At the moment, it is still unclear whether the UK will leave the EU on the basis of a deal, with no deal in place or whether it will leave in October at all. However, in the asset management space, certain matters are now clear regardless of how and when the UK leaves the EU.
Impacted Regulatory Regimes
The asset management industry in Europe is regulated by three primary regulatory regimes, namely the Alternative Investment Fund Managers Directive (“AIFMD”), the Undertakings for Collective Investment in Transferable Securities Directive (“UCITS”) and the Markets in Financial Instruments Directive (“MiFID”). In the absence of a withdrawal agreement and the related implementation period during which EU rules would continue to apply in the UK, and unless the agreement on the future EU/UK relationship provides for a different outcome, these EU laws will cease to apply to the UK as a Member State and the UK will instead become a “third country” according to EU law, much like the United States is today.
Each of the UCITS, AIFM and MiFID regulatory frameworks regulates the provision of asset management services in the EU and each grants EU passporting rights to regulated entities. This enables them to operate (and, in most cases, allows all of their products to be sold) across the EU with minimal additional regulatory burden in the host countries. The fact that the UK will, most likely, no longer be part of those passporting regimes post-Brexit is the biggest challenge facing the asset management industry. It is worth noting that this is a two-way street – UK managers will lose passporting rights into the EU but EU managers (and EU funds) will also lose passporting rights into the UK.
UK asset management firms manage assets belonging to millions of investors in the EU – the UK is the largest centre for asset management in Europe. UK firms risk losing access to such investors but the inverse is also true; such investors risk losing access to those UK firms. It is in the interests of “both sides” to ensure that such access remains. For this reason, the various regulators and industry participants have engineered a post-Brexit landscape that represents, in the short term at least, as positive an outcome as could have been hoped for, particularly in light of the ongoing uncertainty relating to other aspects of post-Brexit EU/UK relations.
Particular Impacts under UCITS
UCITS are the primary public fund in the EU and the UCITS regulations currently require that both the UCITS fund itself and its management company be domiciled in the EU. When the UK leaves the EU, this will have a number of knock-on effects, the most material of which are described below:
- UK UCITS – Unless it re-domiciles to the EU, a UK UCITS will automatically become a non-EU fund and lose its passporting rights. For EU investors in such a fund, this may not be acceptable and so the majority of impacted managers have offered those investors an EU-domiciled equivalent UCITS instead (generally in Ireland or Luxembourg). Where the UK UCITS has an EU management company, that management company will need to examine its licence to ensure it can manage non-UCITS (as UK UCITS will be considered to be non-UCITS or alternative investment funds (“AIFs”) post-Brexit).
- UK UCITS management companies – These will not be authorised to manage and market UCITS. Where they manage a non-UK UCITS at present, that UCITS will need to either appoint an EU management company instead of the UK one or become a self-managed UCITS.
- EU UCITS – Such UCITS will lose access to the UK on a passported basis and their ability to be sold into the UK will instead be subject to local rules which the UK may impose on such funds post-Brexit. Until those rules are put in place, however, the UK has created the Temporary Permissions Regime. This will allow such UCITS to continue to be sold in the UK until the new rules are applied.
- EU UCITS management companies – A vast majority of EU UCITS management companies delegate portfolio management functions to an investment manager, a large number of which are based in the UK. For a long time, it was unclear whether (or, most accurately, when) the necessary inter-regulator cooperation agreements would be put in place to allow this delegation to continue. On 1 February 2019, the European securities regulator, the European Securities and Markets Authority (“ESMA”) announced that it had entered into the necessary cooperation agreement in the form of a multilateral memorandum of understanding (“MMoU”) with the UK Financial Conduct Authority (“FCA”) and it is expected that all Member States will sign up to the MMoU in advance of Brexit day. A separate point arises for an EU UCITS management company that manages UK UCITS; when those UK UCITS become AIFs, the EU UCITS management company will need to ensure it is appropriately authorised to manage AIFs.
Particular Impacts under AIFMD
AIFMD applies to all AIFs and, unlike the UCITS regime, it already recognises the concept of a non-EU AIF and a non-EU management company, called an alternative investment fund manager (“AIFM”). Furthermore, and again unlike the UCITS regime, passporting rights under AIFMD attach to the AIFM rather than the AIF, though they are still conditional on the domicile of the AIF. As a result, the impact of Brexit on AIFs is different to UCITS. In summary:
- UK AIFM and AIFs managed by that UK AIFM – The AIFM will continue to be able to manage EU AIFs, although they will lose access to the AIFMD management passporting regime. Similarly, any UK AIFs managed by the UK AIFM will also lose access to the marketing passport. However, where such UK AIFs are not marketed in the EU, they will fall entirely outside of the scope of AIFMD (including its most burdensome obligations).
- EU AIFM and AIFs managed by that EU AIFM – Any UK AIFs managed by an EU AIFM will lose access to the marketing passport. EU AIFs will be unaffected including, at least in the short term, as regards being sold in the UK – the Temporary Permissions Regime noted above also applies to AIFs.
Without access to the passporting regime, AIFs are subject to the relevant national private placement regime (“NPPR”) applicable in the given target Member State. The NPPR varies from Member State to Member State and indeed some Member States do not allow for any NPPR. As a result, many managers of AIFs currently sold under the passport have decided that reliance on NPPRs is not a viable marketing strategy. Such managers are, depending on their particular circumstances, establishing EU AIFMs or EU AIFs to ensure continued access to the passport.
As noted above, AIFMD already contemplates non-EU AIFs and non-EU AIFMs. In particular, it contemplates such AIFs and AIFMs being granted passporting rights in place of the NPPRs. The extension of the EU passport to non-EU AIFs and AIFMs is contingent on positive advice from the ESMA and approval from the European Commission. ESMA may only issue positive advice in relation to a non-EU country where it is satisfied that there are no significant obstacles regarding investor protection, market disruption, competition and the monitoring of systemic risk. It is expected that, provided UK AIF regulation remains similar in a post-Brexit environment, no significant obstacles would exist which might prevent the UK from being part of any future third-country extension of the EU passport.
Particular Impacts under MiFID
MiFID regulates the manner in which asset managers provide investment services to clients across the EU. In the context of the investment fund industry, the primary services are portfolio management and distribution/marketing. MiFID, like AIFMD, provides for an equivalence mechanism that can allow firms from outside the EU, “third country firms”, to do business in the EU without the need for authorisation in individual Member States. At first glance this is the perfect solution for UK firms providing services in the EU. However, this mechanism was only introduced in January 2019 as part of MiFID II and it is untested. In addition, the equivalence process itself would take at least several months (the European Commission would have to determine that the UK has an equivalent supervisory and enforcement regime to the EU post-Brexit and then ESMA would have to assess individual firms’ applications). For this reason, the MiFID third country regime is not a viable option in the immediate aftermath of a no-deal Brexit and instead industry participants are examining the following options:
- Portfolio management – As regards portfolio management and investment funds, this is not an issue. Both UCITS and AIFMD simply require that a non-EU investment manager be appropriately regulated and that a cooperation agreement be in place between the relevant regulators. As indicated above, ESMA has agreed the necessary MMoU with the FCA and, as such, UCITS management companies and AIFMs will still be able to delegate portfolio management to a UK investment manager.
- Distribution – At present, it is common for UCITS and AIFs to be sold in the EU by sales staff living in London, working for a MiFID firm with access to an EU passport and travelling to Europe in reliance on that. When the MiFID firm loses its passport post-Brexit, it will either have to: (1) establish an EU domiciled MiFID entity; or (2) rely on local country rules which provide that the given marketing activities are unregulated in that country. In the case of option (1), how to continue to use the London-domiciled sales staff also needs to be taken into account.
Conclusion
Brexit poses significant challenges for any asset manager with exposure to the UK, whether through having a base there or simply accessing the UK market. However, in the early days of the Brexit negotiations, a majority of managers determined (correctly, as it turned out) that they could not rely on a smooth Brexit providing similar frictionless cross-border access as enjoyed today. They critically assessed their operations and investment product offerings and took proactive steps. For many, this meant establishing a fund management presence in countries like Ireland or moving assets owned by EU investors out of existing UK funds and into equivalent Irish funds. Ireland has longstanding and close ties to the UK, going well beyond a common language and time zone and a comparable legal system. This, coupled with Ireland’s existing extensive investment fund industry (€2.7 trillion worth of assets are held by Irish domiciled funds which are sold in over 90 countries), means Ireland is perfectly placed to support the global and UK asset management industry as it prepares for a post-Brexit world.
This article first appeared in the International Comparative Legal Guide to Public Investment Funds 2019.