Should UK investment managers be despondent about Brexit?
By Peter Astleford, Partner and Co-Head of the Global Financial Services Group, Dechert
Published: 12 July 2017
For someone who voted against, Brexit can be a scary thought. In our area, how will UK managers maintain and improve their fee flows from European investors post Brexit? Let’s look at the facts. UK managers receive their fees from, broadly, managing UCITS and specialist funds and individual investor accounts. What are the Brexit risks to these revenue streams?
Fees from European retail funds (“UCITS”) - UK managers generally target European investors through UCITS established in Dublin and Luxembourg (the “EEA Gateways”). These funds have an EEA marketing passport and are managed in the UK. This is set to continue after Brexit.
Fees from specialist or alternative investment funds (“AIFs”) - Historically, many AIFs sold into the EEA were based in tax havens. For various commercial, tax and legal reasons, European based funds are now in the ascendancy. In general, these AIFs have an EEA marketing passport to sell to professional investors and are managed in the UK. This will also continue after Brexit.
I should add that while the Alternative Investment Fund Managers Directive (“AIFMD”), provides a mechanism for non-EEA funds to access the EEA, this is likely a red herring for the UK. No implementation of this mechanism is expected soon. Consequently, continuing to work through EEA Gateways is more realistic.
Fees from individual investor accounts – Lastly, UK managers access individual European investors directly via segregated accounts utilising a further European directive, the Markets in Financial Instruments Directive (“MiFID”). MiFID will be replaced by a second version (MiFID 2) prior to Brexit. Thereafter, non-EEA managers will, for the first time, be able to register with the new EU regulator (ESMA) to access European professional investors.
As a result, the three routes to access European investors should remain largely unchanged.
As ESMA could be slow to register UK managers, I recommend managers keep their European plans under review for future political developments. For example, a new manager or marketer could instead be established relatively easily elsewhere in the EEA assuring continued investor access. My only concern here is that a perception of excess competition amongst some EEA countries to attract UK businesses may lead to tighter EEA rules; A first pronouncement is already out there. Planning will also be required to cover UK registered sales staff that target Europe.
Other Incidental Issues – While fees should remain secure, some changes will be required. At present, UK managers can passport their operations into the EEA and vice versa. These reciprocal rights will disappear. As such, UK managers should seek European authorisation for any European branches and vice versa.
Equally, European based funds “operated” from the UK by a UK regulated manager will need to set up alternative arrangements. There are tried and tested routes to achieve this that will allow investment management fee income to continue to flow to the UK.
Conclusions - The next sixteen months (the likely negotiation period if any agreement is to be ratified in time) is probably insufficient to document a comprehensive agreement. More likely is a transitional arrangement allowing more time for definitive documentation while avoiding a “cliff edge”. A transition process will mean that business can continue (albeit while struggling to cope with the welter of existing regulatory changes not to mention the latest FCA "final" asset management report).
As outlined above, a hard Brexit should only require change “at the edges”. Remember, US managers already have significant access to the EEA market on a similar basis. Wholesale changes to those arrangements would be to the detriment of the EEA Gateways, European financial services businesses and investors. Meanwhile there are lots of opportunities for UK managers to find clients elsewhere.
In conclusion, the future looks good overall for a continuing UK and European industry that has seen the value of its open-ended regulated funds rise from euro 6.2 trillion in 2008 to over euro 14 trillion. Managers can get on with business. Those frozen in uncertainty will have only themselves to blame.
To contact the author:
Peter Astleford, partner and co-head of the global financial services group at Dechert LLP: [email protected]