In one of the most important political events in recent European history, the UK voted on June 23rd 2016, in an advisory referendum, to leave the EU. This has created great uncertainty. In this article, we review the political considerations and analyse the potential impact on UK asset managers.
The main uncertainty with Brexit relates to the arrangement which will be negotiated when the UK ultimately leaves the EU. The other uncertainty following the referendum related to how long it will take before the UK transitions into a new arrangement. On October 2nd 2016, British Prime Minister Theresa May confirmed at the Conservative party’s annual conference that the UK will trigger article 50 by the end of March 2017 thereby starting the formal process of leaving the EU. Given the two year divorce process, this means that the UK looks set to leave the EU before the summer of 2019.
What will the UK’s negotiating position be?
The UK Government’s negotiating position is currently unclear, although it is likely to seek both control of EU immigration and continued access to the single market. However, it seems very unlikely that both of these goals can be fully achieved. The EU won’t want to grant the UK an attractive deal as it wishes to deter other countries from leaving. Certainly, those non-EU countries with full access to the single market have had to accept all four fundamental freedoms1.
More specifically, those with access have an obligation to enact all EU legislation (and pay into the EU budget, albeit without any representation). The key question is whether the UK government is willing to give way on migration control in order to retain access to the single market? Currently, it seems that the UK government is likely to prioritise control of immigration over continued access to the single market.
What will the EU’s negotiating position be?
This is even more difficult to answer as the EU is an agglomeration of various national and supranational interests. Some EU member states may be happy to sacrifice elements of free movement in order to maintain free access to the UK market. Other countries may be reluctant to offer the UK very much at all.
What might a final deal look like?
One possibility is a “Norway” type deal. This would mean membership of the EEA (or an equivalent arrangement) and accepting the four fundamental freedoms. If an EEA type solution is achieved then nothing much will ultimately change from the point of view of an asset manager although care would need to be taken during the transitional arrangements. While this option seemed to be favoured early after the referendum it now seems less likely due to the political imperative in the UK of seeking to limit EU migration.
Another possibility is a bespoke deal whereby access to the single market is wholly or partially sacrificed. Based on recent comments from British Government ministers, this looks like the most likely scenario although the details of any final settlement are very unclear.
Finally, the default option is for the UK to leave the EU without any agreement on access to the single market meaning the UK would revert to WTO2 rules. This is assuming the UK was able to accede independently to the WTO without any delay or issues. The UK therefore becomes a “third country”.
Given the level of uncertainty that exists, UK asset managers need to plan for the default option.
UK managers marketing in the EU under AIFMD
In the “third country” scenario, UK AIFMs would lose their marketing passports within the EEA.
In July 2016, ESMA3 stated that there were no significant obstacles impeding the application of the AIFMD marketing passport to the following non-EEA countries: Canada, Guernsey, Japan, Jersey and Switzerland. The two key questions in this regard are:
- When will the European Commission approve these recommendations?
- Will the UK be allowed to be “grand-fathered” in as an equivalent regulatory environment or will it need to be freshly assessed like other non-EEA jurisdictions? This may lead to a gap in access as ESMA has already identified a number of non-EEA countries, presumably for assessment before the UK. If there is a gap in access the UK may need to rely on private placement regimes (which may be phased out from 2018).
UK managers marketing in the EU under the UCITS directive
UK management companies will not be able to passport services to UCITS funds domiciled in the EU. UK UCITS funds will no longer be able to passport into the EU and will likely have to seek country-by-country approval. The possibility of “third country” passporting which exists under AIFMD does not exist under UCITS.
The implications of Brexit for UK managers under MIFID
If the UK does not come to an agreement on EEA membership, it could potentially benefit from a “third country” passport regime under MIFID similar to that in existence under AIFMD. MIFID2/MIFIR will introduce a new arrangement from January 2018 which could allow a UK asset manager to continue to provide portfolio management services to clients in EU member states. The possibility of the UK benefitting from this passport would be contingent on the UK being deemed to be an equivalent jurisdiction following an assessment by ESMA. There is added uncertainty regarding this passport possibility as this has not been legally tested and this would seem unlikely to take place until/if the UK actually exits the single market.
Our view on the likely impact of Brexit
If the UK neither comes to an agreement on EEA membership nor negotiates an agreement for equivalent access, we see the following impact on the industry:
- In the absence of Brexit, a number of UK asset managers intended to passport the services of UK management companies to support investment funds in key EU fund domiciles such as Ireland and Luxembourg. With Brexit, this option will no longer exist. UK asset managers will need to establish management companies in Ireland or Luxembourg or more likely seek the services of independent management companies.
- UCITS and authorised EU AIFMs may delegate portfolio management to non-EU asset managers. An EU UCITS management company or AIFM may continue to avail of portfolio management services from a UK asset manager.
- A small number of UK managers utilise UK funds not just for the domestic market but also for the EU market (though most already use an Ireland or Luxembourg based UCITS/AIFMD compliant fund). The UK’s exit from the EU will likely mean that those managers utilising a UK fund to access the EU will establish a fund structure in Ireland or Luxembourg for that purpose.
- It could be argued that smaller UK managers who do not distribute into the EU on a large scale may prosper in a potentially less onerous UK regime and simply rely on “third country” private placement regimes where required.
- UK authorised UCITS management companies and AIFMs will be considered “third country” counterparties under EMIR4. This is the new European regulation on OTC5 derivatives. It imposes a requirement for clearing through central counterparties. UK asset managers would be subject to less burdensome EMIR rules and may not be subject to the reporting requirements.
- For non-UK managers consideration may be given as to whether or not funds should be established in the UK for the purpose of accessing UK investors. Given the openness of the UK to non-EU products, e.g. Cayman funds, it is anticipated that the UK is likely to be receptive to the inward marketing of funds located in Ireland or Luxembourg. An Irish or Luxembourg UCITS would be required to seek authorisation and register for public sale in the UK. While likely achievable, this will be less straightforward than the pre-Brexit simplified regulator to regulator approval process.
You can download a copy of our guide on the impact of Brexit on UK Asset Managers marketing into the EU here
KB Associates’ Services
KB Associates offers a range of services to investment funds including:
- The provision of UCITS/AIF management company services.
- The provision of designated persons to perform UCITS business plan and AIFMD programme of activity managerial functions.
- The provision of UCITS/AIF operational support.
If you would like to discuss any issues raised in this article or related to KB Associates’ services in general, please feel free to contact Mike Kirby (+353 1 667 1980), Peter Northcott (+44 203 170 8813) or Mike Parton (+1 345 946 4224).
1 Free movement of goods, services, capital and people
2 World Trade Organisation
3 European Securities and Markets Authority
4 European Market Infrastructure Regulation