Even With Hard Brexit, UK Asset Managers Can Still Serve the EU
UK firms manage approximately L1 trillion in assets for European investors outside of the UK. With the Brexit negotiations slated to start this month, the UK Investment Association has raised serious questions about whether those assets could be taken away from UK asset managers – especially given Prime Minister May’s prioritization of immigration limits over capital markets.
However, even if the UK does not obtain preferential access to the EU’s capital markets in the Brexit negotiations, UK firms can continue to manage assets for EU clients, just like other non-EU firms including many US money managers. The two key strategies employed by non-EU asset managers have been: indirect passporting and regulatory equivalence.
The EU’s UCITs directive governs the sales of mutual funds to EU’s public investors. (UCITs stands for Undertakings for Collective Investments in Transferable Securities). Most importantly, UCITs allows a fund registered in one EU jurisdiction to be passported to any other EU country – automatically registered by notice to the other country and sold to all investors in that country without the need to register again.
For years, non-EU fund managers have established wholly owned EU subsidiaries in Luxembourg or Ireland, registered UCITs funds there and passported these UCITs funds across the EU. Luxembourg and Ireland have been very flexible on the requirements for these non-EU subsidiaries, while non-EU managers have become quite adept at replicating their existing funds for sale to EU investors.
So UK firms, even without preferential treatment after Brexit, should be able to use indirect passporting to sell UCITs funds throughout the EU. Of course, the bureaucrats in Brussels might try to impose new requirements for extensive staff and operations in these subsidiaries of non-EU managers. However, these requirements would be strongly opposed by Ireland and Luxembourg, as well as all the non-EU countries that currently utilize indirect passporting.
For alternative investment funds, UK firms should be able to DIRECTLY serve their EU clients through the evolving strategy of “regulatory equivalence” WITHOUT establishing an EU subsidiary. This strategy has already been embedded in the AIFMD (Alternative Investment Fund Managers Directive), which applies to the sale of hedge funds, private equity funds and real estate funds to professional investors throughout the EU.
Under the AIFMD from 2018 onwards, the EU regulators may grant a passport for sales of such funds from outside the EU -- if fund regulation by the manager’s home jurisdiction is deemed equivalent to the EU’s legal framework and the home jurisdiction provides reciprocal treatment to EU managers of alternative funds. Based on such a AIFMD passport, UK firms could sell alternative investments throughout the EU without establishing an EU subsidiary (though they would have to appoint an EU-based depositary).
Under the regulatory equivalence standard, EU regulators recently gave the green light to EU-wide marketing of alternative investment funds by firms in several countries– including Canada and Japan as well as the British-dominated islands of Guernsey and Jersey. Since the UK has fully implemented the AIFMD, it should easily meet the “regulatory equivalence” standard at present. Going forward, the UK government plans to import into UK law all EU rules on capital markets, unless and until specifically repealed by Parliament.
Yet, EU approval of UK’s regulatory equivalence is not automatic. In the process of Brexit negotiations, the EU might withhold approval of regulatory equivalence as a bargaining chip, though the EU would not have a strong substantive argument for discriminating against the U.K.'s regulatory regime and might be open to lawsuits based on international trade laws.
Similarly, MIFID 2 ( Markets in Financial Instruments Directive), effective in 2018, will allow non-EU firms to be discretionary portfolio managers of separate accounts for EU investors if the home jurisdiction of the non-EU firm has an equivalent regulatory system to that of the EU. As with the EU’s approach to alternative investments, the home jurisdiction must provide reciprocal treatment to EU managers of separate accounts.
Under the new third country provisions of MIFID, an asset manager in a non-EU country has a choice. Such an asset manager can set up an EU branch to sell separate account services to retail investors and comply with the general requirements of MIFID. Alternatively, a non-EU asset manager can limit its sales efforts to separate account services to professional investors. Under that alternative, the manager must register with an EU regulatory agency but does not have to establish a branch in the EU.
In short, even assuming a hard Brexit, UK firms have several avenues available to sell asset management services to investors in the EU. In some cases, the UK firms may have to add an office in the EU; in other cases, they may have to limit their sales to professional clients. The big question is whether the EU will try to erect special barriers to UK firms that, like non-EU firms, follow the strategies of indirect passporting or regulatory equivalence.