Brexit and Alternative Asset Managers
Posted on 30 Oct 2018
Managing the Impact of Brexit on UK Alternative Asset Managers
Much speculation has been made on what the consequences of Brexit for the Alternative Asset Management industry will be and yet, we won’t have a choice but wait and see what will happen after March 2019. A few months back, AIMA published a thought leadership piece on Brexit and the Alternative Asset Management industry, specifically on managing the impact. The position AIMA takes in this paper is based on the assumption that financial services will be addressed “in a Free Trade Agreement grounded in the principles of mutual recognition and reciprocal regulatory equivalence” (AIMA, 2018) between the EU and the UK after March 2019. It is important to take a closer look at what will need to be addressed during the transition period. Based on government statements, the UK is most likely going to leave the EU’s single market and existing cross-border provisions will cease to apply for UK firms as a result.
Keeping with the assumption that the UK will withdraw from the single market, it will become a “third country” under various EEA rules. As a result, this means that UK alternative asset managers need to change the way they are currently doing business with EU investors and clients. AIMA suggests dealing with the following matters specifically during the transition period:
EQUIVALENCE: Large parts of EU financial services legislation incorporate frameworks that allow third-country firms to provide services to EEA clients on the condition that the rules of their home jurisdiction have been deemed equivalent to those of the EU. Thus, the UK should seek an equivalence determination in respect of UK rules by the European Commission that covers the relevant sectoral legislation in which equivalence determinations exist. Moreover, the UK should also ensure that it has its own equivalence assessments in place to replace those that have been adopted by the EU previously.
COOPERATION ARRANGEMENTS: For future relationships, cooperation arrangements between supervisory authorities will be necessary and will often be a pre-requisite for market access. It should be noted that under current EU legislation, such arrangements can only be negotiated between EU competent authorities and third-country competent authorities. Thus, the UK should utilise the transition period to finalise the required cooperation arrangements, e.g. to allow for private placement of funds.
CHANGE OF STATUS ISSUES: Many UK firms are likely to undergo a change of status under EU law, depending on the future relationship with the EU. EU financial services legislation does not contain provisions which regulate the change of status of an undertaking from an EU entity to an non-EU entity, e.g. if UK managers market their non-EU funds under a private placement regime, they will have to change status for purposes of that regime, which will most likely require de-notification under one regime and registration under another. These changes of status should be possible during the transition period to avoid disruption.
However, one of the most important factors when it comes to Brexit is for the UK to seek a deal with the EU that ensures that UK firms’ relationships with EEA investors and clients that existed before Brexit can continue uninterrupted afterwards by virtue of “grandfathering” provisions.
When Brexit occurs, the change of relationship between the UK and EU will require decisions to be made about:
1.) Whether and to what extent entities from the EEA member states will be able to still claim a preferred status for inbound asset management activities
2.) Whether and to what extent the relationship between EEA firms and UK investors/clients can continue uninterrupted following Brexit (as mentioned before by virtue of “grandfathering” provisions).
3.) What the status of UCITS will be in the UK going forward
AIMA’s general suggestion is for the UK to opt for an approach that prioritises openness over reciprocity.
Current state of play
The AIFMD contains a number of provisions that govern the management and marketing of alternative investment funds (AIFs) in the EEA. There are different provisions that apply, which depend on where the alternative investment fund manager (AIFM) has been established and where the AIF to be marketed has been established.
Impact of Brexit on cross-border marketing and managing activities
Assuming Brexit entails the withdrawal of the UK from the single market, UK AIFMs will no longer qualify for the management and marketing rights under Articles 32, 33 and 36. What will most likely happen is that UK AIFMs will be treated as third-country AIFMs. As a result, because of the change in status from EEA AIFM to non-EEA AIFM, UK AIFMs will no longer be eligible to manage UK funds pursuant to the EEA management passport or market their AIFs in the UK. The AIFMD does not contain any provisions dealing with the withdrawal of notices/registrations filed under Articles, 32, 33 and 36 in circumstance such as the one at hand, i.e. Brexit. Thus, in the absence of any agreement or clarity on a proposed approach, uncertainty will prevail over existing relationships which have developed under these arrangements.
At the moment, the right of non-EEA AIFMs to manage EEA AIFs is subject to the national law of each EEA member state. Therefore, the right of non-EEA AIFMs to market in the EEA any AIFs they manage is subject to:
1.) The requirements of Articles 42
2.) The conditions set out in the Article 42 private placement regime of the EEA member state where the marketing is to take place, if the EEA member state has one.
The minimum requirements of Article 42 do not require compliance with the full scope of requirements of the AIFMD that apply to EU AIFMs, however, Article 42 does require, among other things, that appropriate cooperation agreements are in place between the supervisory authorities of the EEA member state where the marketing occurs and the supervisory authorities of the third country where the non-EEA AIFM is established.
UK AIFMs that would want to use any available Article 42 private placement regimes following Brexit will encounter a timing issue which would need to be resolved to allow for a seamless transition. UK AIFMs will not be non-EEA AIFMs until after Brexit. Neither the AIFMD nor EEA member state private placement regimes under Article 42 currently make provision for an entity that is not a non-EEA AIFM to file the required registration paperwork (can take a minimum of 20 days from filing to process or longer, e.g., Sweden where it takes up to 60 days).
Impact of Brexit on Cross-Border Delegations
Brexit may also affect delegations from authorised EEA AIFMs to UK-based asset managers. Article 20 of the AIFMD requires that, where the delegation concerns portfolio management or risk management and is conferred on a third-country entity, a cooperation agreement between the competent authority of the EEA AIFM and the supervisory authority of the delegate is in place.
AIFMD Third-Country Passport
The AIFMD contains provisions in Articles 35 and 37 to 41 that could allow non-EEA AIFMs to access marketing and management rights similar to the EEA marketing passport, provided that ESMA has made a positive assessment regarding the third country where the AIFMs (and, where applicable, AIFs) were established and provided that relevant cooperation agreements are in place.
AIMA’s stand on this is that they fully support the finalisation of the process of activating the third-country marketing passport, as well as the third-country management passport. Thus, AIMA encourages the UK government to seek to have ESMA perform its assessment for this purpose during the transition period and to get the necessary cooperation agreements in place during the transition period as well.
Practical Implications of Brexit
Things are a lot less complex for UK UCITS and UK UCITS management companies compared to the situation of UK AIFs and UK AIFMs as described above. The UCITS Directive requires a UCITS and the UCITS management company to be established in the EU.
The withdrawal of the UK from the single market would mean that current UK UCITS will no longer be eligible to be UCITS unless they relocate to the EU. Moreover, UK UCITS management companies will also no longer qualify to manage directly any UCITS, UK or otherwise, unless they relocate to the EU. UK UCITS management companies that choose to redomicile may also need to apply for new UK FCA authorisations to complement their Brexit restructuring plans, e.g. setting up a branch in the UK. There may be a number of legal and regulatory questions about a branch structure such as this, thus, these firms might need a streamlined authorisation process so that no unnecessary disruption is created.
Some UK UCITS offered solely to UK investors may choose not to redomicile. In those cases, the FCA will need to make a decision as to whether those UK UCITS would be treated by the FCA going forward as UK AIFs and need an authorised UK AIFM, or if they would be treated by the FCA as UK residual CIS or something else. Despite the outcome of these questions, from an EEA point of view, UK UCITS and UK UCITS management companies which do not redomicile will be considered non-EEA AIFs and non-EEA AIFMs, respectively, which could lead automatically to enforced redemption where investors are obliged to invest only in EEA regulated funds.
3. MiFID 2/MiFIR
Practical Implications of Brexit
Cross-border provision of services by UK alternative asset managers
MiFID II, like the prior MiFID framework, enables authorised investment firms to provide investment services across the EU, subject to making a notification under Article 34 of MiFID II. Many UK alternative asset managers rely on this provision to provide portfolio management services to clients across the EU. The withdrawal of the UK from the single market means that this intra-EU passporting right will be lost. The implications of this are not entirely clear from the point of view of relationships with EU clients that pre-date Brexit, but it is likely that UK investment firms would – if there is not a specific agreement addressing this point – have to stop providing services to those clients or establish an authorised MiFID investment firm within the EU in order to provide services to those clients. Whether firms choose to do this depends on the feasibility and cost of establishing a new legal entity in the EU and the ease of obtaining local authorisation.
Practical Implications of Brexit
The FIA published a paper (‘The Impact of a No-Deal Brexit on the Cleared Derivatives Industry’), which highlights the important role of equivalence and recognition in the context of the status of the UK clearing infrastructure for EEA firms. Article 13 of EMIR provides a mechanism to avoid duplicative or conflicting rules, whereby counterparties entering into a transaction subject to EMIR shall be deemed to have fulfilled their EMIR obligations where at least one of the counterparties is established in an equivalent third country. The application of this provision is not clear in a fund management context. For example, an offshore (i.e. non-EU/EEA) fund with a UK investment manager: After Brexit, the investment manager will presumably be subject to UK rules replicating EMIR. However, given that EMIR’s definitions of financial and non-financial counterparty attach to the investment fund, rather than to the investment manager, it is not clear that the offshore fund managed by the UK manager would be able to benefit from an equivalence determination in respect of UK rules, given that it is not “established” there (Article 13 of EMIR). In the extreme, this could lead to a situation where UK rules have been deemed equivalent by the European Commission, but UK investment managers are nonetheless unable to enter into OTC derivatives transactions with European brokers on behalf of the funds they manage without those funds being subjected to competing EU and UK rules. This reflects the fact that the funds themselves might not be established in the UK.
Asset managers have good reason to be concerned about the consequences of Brexit. Not only could it impair economic growth in the UK, it is likely to make their ability to operate far more complicated and costly.
Laven has recently participated in a Brexit Q&A report with HFM, which includes more details and our vision on what will happen after March 2019. To download the report, click here.