more than two years for Switzerland and the EU to negotiate an institutional framework rather than bilateral agreements from scratch, it seems unlikely that the UK will be able to negotiate a bilateral agreement framework in time, let alone persuade the EU to accept limitations on free movement of workers.
A U-turn? Both Switzerland and Iceland have previously made EU membership applications and then retracted them following a change in political winds. It is not inconceivable that political machinations in the UK may result in the EU referendum result not being implemented.
The way forward If the UK agrees an EEA/Norway model, then authorised firms will retain their EU passports and there will be no need to relocate their businesses.
While impacted UK fund and asset managers may be of a mind pre-emptively to relocate their headquarters or their AIFs to an EU jurisdiction such as Ireland, Germany or Luxembourg, we recommend a ‘don’t panic, wait and see’ approach.
It is important to have a strategic plan for each of the models and to be ready to move in the event there is a real need to do so, but there is no immediate urgency to make changes now.