It’s been three weeks since the UK voted to leave the EU and, quite frankly, the situation has not become any clearer. We still don’t know exactly when the UK plans on triggering Article 50 of the Lisbon treaty, to formally start the process of exiting the EU. At the same time the remaining EU states, dubbed the EU 27, have made it clear that there will be no negotiations, formal or informal, until Article 50 is triggered. So, for the time being, we’re at a bit of an impasse.
As we sit in this uncomfortable holding pattern, the industry has started to let its imagination run wild. A recent story in the FTfm even claimed “Brexit: Leaving the EU threatens fund passport”.
Some lawyers and analysts fear that the City will be damaged by the loss of “passporting” privileges that allow UK financial institutions to access the EU single market without restrictions.
Most UK asset managers have bases in Luxembourg or Dublin for their mutual fund ranges and will — in theory — still be able to sell these funds, known as Ucits, to the EU market after Brexit.
That is not a foregone conclusion, however. Haley Tam, an analyst at Citigroup, the bank, in London, says Brussels could choose to introduce tougher rules that would require funds domiciled in Dublin and Luxembourg but run by UK managers to be subject to more onerous rules.
While Brexit certainly isn’t good news for UK asset management, there is no immediate threat to UK managers’ Irish and Luxembourg UCITS funds.
The UCITS Passport is Different
The purpose of the UCITS framework was to create a single market for collective investment funds. The term “UCITS passport” refers to the fact that any authorized UCITS in one EU country can be sold freely into another. Asset managers typically use either Ireland or Luxembourg as domiciles for their UCITS funds and then sell them across Europe (and, indeed, the world).
The big difference between the UCITS passport and other financial service passports, like MiFID, is that UCITS is regulated at the fund level, not the manager level. This is a crucial point and means that the math around Brexit and the UCITS passport is very different. Local regulators are responsible for approving UCITS funds and unlike, for example the AIFMD, in the UCITS framework there is no distinction between “EU managers” or “non-EU managers.”
If Brexit results in the UK losing access to the EU market, UK managers will simply go from being EU managers of UCITS funds to a non-EU manager of UCITS funds, which will have no impact on their Irish and Luxembourg UCITS passports. In this way, they will join managers in New York, Hong Kong, and Melbourne who all manage and distribute UCITS across the EU. Bottom line, the UCITS passport has nothing to do with the domicile of the asset manager and is based solely on the domicile of the UCITS fund.
Substance Requirements Already Exist
The UCITS framework contains no rules around required substance in order to get the UCITS passport. All substance requirements are determined by the local regulator, who decided what the appropriate level of governance and oversight is for the UCITS funds it authorizes. Here again, Ireland and Luxembourg both have existing requirements around fund convergence, which include, to some degree or another, local substance requirements. In fact, just a few weeks ago, we discussed Ireland’s plans to increase its fund governance substance requirements.
The substance requirements apply to UCITS managers, regardless if they are from London, Frankfurt, or Kuala Lumpur. So, much like the UCITS passport itself, the UK losing access to the single market will have no bearing on its substance requirements in either Ireland or Luxembourg.
Changing UCITS Framework Isn’t Easy
The worry of some is that the EU 27 may look to punish the UK post Brexit and introduce new UCITS rules to inhibit the UK from accessing UCITS. While it is possible, if not likely, that the UK EU divorce proceedings may be ugly, this doesn’t mean that the UCITS framework can be unilaterally altered. Introducing the concept of the EU vs non-EU managers or EU-wide substance requirements would require a change to the UCITS framework. This is not a speedy process, to the say the least. It took nearly six years for UCITS 5 to become a reality.
Even if there were factions who would like to see the UK’s UCITS access restricted somehow, they would surely face stiff resistance from Ireland, Luxembourg, and the Netherlands. Any attempt to make these substantive changes to the UCITS framework would be the subject of intense debate. Overall, UK asset managers have a lot of things to worry about when it comes to Brexit but, for the time being, the loss of the UCITS passport isn’t one of them.