With all eyes fixated on the UK General Election result and the British and Irish Lions tour to New Zealand, it was easy to see why two very important pieces of Brexit-related news may have gone unnoticed.
The first surrounded an opinion issued by the European Securities and Markets Authority (ESMA), which said that any outsourcing or delegation arrangement from authorised entities in the EU27 to a third country “should be strictly framed and consistently supervised.” Letterbox entities cannot be allowed to proliferate in the EU27 and organisations must have substance, ESMA further warned. ESMA also said that it would develop more sector-specific details for asset managers, investment firms and secondary markets at a later stage.
The big concern for UK asset managers is whether they will be able to continue leveraging management companies to passport AIFM (Alternative Investment Fund Manager) and UCITS products cross-border, particularly if ESMA adopts a prescriptive approach. UK UCITS and AIFMs – post-Brexit – will no longer be designated as such, but will be identified by EU regulators as third country funds unless an agreement of sorts is reached. This possible clampdown on substance is also a concern for Irish and Luxembourg regulators which oversee a large proportion of the management companies in question.
Jean Marc-Goy, counsel for international affairs at the Commission de Surveillance du Secteur Financier (CSSF) in Luxembourg, said substance checks needed to be assessed on a case-by-case basis. “We intentionally do not give a minimum number of staff that we expect to be on the ground. We look at each business and check both quality and quantity but it is all determined on a case-by-case basis. We feel some of the proposals on the table at ESMA are going into too much detail on the issue and are going quite far,” said Marc-Goy, speaking at the Association of the Luxembourg Funds Industry (ALFI) conference in London last week.
He added that costs needed to be taken into consideration when discussing substance, but said that Luxembourg was not light-touch in its approach. The CSSF is reportedly conducting more onsite visits to investment funds, and has increased its staffing to undertake this work.
EU27 regulators are expecting a deluge of application requests from UK financial institutions looking to maintain passporting access. ESMA said national competent authorities needed to prepare for this. ESMA added it would establish a forum – the Supervisory Coordination Forum – to allow individual regulators to discuss issues relating to the relocation of UK market participants. This is to prevent supervisory convergence amid concerns that some member states are having a race to the bottom around oversight in order to win a dominant share of relocating UK businesses. In terms of the EU, the general consensus is that regulators are becoming more protectionist. Experts have repeatedly said that the UK Financial Conduct Authority’s (FCA) departure from ESMA will be a huge loss in terms of the future development of the EU’s capital markets. This was reinforced by Marc-Goy. “With the UK FCA in the EU, we have had a trusted and good ally by our side. The FCA is highly experienced and full of knowledgeable people who know what they are talking about. The FCA’s departure from ESMA is a pity from both a Luxembourg and UK perspective,” he said.
This comes following reports that the FCA has written to leading asset management companies requesting information about how they are dealing with Brexit. The questions are varied, according to the reports, and ask whether managers are relocating staff or operations to the EU; whether they have sought licenses from foreign regulators; and how Brexit may impact their capital base and IT infrastructure. The asset management industry has adopted a cautious approach to Brexit and certainly has not rushed its decision-making process.
Several major asset managers including M&G and Jupiter have strengthened their EU subsidiaries to ensure they are not shut out from their continental clients, while some US branches with UK operations have done the same. A number, however, are refraining from executing any Brexit contingency plan, particularly as the negotiations have not even started yet. They argue that setting up a new subsidiary is expensive and time-consuming, and may be utterly pointless if negotiations prove fruitful.
But not all asset managers will look after EU money. If most of their assets are US or Asia-Pacific (APAC)-based, there is clearly little or no incentive to be based in the EU. However, APAC investors do buy a lot of UCITS products, so there may be some pressure on UK managers to set-up EU branches.
Nonetheless, with the UK General Election uncertainty, some asset managers may not wait for Brexit talks to conclude before relocating in the event of a Labour Party win. The Labour Party has repeatedly said it will introduce a Financial Transaction Tax (FTT) – among other things – and this could lead to a mass exodus from the City of London.