Following the result of the UK referendum on 23 June 2016 to leave the EU, there is still a considerable amount of uncertainty about the impact of the decision on the financial services industry, including asset and fund managers.
As many commentators have pointed out, the Brexit vote was consultative and strictly has no legal effect, but provides an electoral mandate for the UK to leave the EU. However, the key step will be when the UK Government decides to trigger Article 50 of the Lisbon Treaty, and the timing of this is currently uncertain. There are also differing legal views over whether Article 50 can be triggered merely by exercising the royal prerogative power, or whether an Act of Parliament is required.
Business as usual?
UK based asset and fund managers are a significant part of the financial services industry with an estimated US$6.6 trillion of assets in the City of London invested by hundreds of fund groups. Given that there is a two-year period under Article 50 for the UK to negotiate its withdrawal from the EU, one view would be to take a "business as usual" approach. However, the impact of Brexit is already being felt on the fund management industry. Seven UK commercial property funds have announced that they are halting redemptions, and this has also impacted on the share prices of some leading fund management groups. The new FCA Chief Executive, Andrew Bailey, has indicated that the FCA will look at the structures of open-ended property funds, and whether these need to be changed. In the meantime, funds will be reviewing their redemption provisions, including rights to impose redemption suspensions or gates.
Despite these unsettling issues, routine compliance issues still need to be addressed. The AIFMD, MiFID and now the new Market Abuse Regulation (MAR, in force from 3 July 2016) must be complied with.
However, it is necessary also to consider the possible longer-term regulatory implications.
Impact on UCITS
The impact on UK-based UCITS funds could be significant. A UCITS fund can only be established in the EU, and will either be a 'self-managed' fund or will appoint a management company (ManCo). A UK-based fund with a UK manager would continue to be authorised in the UK, and its activities in the UK market would be unaffected. However, the fund would no longer qualify for the UCITS marketing passport. It would therefore (in the absence of a settlement with the EU which allows the UK to enjoy equivalent status) need to redomicile and obtain authorisation in another EU member state, so that it could continue to be recognised as a UCITS, and to benefit from the marketing passport. Similar considerations would apply to the ManCo needing to redomicile in another EU member state.
Where a UK UCITS fund did not redomicile and lost its UCITS status, it would be likely to be redesignated as an alternative investment fund.
Impact on Alternative Investment Funds (AIFs) and Managers (AIFMs)
The AIFMD regime is broader than the UCITS regime, and there are a number of different options in terms of EU AIFs and non-EU AIFs, UK/EU AIFMs and non-EU AIFMs. In the absence of a settlement with the EU, UK AIFMs managing an EU AIF will lose their EU passporting rights. A UK AIFM that wanted to market its funds in the EU would need to rely on the local national private placement regime (NPPR), or reverse solicitation (which is interpreted more strictly in some EU member states than others). Alternatively, the UK AIFM could opt to delay its marketing until the UK is evaluated and approved by the European Securities and Markets Authority (ESMA) for purposes of marketing into the EU. Commercial and marketing considerations are likely to make the second option less attractive. A third option may involve using an AIFM within the EU with delegation of some aspects of the fund management activity to the UK AIFM but in that case it would be necessary to keep within the limits of what the AIFM permits by way of sub-delegation.
Where a UK AIFM manages a non-EU AIF, it must currently, under Article 36 of the AIFMD, comply with many of the AIFMD requirements, with the exception of the depositary requirement under Article 21. If the UK left the EU, it would be open to the FCA to introduce a lighter private placement regime.
The marketing of a non-EU AIF in the EU would continue to be subject to the various local NPPRs, but as a non-EU AIFM, UK AIFMs as "third country firms" would need to comply with Article 42 of the AIFMD, which is a reduced regime focused on transparency requirements such as annual reporting and disclosure to investors.
Non-EU AIFMs managing non-EU-AIFs will by definition not be directly affected by Brexit, and will continue to market on the basis of NPPRs.
The UK has already opted out of the Directive on Criminal Sanctions for Market Abuse (CSMAD), and has its own criminal regime for insider dealing and market manipulation, therefore little will change in this regard. The UK, like the other EU states, has recently implemented MAR, and firms have been updating their policies and procedures. Asset managers will be advised to have tightened up their procedures on suspicious transaction reporting, insider lists and market monitoring. Given the two year transitional period for leaving the EU, this work will not have been wasted. In addition the scope of MAR relates more to financial instruments rather than entities. The development of MAR was significantly influenced by the UK market abuse regime, and therefore any post-MAR UK regime is unlikely to be significantly different. Therefore, we expect little to change on complying with the market abuse regime.
The management of individual client portfolios is a MiFID investment service, which normally requires authorisation under MiFID when the service is provided in an EU member state. Many UK fund managers use a MiFID passport to undertake services in other EU member states, including portfolio management.
MiFID II will introduce a new EU-wide regime for third country MiFID services, including portfolio management. It will be important to see whether the UK will fall under this harmonised regime for third country access to enable passporting to professional clients in EU member states.
MiFID II is not due to come into force until January 2018, and again, given the transitional period, is expected to be implemented in the UK prior to UK exit. The UK would also be well placed to meet any equivalence test following exit assuming MIFID II implementation takes place in the meantime.
Given current political uncertainties, it would be rash to make too many predictions for the future about what actions firms should be taking, other than at a high level. A number of possible post-Brexit models have been suggested, including following the Norwegian model based on becoming a non-EU member of the EEA and EFTA, the Swiss model based on bespoke sector-specific treaties and a Customs Union similar to the Turkish approach. However, it is probably fair to say that a solution which preserves passporting or something similar, based on an equivalence or recognition regime, would deliver a more favourable outcome than other options.
In the meantime, the prudent approach for asset and fund management firms will be to maintain a balance between "business as usual", combined with some strategic scenario and contingency planning, which may involve considering some re-location to other EU hubs.
Read more in our Global Financial markets insight issue