On Friday 13 November 2020, AMX hosted an online briefing for consultants and trustees that looked at the implications of Brexit for the fund management industry. Here are the highlights from the session.
 

The United Kingdom left the European Union on 31 January 2020 and immediately entered a transition period. As a result, the UK is still following EU rules and trading as if it were a member. That ends on 31 December 2020.

As of 1 January 2021, the UK will be a ‘third country’ outside the EU Single Market. That has major implications for the financial services sector, unless the UK and EU agree new regulatory arrangements before then. The key impact is likely to be the immediate loss of ‘passporting’ rights that enable UK firms to operate across the EU.

We asked our guest speakers Paul Edmondson, a partner at CMS, and Tammy Yong, Head of Legal at AMX, to consider the regulatory issues caused by these changes and the key questions for asset managers. Ian Barnes moderated the event and around 20 consultants and trustees logged in for it. Here is a summary of the key points raised.

As Ian pointed out, most of the public discussion around Brexit has been about trade in goods, not in financial services. While there may be some benefits to an independent trade policy in goods, the reality is quite different for the asset management industry. London and the EU have a highly integrated value chain of investment managers, advisors and other professional service providers.

EU fund regulation, such as UCITS, has become the global gold standard in terms of governance. As a result, EU domiciled funds are readily sold all over the world, including in the rapidly growing Asian markets. UK asset managers currently have unrestricted access to these funds, but it looks likely that such access will end on 31 December, with potentially negative consequences.

Companies like AMX emphasise good governance and use of the most appropriate fund structures, particularly with regard to achieving beneficial tax outcomes that enhance returns. Distribution and regulatory changes following the end of the Brexit transition will put such topics front and centre for many trustees and consultants when selecting asset managers. It is important that they don’t become a distraction for investment decision makers.

This is a vast topic, with many unanswered questions, and our discussion only touched on certain aspects of the regulatory changes and distribution issues. Our focus was on the questions trustees and consultants should be asking their asset managers.

Given what we know now, will clients need to disinvest from their current funds?

Tammy started by reassuring the audience that there was no immediate prospect of the EU or the UK forcing clients to make wholesale changes to their choice of funds. As things stand, the many UK pension schemes with investments in non-UK domiciled pooled funds, in jurisdictions like Luxembourg or Ireland, should be able to continue with those arrangements. However, the real issue is whether those funds will be available to UK investors in future and whether UK firms will still be able to provide services to those funds.

As Tammy explained, passporting is incredibly convenient for financial services providers across Europe. If you are regulated in one EU country, under the passporting regime your authorisation in one EU Member State is recognised by all other Member States as an authorisation to do business in their territory as well. This has enabled many UK asset managers and other finance professionals to provide valuable services to EU firms – including to investors in smaller markets that they may not have targeted otherwise.

As the table from the FCA above shows – more UK firms now use passporting to serve the EU than vice versa. Leaving the EU will affect the management and marketing of these funds because UK firms will lose their passporting rights (unless other arrangements are agreed and put in place). In fact, UK UCITS will even stop being UCITS and become non-EU AIFs.

What, if anything, might replace passporting?
 

Paul explained that the Political Declaration (which the UK and EU agreed in October 2019) is guiding negotiations between the UK and the EU. This indicates that any deal on financial services would use ‘equivalence’ to determine whether UK firms could provide financial services in the EU. Equivalence is not a new idea; it has existed in EU law for some time and governs how firms in non-EU countries access the EU Single Market.

If the EU determines that the financial regulations in a non-EU country are equivalent to its own, certain consequences flow from that. However, the benefits are limited and vary from one financial services sector to another, reflecting the number of different EU directives covering the industry. The three key points are that the UK has not yet received an equivalence ruling from the EU, such a ruling is entirely at the EU’s discretion, and the EU can withdraw it at any time with little notice.

Equally importantly, there are no benefits to UK UCITS funds or market access benefits for UK life companies from equivalence. There may be some benefits in the future for investment managers and funds under MiFID and AIFMD but it’s not certain. A lot will depend on how much goodwill there is between the EU and UK when negotiations over a new deal finally end.

What happens if there is no deal?
 

A lack of a deal doesn’t automatically prevent the EU from granting the UK equivalence. The mechanism exists in current EU law and the EU can apply it to any third country. However, whether the EU chooses to apply it, and in which areas, will depend on what it thinks is in its best interests.

Some people have said we can fall back on WTO rules. However, WTO rules on financial services are even less help than equivalence, particularly for UK companies wanting to do business in the EU. In short, without a deal, equivalence is the best we can hope for, but it won’t happen automatically.

As a result, cross border activity is likely to become more expensive and administratively burdensome. Many companies will look at using different legal structures to continue to serve existing customers but it will become harder for UK firms to market into the EU.

The UK, on the other hand, is doing all it can to enable EU companies to manage and promote funds in the UK under its Temporary Permissions Regime (TPR).TPR allows EU firms and funds that already operate in the UK, including life funds, to continue doing so for up to three years, during which they can apply for full UK authorisation. Individual EU countries also have some regulatory discretion to set their own rules. For instance, Ireland and Luxembourg have said UK managers can continue to run funds in their jurisdictions for now.

As Paul explained, CMS can advise managers on the most appropriate fund structures for their business. In summary, the choices they face are set out in this table.

*UK managers are either setting up EU subsidiaries or ‘renting Mancos’.  

What do you need to know?
 

Trustees and consultants need to be asking similar questions to those in the table above: where is the fund established and how are relevant service providers authorised to manage the fund and promote it in the UK? They will need to be confident that their clients have invested with managers who have received accurate legal advice and have fully prepared for the change in regime. Should managers not have the necessary processes in place, they may fail to raise the assets they intend to, raising questions about their long-term commercial viability.

Adjustment is likely to be more of an issue for small boutique asset managers than for larger managers that already have a presence in both the UK and the EU. The challenge will vary depending on the product or service on offer (segregated discretionary fund, life policy, AIF or UCITs). That said, there are solutions to most of the problems.

One option for a UK firm is to set up a fully resourced and regulated AIFM or management company in the EU. However, the EU has been tightening its rules to prevent companies simply resorting to brass nameplates. As the Central Bank of Ireland has made clear, firms moving to Ireland must demonstrate sufficient ‘substance’ in the new office – including senior people on the ground.

That’s where firms like AMX can help. It provides a fully regulated door into the EU. This is a cost-effective way for asset managers to ensure they can continue serving their EU client base, and meet regulatory requirements.

What is AMX doing to prepare for Brexit?
 

Tammy explained that AMX’s UK entity could still market itself in the EU but that, like other UK firms, it would have to comply with a more complex, country-by-country, regulatory landscape. As such, AMX UK has strategically analysed individual EU countries where it would want to market its services and RAG rated each one. It is now applying for local licences where required in priority markets.

However, AMX Ireland is already set up as an AIFM and ManCo in Ireland, so is on the ‘right side’ of the rule book, including meeting the ‘substance’ requirements of having senior people in Ireland. As such, it can provide a ‘chaperoning’ and marketing service for UK asset managers that lack EU-based distribution. Alternatively, UK asset managers can choose to launch EU regulated funds on the AMX platform for distribution into the EU – and globally – see the high-level decision tree below for reference.

At the same time, UK investors can still access AMX funds as AMX Ireland has applied under TPR to continue marketing funds to professional investors in the UK. For more details for your firm or your clients, please get in touch. We can walk you through each of the options and help you select the most appropriate one.