The UK’s withdrawal from the European Union (EU) following the referendum last week is leading to UK fund managers looking to restructure their funds out of Ireland and Luxembourg with third party management companies (Mancos) reporting a surge in interest.
The vote calls into question the ability of UK fund managers with UCITS or AIF structures to passport freely across the EU to end investors. The precise terms of Brexit are unknown and there is unlikely to be much clarity in the immediate future given the magnitude of Brexit and the sheer challenges faced by negotiators from the UK and EU over the coming months and years.
The exact nature of the UK’s exit and its terms for fund managers are therefore unknown. Retaining membership of the European Economic Area (EEA) would allow passporting to continue. However, EEA membership is contingent on free movement of people, and this may be a politically unacceptable compromise for some proponents of Brexit, a point that has been made by politicians already. A refusal to sign up to the EEA would result in a cessation of passport rights completely as the UK would become a non-EU/EEA third country.
In the event of failing to join the EEA, UCITS and AIFs domiciled in the UK would have to market through National Private Placement Regimes (NPPR), which for AIFMs is likely to be shut off by 2020. The inevitable uncertainty is causing UK fund managers to restructure.
“Firms domiciled out of the UK are exploring how to restructure their fund vehicles in Luxembourg and Ireland, which have an excellent track record of servicing and regulating the fund management industry. The likelihood is that AIFM and UCITS UK regulated entities may elect to move to onshore EU countries so as to attain UCITS and AIFMD distribution benefits and delegate investment management back to the UK through a Manco structure,” said Aymeric Lechartier, managing director at Carne Group.
Third party Mancos are just one option for managers, although they are probably the most cost effective. UK fund managers could build a physical presence in the EU although this can be expensive. Another alternative would be for UK managers to partner with a UCITS or AIFM within the EU, a structure that has been deployed by US and Asia-Pacific (APAC) managers for many years. This also is quite cost effective.
The UK – at present – is likely to retain membership of the EU for the next two years while negotiations are underway. “Whilst the UK is likely to remain as a member of the Union for at least the next two years, investors make investment decisions on longer time horizons. So will an investor who has purchased a UCITS or an AIF be happy to be a shareholder in a Non-EEA AIF in three years-time?” read a Carne Group briefing.
The Carne Group briefing added that UK managers needed to reassure existing and prospective investors, and future proof their businesses to deal with any fall-out or consequences of Brexit. “Investors will continue to allocate into UK managers. UK managers simply need to adapt to the regulatory changes that will impact their businesses. EU investors allocate to US, Hong Kong and Singaporean managers who have EU funds. That will not change. However, it is essential that UK fund managers acclimatise to these developments to provide peace of mind to their clients,” said Lechartier.
Depositaries and Depositary-lite institutions who have attained Variation of Permission (VOP) authorisations from the Financial Conduct Authority (FCA) will also likely have to restructure their entities somewhere in the continent, again most likely Ireland or Luxembourg, if the UK fails to sign up to the EEA. Depositary institutions must of course be based in the EU if they are to provide their services to AIFMs or UCITS.
Regulations and directives such as the Markets in Financial Instruments Directive II (MiFID II) will continue to apply until withdrawal is finalised. Again, the FCA has told managers that compliance with rules such as MiFID II is a must despite the vote. The rules will continue to apply if the UK wants to join the EEA, or if it wants to attain regulatory equivalence with the EU.
Perhaps the big unknown is the future of pan-EU distribution. The Capital Markets Union (CMU) has only just begun consulting on pan-EU distribution and some of the administrative and regulatory challenges faced by fund managers when marketing across the EU. The resignation of Lord Jonathan Hill, the EC Commissioner in charge of CMU, does raise questions as to how the initiative will pan out under new leadership. It is highly likely CMU will be delayed as regulators deal with the fall-out from Brexit.
Depending on the outcome of negotiations, the UK will have far less say in how distribution can be streamlined and simplified under CMU. A number of countries have sought to gold-plate distribution under both UCITS and AIFMD in recent years, and this could yet continue without the UK’s active participation in these critical discussions.