On 31 January 2020, the United Kingdom officially ceased to be a member of the European Union.
By way of recap, the UK voted to leave the EU in a referendum on 23 June 2016. The UK had initially been due to leave the EU on 29 March 2019 (two years after the government invoked Article 50 and triggered the withdrawal process), but agreed a series of extensions with the EU, delaying “Brexit” to 12 April 2019, then 31 October 2019 and finally 31 January 2020.
As many readers will be aware, whilst the UK has now left the EU, the withdrawal agreement contains a transition period, expected to run to 31 December 2020, during which time the UK government and the EU will continue to negotiate the terms of their future relationship. Critically, during the transition period, EU law will generally continue to apply in the UK as it did prior to 31 January.
For UK private fund managers, and European fund managers marketing their funds into the UK, the EU Alternative Investment Fund Managers Directive (“AIFMD”) will continue to apply during the transition period in the same way it did prior to 31 January 2020. Accordingly, any “passport” rights granted under the AIFMD are temporarily preserved.
Looking beyond the transition period, several interesting issues arise.
Since the referendum result was announced, many UK private fund managers have established or engaged a European alternative investment fund manager (“AIFM”). In a typical construct, the AIFM will retain overall responsibility for investment management, but delegate the portfolio management function to the UK investment manager. There was previously a question mark over whether this structure would work from an AIFMD perspective. One of the conditions under AIFMD for delegating portfolio management or risk management functions to a third country (i.e. non-EU) undertaking is that co-operation agreements must be in place between the competent authority of the AIFM’s home Member State (e.g. the CSSF) and the supervisory authority of the third country undertaking (e.g. the FCA). The concern was that such arrangements would not exist following Brexit, however in February 2019 the FCA announced it had agreed Memoranda of Understanding with the EU and EEA national competent authorities which met the relevant criteria.
A related question, from the perspective of the UK investment manager, is whether in carrying on the delegated portfolio management function, it is providing portfolio management services into Luxembourg for the purposes of the EU Markets in Financial Instruments Directive (“MIFID”). After the transition period (and depending on the outcome of the ongoing negotiations), the UK investment manager may not have the benefit of the MIFID “passport”, which enables a firm authorised in one EU Member State to provide services in and into others. However, the general view is that portfolio management is carried on at the place of the manager (rather than the place of the client) such that the UK investment manager would not be providing portfolio management services into Luxembourg, and not require the passport. As such, this arrangement should not be affected by Brexit, although we can expect further scrutiny on the limits of this type of delegation in the years to come.
The position is more difficult where a UK fund manager provides non-discretionary investment advisory services to a Luxembourg AIFM as, in contrast to the above, investment advice is typically regarded as being provided into the jurisdiction of the client, such that in these circumstances a MIFID passport would likely be necessary. This sort of arrangement is expected to remain workable, but additional considerations will apply.
There are also concerns as to whether certain other European activities of UK fund managers should be regarded as MIFID investment services that would or may require a licence in the future. Whilst again subject to the outcome of the ongoing negotiations, local analysis may be required as the position and interpretation of the relevant provisions of MIFID varies from Member State to Member State.
Brexit will also have an impact on the basis in which funds are marketed into and out of the UK
On leaving the EU, the UK will (subject again to the outcome of the ongoing negotiations) become a third country, such that UK managers will need to market their funds under Member States’ National Private Placement Regimes (“NPPR”). NPPR have been successfully navigated by US and other non-EU managers for a number of years but there are differences to marketing under the passport that managers will need to adapt to. One unexpected winner here may be UK managers that fall beneath the AIFMD threshold (essentially, €500m AUM for a manager of unlevered closed-ended funds) and were therefore unable to benefit from the AIFMD passport before Brexit. Although NPPR coverage across Europe is not perfect it is a lot more comprehensive than the national regimes governing marketing by EU sub-threshold managers, which are extremely limited.
For inbound marketing, the UK will treat the EU as a “third country” so that funds from anywhere other than the UK will need to be marketed into the UK under the UK NPPR (which is, thankfully, one of the least burdensome). In the short term EU managers who registered for marketing before the end of the transition period are expected to have access to the UK’s Temporary Permissions Regime, giving up to three years’ additional relief. EU Member States may establish similar reciprocal arrangements, though there has been no indication of this yet, perhaps pending the negotiations being conducted at an EU level.
These are some of the issues on which Fried Frank has been advising since the referendum result was first announced. For further information and advice regarding your Brexit strategy, please contact Gregg Beechey or your usual Fried Frank contact.