Although the outcome of the Brexit negotiations remains uncertain, there’s less doubt that it will affect access to the AIFMD passport.
Last time we discussed Brexit, it was to refute the idea that the UK will lose access to the UCITS passport as a result of the referendum. But what about the AIFMD passport, the other major EU product passport for “alternative funds,” such as hedge funds, private equity, and private debt funds? Unfortunately for the denizens of Mayfair, it is clear that Brexit will cause the UK to lose access to the AIFMD passport.
Contrary to UCITS regulations, AIFMD directly regulates alternative asset managers and indirectly regulates alternative funds. As a result, there are specific provisions in the AIFMD that apply to EU and non-EU AIFMS (Alternative Investment Fund Managers). This means that when the UK does officially part ways from the EU, UK AIFMs will go from being EU AIFMs to non-EU AIFMs and this change in status has two key consequences.
The first consequence of becoming non-EU AIFMs is that UK managers will have to be regulated by an EU regulator. All non-EU AIFMs must be authorized by the EU regulator from the “Member State of Reference”. Under the terms of the AIFMD, the Member State of Reference is the EU country where the manager intends on selling the majority of its AIFs (Alternative Investment Funds). For example, if Germany is the primary market for a manager’s funds, then it must get authorization from BaFin. Of course, in addition to the Member State of Reference, UK asset managers will also continue to be regulated by the FCA. Bottom line: post-Brexit, UK managers selling alternative products in the EU will end up with additional regulatory oversight.
The second consequence of becoming a non-EU AIFM is that UK hedge funds will ultimately lose access to the AIFMD passport as it is only available to EU managers and EU funds. So, even if an UK manager has an EU fund, when it becomes a non-EU AIFM it would lose access to the passport. Without access to the passport, managers will have to rely on various national private placement regimes to sell their products in the EU.
In order to get access to the AIFMD passport as a non- EU AIFM, the UK would need to be granted an “equivalence” ruling from the EU Commission, Council, and Parliament. On the face of it, this should be pretty straightforward since the UK has already transposed the AIFMD in to UK law. Assuming there is no post-Brexit regulatory bonfire (and we’re already on the record as being dubious of this idea), it would be hard to argue the UK did not have an equivalent regulatory environment. However, as we have seen, extending the AIFMD passport is not as easy as it seems. At the moment, a non-EU country has yet to be granted access to the AIFMD passport. Depending on how the divorce proceedings go between the UK and EU, it is not hard to envision the EU dragging its feet on granting AIFMD equivalence to the UK.
While losing access to the AIFMD may not seem significant now, sooner or later not having access to the AIMFD passport will become an issue for UK managers. In 2018 the EU is going to look at abolishing private placement all together. When this becomes the case, UK managers are going to have to make some decisions. If it appears that the UK is on course for an ugly breakup from the EU, then firms may want to consider establishing a presence in the EU. Similar to the issues we discussed previously around the MiFID and Management Company Passport, this would involve setting up a new AIFM entity in an EU country to ensure that UK managers would continue to have access to the passport. However, it is still unclear how much substance the EU member state would require of the AIFM and how much activity could remain in the UK.
For the time being, there is no immediate action that needs to be taken. Until the exit negotiations are completed, the UK hedge fund managers will continue to be EU AIFMs and have access to the passport. However, there’s little harm in planning for a world where they won’t have access to the AIFMD passport.