So, it happened. Last Thursday, the UK voted to leave the EU; officially making Brexit a thing. This is an outcome that many, especially in financial services, had hoped would not come to pass. However, as they say, we are where we are; so, we must start contemplating the ramifications of the UK leaving the EU. Up until now we have focused on how Brexit wouldn’t impact financial regulation but now we need to consider how it will.
The long-term impact of Brexit largely depends on the outcome of the negotiations regarding the nature of UK’s new relationship with the EU. How the UK will access the EU market post-Brexit is a major concern for the financial services industry and it could be at least two years, if not more, before we know the answer to that question.
At the moment there is considerable uncertainty on what the future relationship between the UK and EU will look like. We are entering uncharted territory as no country has ever actually triggered Article 50 of the Lisbon Treaty and attempted to leave the EU. The UK has indicated it intends to wait until it has a new Prime Minister before triggering Article 50, which is likely to be in October. In the meantime, countless meetings amongst various policymakers, on either side of the English Channel can be expected.
Brexit could have the largest impact on financial passports and asset managers will need answers to three big questions in post-Brexit negotiations.
- Will cross-border management companies still be allowed in the UK?
UCITS management companies oversee the operation of UCITS funds and act as the central coordinator of all service providers. Since UCITS 4 came into effect in 2011, managers can use cross-border management companies to operate and oversee funds in multiple jurisdictions. For example, an asset manager can use a Luxemburg management company to oversee both its Luxembourg and UK UCITS funds.
The question is in a post Brexit world will cross-border management companies still be allowed to oversee UK funds? And will UK management companies be able to oversee funds in other EU countries? If not, asset managers will have to bifurcate their cross-border management companies and create one for the UK and one for the EU. This will involve extra costs and inefficacies for asset management firms, as they will lose out on economies of scale.
- Will UK based managers still be able to use MiFID permissions to sell into EU?
The MiFID (Markets in Financial Instruments Directive) regime has a wide scope that includes portfolio management, execution, and investment advice. Under MiFID, firms are able to passport their permissions and provide financial services across the EU. Typically, many asset managers have established their MiFID firm in the UK and then used the passport to sell their products across the EU. Brexit raises the possibility that this may no longer be possible.
The potential impact of the loss of the UK’s MiFID passport will really depend on the asset manager’s scale. Many large asset managers already have offices in other EU countries. So, for them it will be a matter of moving the MiFID license to an EU entity, which may also require the movement of some functions to appease local regulators and ensure the MiFID license is not merely a “brass plaque”. While certainly inconvenient, this may not be overly disruptive.
For smaller managers, who only have offices in London, the loss of the UK’s MiFID passport could be much more disruptive. Many US and Asian asset managers who don’t have another EU office to rely on, will be forced to establish a new office within the EU. The question then becomes do they need to maintain a UK presence or should they completely decamp to other countries in the EU?
- Will reciprocal access remain between the UK and EU markets?
Perhaps the biggest threat that Brexit poses to asset management is to the UCITS passport. Currently, UK UCITS funds can be sold freely across the EU and EU domiciled funds, typically from Ireland or Luxembourg, are allowed to be freely sold into the UK. The big question is whether this reciprocity will continue in a post-Brexit world?
The EU classifies the fund world into two categories: UCITS and everything else. And everything else falls under the AIFMD framework. If UK UCITS funds are not granted access to EU investors, they will then be classified as “alternative” by EU rules and governed by the AIFMD framework. This classification could have a huge implication on distribution because alternative funds cannot be sold to retail investors. If formerly UK UCITS funds are denied access to the EU, then the question becomes will EU UCITS be allowed to continue to be sold to UK investors?
If the reciprocal fund passports do disappear, it will force asset managers to assess their fund ranges. For managers who use Ireland or Luxembourg funds, they will need to consider if they want to set up UK domiciled funds in order to pursue UK investors. While managers with UK funds will need to decide if they want to set up EU domiciled funds to pursue EU investors. In the long run this could lead to the UK being viewed as an entirely domestic market. Some managers, who can no longer access the UK via their cross-border funds, may abandon the market completely, leaving UK investors with fewer investment choices.
While Brexit will have many other economic and political implications, these are the three key decision points that could have largest impact on asset management. The immediate challenge is that it doesn’t seem there will be any clarity on what the UK’s future EU relationship will look like anytime soon, leaving the industry in limbo; which will have a direct impact on the growth of the UK asset management industry.
For new managers thinking about coming to Europe, the uncertainty will certainly give them pause. Pre-Brexit, London would be the natural choice for asset managers looking to establish a European presence. Now, that is no longer necessarily the case. After all, why set up a London office it you may not be able to use the passports to access the EU market?
It is quite possible that these passport issues will be resolved in the exit negotiations and that there will be very little change to the status quo. Nonetheless, it wouldn’t be the worst idea for asset managers to start drafting a Plan B, just in case.