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Businesses and their internal and external lawyers face a mixture of challenge and opportunity in the wake of Brexit, with access to markets concerns high on fund managers’ agenda. Tom Dunn and Anna Davis, of Burges Salmon, assess where change will be felt most keenly.
The UK economy is expected to experience continued uncertainty and volatility both prior to and post the triggering of Article 50 TEU. For fund managers, this carries with it the risk of capital outflows from their funds, such as those witnessed in the aftermath of the referendum result which forced many property asset and fund managers to suspend withdrawals by investors and/or invoke gating mechanisms.
Such decisions create legal and reputational risk (in particular where competitors are not doing the same) and we have identified a number of key strategic steps that managers who are worried about outflows should consider. In the first instance, policies for handling suspensions and the gating of redemptions should be revisited and updated where appropriate. The directors of the fund/fund managers are ultimately responsible for any decision to suspend or gate so they should be involved in this process. Consideration should be given to applying fair value pricing where this is appropriate. Fund managers should be following recent Financial Conduct Authority guidance issued on 8 July 2016 and watching out for new regulatory developments in this area (eg regarding open ended property funds). Above all, fund managers should ensure they protect and treat fairly both redeeming and remaining investors, and maintain open lines of communications with their investors.
As an overarching concept, adopting EU law directly into UK legislation appears to be a practical approach—it initially gives short-term certainty then allows the UK to make unilateral changes over time.
Over the longer term, fund or asset managers who undertake little or no cross border activity may wish to lobby for change to the relevant UK legislation, wanting to see it more closely aligned and tailored to the UK marketplace.
There are implications of a divergence from EU law however—other asset managers for whom cross-border activity forms a key part of their business will want to see a UK legislative and regulatory regime that provides the best chance of being awarded ‘equivalency’ status by the European Commission in certain key areas.
Striking the right balance here is therefore an important challenge post-Brexit and one that firms and their lawyers can be reflecting on now.
A ‘hard Brexit' (where the UK fails to achieve any special status in the post-Brexit EU and therefore becomes a ‘third country’ for the purposes of EU legislation) would have a significant impact on UK fund managers marketing UK funds into other EU Member States, or those managing funds domiciled in other EU Member States. The key issue, of course, is the loss of ‘passporting’ rights into the EU—that is, the ability to carry on certain activities in another Member State on the basis of the firm’s home state authorisation (and subject to equivalent regulatory requirements). The impact of this varies depending on the EU Directive which affords the passporting rights.
The Undertakings for Collective Investment in Transferable Securities Directive 2009/65/EC (UCITS) schemes can be marketed to retail investors throughout the EU (references to the EU are intended also to cover the EEA since passporting rights apply across the EEA where the relevant EU legislation has been incorporated into the Agreement on the EEA). To qualify as UCITS scheme, the scheme must be domiciled in the EU, managed by an EU manager and have an EU depositary (which was established in the UCITS’ Member State). This means that in the event of a hard Brexit, UK domiciled UCITS would lose their status as UCITS schemes and UK management companies would no longer be able to manage UCITS schemes in other Member States. UK domiciled UCITS would become non-EU alternative investment funds (AIFs), which cannot be marketed to retail investors in other EU Member States (see below).
In this eventuality, it would be possible to restructure UK domiciled schemes to ensure they keep their UCITS status. The scheme would need to be domiciled in the EU with an EU manager and depositary appointed. Investment management can (currently) be delegated outside of the EU (eg back to UK), subject to certain conditions. For UK firms who manage UCITS schemes in other Member States, it would be possible therefore for investment management to be undertaken by the UK firm as a delegate of an EU manager instead.
For those UK UCITS that are currently marketed exclusively to UK investors it is likely the change of status will have little impact.
Broadly, AIFs are collective investment schemes that are not authorised as UCITS. EU AIFs—where managed by full-scope alternative investment fund managers (AIFMs)—may be marketed to professional clients. Full-scope AIFMs may also manage AIFs established in other Member States.
In the event of a hard Brexit, UK domiciled AIFs would become non-EU AIFs which could not be marketed in the EU under the current the Alternative Investment Fund Managers Directive 2011/61/EU (AIFMD) passport. AIFMs would no longer be able to manage AIFs in other Member States.
As with UCITS, portfolio management can (currently) be delegated instead to a non-EU management company, subject to certain conditions, so it may be possible to restructure the AIF and AIFM into the EU and delegate portfolio management into the UK.
UK AIFs could only be promoted to EU clients on a private placement basis (and only providing that a number of conditions in the AIFMD are satisfied). Each Member State will have a different national private placement regime (NPPR) so UK AIFMs would have to comply with each Member State’s regime on a case-by-case basis.
Under the Markets in Financial Instruments Directive 2004/39/EC (MiFID), UK investment firms can carry on investment services and activities in other EU jurisdictions, either cross border or by establishment of a branch, on the basis of their UK authorisation.
In the event of hard Brexit, UK firms would no longer be able to make use of their MiFID passports, and would need to establish an authorised subsidiary in each Member State in which they undertake MiFID services or activities, or otherwise obtain local legal advice confirming whether their existing activities would fall under any exemption in the relevant jurisdiction. To compound matters, there are considerable local law differences around issues such as the place of supply of such services, the location of the client and the regulation of marketing. Local legal advice in each host jurisdiction is therefore likely to be needed on an initial and ongoing basis (to notify the firm of applicable regulatory changes etc).
Third country passports
Some EU legislation contains mechanisms for allowing firms based in jurisdictions outside of the EU (third countries) to gain access to EU markets through a third country passport. Often this is contingent on the third country’s regulatory regime being deemed to be equivalent to that of the EU. While in theory the UK regime should be technically equivalent at the point of Brexit, the determination of equivalence can be a lengthy process and subject to political considerations. The extent to which the UK regime will remain equivalent following Brexit is also uncertain (as outlined above).
There is currently no mechanism allowing third country passporting in UCITS. AIFMD does envisage extending passporting rights for both the management and marketing of AIFs in the EU by third country firms. However, the provisions are not active yet. One of the conditions of non-EU AIFMs being able to use such passports is the deemed equivalence of their home state regime by the EU Commission. The European Securities and Marketing Authority (ESMA) gave advice and opinion to the Commission in September 2016 on a number of non-EEA jurisdictions, they are:
The Commission is currently considering whether to activate the third country passport provisions for these jurisdictions (by means of a delegated act).
There is currently no mechanism allowing third country passporting in MiFID. However, Directive 2014/65/EU (MiFID II), which will amend and replace MiFID from 3 January 2018, will introduce two new third country passports for firms providing investment services in certain circumstances:
Fund managers and their lawyers can usefully be carrying out contingency planning now. We suggest that firms undertake an impact assessment of hard Brexit to their firms and take practical steps to address the management of capital outflows during this uncertain period as outlined above.
Those firms with UK funds marketed into Europe, or those UK firms managing European funds, can be coming up with contingency plans now based on what they would do should the UK fail to achieve any special status in the post-Brexit EU. Of course it is also worth considering how Brexit is likely to affect firms’ key competitors (eg those marketing to UK investors or managing UK funds from other EU jurisdictions) and whether any opportunities might arise.
It is worthwhile now for firms to consider whether there are any aspects of current legislation or regulation that cause particular difficulties. This may be of particular relevance for firms who undertake primarily or exclusively UK activity, where the benefits of equivalence with EU law are likely to be less important.
These are all areas on which firms may wish to lobby the UK government and other key stakeholders as the process towards and beyond Brexit progresses. Firms should be engaging with the industry and industry bodies to get intel and to feed in their views and the impact on their business.
Finally and importantly, firms should be considering whether any immediate communication and reassurance can and should be given to their clients.
Interviewed by Julian Sayarer.
The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.
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