Brexit is no simple break
• The implications of the UK’s EU departure will be complex and wide ranging for asset managers
Will Brexit raise high barriers?
I have found myself talking about Brexit a lot since the referendum result in June 2016. However, despite the many Brexit headlines, speeches and talks about talks, the state of play has not changed much in the last 24 months. The UK has secured an agreement that there needs to be a transitional phase, which in effect will extend the date of Brexit from March 2019 to end-2020 or beyond. But asset managers cannot wait until the end before deciding what to do. They are already ‘Brexit proofing’ their businesses by setting up EU27 hubs able to continue servicing EU clients regardless of what the final trade agreement looks like.
In the early days after the referendum there was much talk about attempts by other European national regulators to attract UK-based firms to relocate activities. Partly as a result of this, last year the Financial Conduct Authority (FCA) asked the UK’s biggest asset managers for information on how they are preparing for Brexit. Following those submissions, the FCA announced plans to create an asset management hub to support new entrants to the UK fund space, in particular with regard to the various regulatory hurdles.
The hub will help start-ups through the pre-authorisation and authorisation procedures by means of a ‘user-friendly’ support system. The first phase of the programme was launched in late 2017, with start-ups offered pre-application meetings and dedicated case officers. The regulator plans to expand the service, providing quarterly surgeries and online booking for pre-application meetings.
In late 2017, the UK government vowed to ensure UK-based asset managers can continue to offer UCITS-like funds after Brexit. In a report, the UK Treasury said it sought to improve the outlook for the £8.1trn (€9.2trn) UK asset management industry to ensure it remains competitive.
An asset management taskforce comprised of chief executive officers and other stakeholders is meeting on a quarterly basis until October 2019.
Brexit’s impact on Europe
For other European member states, Brexit is not all about stealing market share from the UK. Many in Europe are carefully considering what ramifications Brexit could have on the many efforts that are being made to bolster competition across European investment markets. Most market participants are agreed that Brexit needs to be managed well to ensure vital market structure and capital market flows are not damaged.
While the investment landscape post-Brexit is as yet unclear, it is apparent that the ramifications of Brexit will be far wider than a simple break between the EU and the UK. Several MEPs are calling for a fundamental review of the different third-country rules in EU legislation, for example. The outcome could have a significant impact on the UK’s ‘equivalence’ status post-Brexit and that of all other non-EU/EEA countries.
Last year we looked at the complex issue of how UCITS, AIFMD and MiFID passports are likely to work post-Brexit. Our analysis – undertaken in 2016 – still holds true. However, in May 2017 the European Securities and Markets Authority (ESMA) issued an opinion on principles for the supervisory approach to the relocation of activities from the UK to elsewhere in the EU, followed in July 2017 by more detailed sector-specific opinions. From these, a further and significant issue has arisen: the future regulatory approach to delegation.
ESMA says that no reliance should be placed on firms’ existing authorisations and there should be no derogations or exemptions. It adds that regulators should consider carefully their ability to assess documentation presented in a foreign language without appropriate translation.
ESMA also published a letter from Steven Maijoor, ESMA’s chair, to vice-president Valdis Dombrovskis, inviting the Commission to consider extending its proposed enhanced approach for the recognition of third-country central counterparties to other entities. This intervention further underlines that the EU’s evolving approach to third countries is a business risk for firms around Europe and elsewhere as Brexit approaches.
Delegation debate heats up
The European Commission says that “the future departure of the EU’s currently largest financial centre means that supervisory arrangements must be strengthened to ensure that financial markets continue to support the economy on an adequate and sound basis”.
The Commission proposes to mandate ESMA to review the arrangements of firms that intend to make extensive use of delegation or outsourcing to third countries. It would amount to second-guessing national regulators’ views and has moved to centre stage the practice of domiciling a fund in one EU member state and delegating the investment management function to the UK.
The Commission notes that current supervisory practices vary from one member state to another. It argues that this gives rise to regulatory arbitrage, or a race to the bottom, with firms benefiting from the EU passport while essentially performing substantial activities outside the EU. It also exposes the EU to financial stability risks, it says, particularly where the third country’s supervisory authorities lack the necessary tools to supervise those activities.
It is proposed that where a firm intends to delegate or outsource a material part of its activities or any of the key functions to a third country, the national regulator must notify ESMA, providing sufficient detail to enable it to make an assessment. ESMA has up to two months to issue an opinion. If the national regulator chooses not to follow ESMA’s view, the EU authority must make its view public. It therefore seems unlikely that a national regulator would go against ESMA’s opinion, as the firm could face reputational risk.
ESMA has sought to reassure the industry. Its chair, Steven Maijoor, said in March 2018: “We are not looking to question, undermine or put in doubt the delegation model. We know that this is a key feature of the investment funds industry and that the flexibility to organise centres of excellence in different jurisdictions has contributed to the industry’s success.”
Neither is there is any indication that ESMA’s new powers would be applied retrospectively, but it looks like the detailed rules on delegation under the AIFMD will be extended to UCITS. The Commission has said the lack of harmonisation between the two directives makes it challenging to interpret the two directives “with the same spirit”. It indicated that it was open to the idea of creating stricter rules on delegation to the UCITS directive too.
A UK question, a global issue
Brexit is not just about the future of London, as a financial hub for the UK-based investment and fund management industry. It is about what this means for other EU member states – EU27 – and elsewhere.
Until now, most business in and out of the UK has taken place via EU regulatory passports – UCITS, AIFMD or MIFID II. The loss of one or more of these passports would have varied implications in the retail and professional market places right across Europe and, indeed, the globe.
Julie Patterson is director, asset management regulatory change, at KPMG