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Funds First Brexit seminar June 2018 – fund managers’ regulatory options and challenges

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Summary: At our recent Funds First seminar we shared some technical and market issues and updates on Brexit. We were delighted to welcome Katherine Davidge from Deloitte as our guest speaker. This briefing sets out some of the highlights of the issues discussed, which we hope will also be of interest to those who could not attend the seminar itself. We hope to see you again in the Autumn for the next in our series of Funds First seminars.

Overview of Brexit negotiations

Our headline observations are set out below.

  • The UK will cease to be a formal member of the EU at 11pm on 29 March 2019, which is in around 41 weeks’ time (as at mid-June).
  • We can take comfort from the fact that a promising transitional deal is on the table, which would effectively mean a 21 month extension of the status quo in terms of market access, from 29 March 2019 to the end of December 2020. Although the UK will no longer be able to influence legislative and regulatory developments within the EU during the transition period, unless invited to participate by the EU.
  • However, to coin one of the many Brexit clichés, “nothing is agreed until everything is agreed” and we don’t expect any clarity on the withdrawal agreement until October 2018 at the earliest. The future UK-EU relationship is a separate scope of work to the withdrawal arrangements, the negotiation of which has not yet started. Firms are generally working on the basis that they cannot wait for any certainty on the transitional arrangements in terms of their Brexit project planning.
  • A concern in the industry is the lack of flesh on the bones of the UK government’s proposals for an agreement on financial services, a concern which continues given the delay in its White Paper (originally expected to be published this month).
  • EU institutions and key member states (France and Germany) have already made it clear that open access/a comprehensive trade agreement is a non-starter. In reality, therefore, the UK is unlikely to get more than Canada’s limited trade agreement. However, we obviously can’t predict where this will end up – a familiar theme so far in the Brexit talks is that the UK sets out its position, the EU sets out its position and where we end up isn’t in the middle (it’s the EU position)!
  • Access by EU27 firms into the UK post-Brexit and following the expiration of the temporary permissions regime may well continue; however we were reminded that MFN/WTO rules mean that the UK cannot give preferential treatment to EU/other third countries unless there is ‘sufficient justification’.

Market access options post-Brexit

In this part of the seminar we examined market access options in a post-Brexit world, on the assumption that the UK becomes a third country, with no regulatory equivalence decision from the European Commission across the core single market directives, no enhanced equivalence, and no new access arrangements agreed, either universally, or by individual member states. We referred to recent data to illustrate that Europe is now the UK asset management industry’s most significant source of international customers, including that of the Investment Association: £2.6 trillion of the £8.1 trillion assets in the UK is managed on behalf of overseas investors; £1.4 trillion of which (in other words, over half) is for European clients.

The case study analysis threw up various thoughts on commercial as well as technical issues. Some headline comments are below.

  • For a UK AIFM that becomes a third country (non-EEA) AIFM on the UK’s withdrawal from the EU, the ideal position would be that member states agree to automatically convert its marketing passports into article 42 private placement notifications on a country-by-country basis. However there is no guarantee that this will happen or that any grandfathering will be put in place. Instead, firms will need to take stock of their marketing strategies, be ready with any pre-emptive applications to the national competent authorities (NCAs) and manage timings and cost implications. This should enable them to be as prepared as possible when the details are known.   
  • For UK AIFMs wanting to market their AIFs in the EEA following the UK’s withdrawal from the EU, regulatory co-operation agreements will have to be in place between the UK and each relevant EEA member state. Although in theory agreeing and implementing these agreements is less sensitive politically than equivalence determinations (the FCA lists over 50 MOUs already in place), it may add another time constraint and could potentially mean that even article 42 isn’t available for some time after a hard Brexit. 
  • EEA AIFMs of EEA AIFs that delegate portfolio management to a UK firm have to comply with the AIFMD delegation requirements.  Of course, these are already in place and, unlike UCITS, AIFMD already permits delegation of portfolio management to third country firms. However, there has been plenty of political comment and noises from ESMA about whether the rules on delegation and the letter-box tests will be tightened up post-Brexit. Certainly firms will need to consider the substance tests with any models being planned – and given the timing, firms will also want to consider how that will interact with their UK planning for the senior managers and certification regime (SMCR).  In addition, delegation to third country managers once again needs co-operation agreements to be put in place.
  • The EU is consulting on changes to some of the marketing provisions under both AIFMD and UCITS, which include a formalised pre-marketing regime for AIFs across the EEA. This is an area where the UK and certain other countries are being quite helpful to managers, but others very restrictive. The proposed amendments will force those more restrictive countries to allow managers to have initial discussions with investors and test the market. It follows that, having had that initial discussion, it becomes difficult to say there has been a reverse solicitation, but at least managers can work out whether it is worth the time and cost in getting an article 42 notice or passport in place before fully committing to their marketing strategy. 
  • We then looked at some of the positions under MiFID II for third country firms.  Assuming the MiFID passports fall away post-Brexit, a typical discretionary mandate begins to throw up a number of difficulties. We talked through a scenario of a UK manager (a MiFID investment firm) with a Dutch pension scheme client; assets held by a US custodian in a Dublin branch. The manager executes trades for the portfolio through brokers across Europe, including Paris and Frankfurt. Without passports there is a risk that the UK manager could be deemed to be carrying on regulated activities in some or all of those jurisdictions, each potentially with different tests as to whether it is providing the services there or from outside the jurisdiction. As a result, the manager may be forced either to run the mandate through an EU27 affiliate or obtain a licence. 
  • There are inherent issues with each of the market access mechanisms potentially available under MiFID II. For instance, the ability for a third country firm to provide services on cross border basis, either with or without establishing a branch, relates to eligible counterparties and per se professional clients only (so not retail or elective professionals) and requires an equivalence decision, registration with ESMA and co-operation agreements. Also, our conclusion when discussing the ability to open individual branches to provide services to elective professionals and retail, was that this provides no obvious greater benefit than that of having authorised subsidiaries in the relevant EU27 member states instead.

Industry Insights

Katherine Davidge from Deloitte provided some excellent practical insights on how clients are placed on their Brexit journey, key considerations for implementation and target operating models. In her experience, generally firms are looking at solutions that will minimise the disruption on their business in terms of relocation, contracts and AUM; although some are using it as an opportunity to re-structure or rationalise existing structures. A few highlights are set out below.

  • In terms of diagnostic and contingency planning, many firms are making use of other group entities and existing footprints within the EU27 where possible. When starting from scratch, an assessment of a short list of locations is undertaken looking at the differences from regulatory, tax and people perspectives. The popular jurisdictions for asset managers include Eire, Luxembourg, France, Germany and the Netherlands.
  • Although regulatory and tax considerations are often at the forefront of discussions and decision-making, HR issues are also key in driving location selection because of preferences of key individuals or the local talent pool. There are also different employment law impacts, personal taxation and in remuneration regimes which make locations more or less attractive for the individuals that may be relocating. Planning is key, to avoid choosing an operating model and location that is then problematic to staff.
  • For those who haven’t already started planning their Brexit projects, it is important to start now. Deloitte’s experience is that most of their clients are assuming a cliff edge in March next year. Working on an average 4-6 month regulatory application turnaround time, firms need to be ready to submit applications towards the end of Summer 2018 at the latest.

Please do not hesitate to get in touch with any of the BCLP Investment Management team or your usual BCLP contact if you would like to discuss any of the issues raised in this briefing in more detail, including how they may apply to your specific fund structures and planning.

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