What A No-Deal Brexit Would Mean for Asset Managers

Once thought of as a politically motivated scare tactic within the Brexit debate, as the clock counts down to Brexit day, a no-deal Brexit is becoming a real possibility. Here’s what asset managers need to know: 

The UK government has released the first in a series of Brexit Papers advising the financial services industry of various consequences if there’s a no-deal Brexit. If any area of the negotiations is vulnerable to disruption from a no-deal scenario, it’s financial services and in particular, cross-border funds that rely on passporting rights. Asset managers, currently working on their contingency plans, should continue to prepare for each possible scenario.

Known Unknowns

A no-deal Brexit is often referred to as “the cliff-edge.” This scenario may come about in one of two ways. The next major step in the Brexit process, the EU summit, is set for October, however both sides can’t even agree on that. In a radio interview this weekend, UK cabinet minister David Lidington said he believes the summit could slip into November if necessary. Meanwhile, just last week the EU’s Michel Barnier said talks must be wrapped up “certainly not later than the beginning of November.” A no-deal could happen if the negotiating parties at the fall EU summit agree to a deal, but then it’s rejected by the UK Parliament or the Member States. In this event, there is a second chance at gaining agreement at an EU summit slated for December, still requiring approval from the UK Parliament and ratification from all 27 Member States. This vote is anything but a formality, with heightened concerns over previously “leave” constituencies that now are leaning towards “remain” and opposition parties who will likely view the vote as a political opportunity. If the two-year Article 50 process comes to an end without an agreement, the UK would leave the EU on 29 March 2019 without a deal in place. With just over six months to go, and no signs of firm agreement thus far, a no-deal Brexit is a very real possibility.

Reality Bites

In the event of a no-deal Brexit, many areas of the economy have existing global rules and can fall back on bilateral agreements. For example, when it comes to trade between the UK and the EU, World Trade Organisation tariffs would apply. However, the UK financial services sector was largely constructed based on the EU passporting regime, EU Directives, and branch permissioning. The industry would be left with several uncertainties until both sides agreed on an arrangement. At this point in time, there is no published plan for what happens if an October or December deal is rejected by one side or the other.

If UK asset managers do not have funds set up under EU-domiciled management companies, any existing UCITS funds will revert to AIFs and they will not be permitted to passport into EU Member States. These restrictions would also apply to EU managers wanting to trade in the UK. A no-deal Brexit is a two-way street with losses on each side.

Possible scenarios are:

Brexit Equivalence Impact

If a Brexit deal is possible, we’re likely to see it take a shape similar to one of three existing models:

The Norway model – Norway contributes to the EU budget and adheres to the EU rules and regulations. However, there is misalignment because the financial services sector is required to follow rules and regulations even without influence and engagement on shaping those rules because they lack EU membership.

The Switzerland model – Switzerland contributes to the EU budget, but it’s a smaller amount than within the Norway model. Switzerland must adhere to some of the EU rules and regulations. This model is considered attractive given its lower EU budget contribution however, the challenge remains where the industry is bound by rules and regulations over which it has no influence.

Customs Union or Turkey model – The Turkey model, also known as the customs union, includes an agreement for no tariffs or quotas on exported industrial products, but that only applies to goods, not services. This may seem attractive to the wider UK economy but would leave the financial services industry without EU market access.

Possible models post Brexit

Brilliant Brexit

Whilst focus has remained on retention and continuation of seamless EU access to the best extent possible, if the time horizon of Brexit is extended, it is irrefutable to suggest that the UK as a financial center will look to leverage its existing global role. The fact that the UK will be free from the EU regulatory Trilogue approval process means that it may be able to frame a more nimble and flexible regulatory environment in several key areas.

1. OEICS Recast as “UCITS Lite”

Many open-ended investment companies (OEICs) operate based on UCITS regulations. It’s possible for UK OEICs to retain many of the factors that investors covet in UCITS, such as high corporate governance standards, independent depository oversight, whilst allowing more flexibility in parameters elsewhere. For example, a “UCITS Lite” product might have less stringent investment concentration rules, allow higher proportions in specifics holdings, allow greater leverage or borrowings upon discretion of the board, and also lighten the stringent remuneration provisions on the asset managers of such funds. These discretions may reduce fund costs and increase returns in a market where these components are increasingly important.

2. Commonwealth Funds Passport

The British Commonwealth is made up of 53 independent and voluntary member states dispersed across the globe and are mainly countries which previously formed what was known as the British Empire. With the UK leaving the EU, it needs to forge new alliances and perhaps leverage historic ties.

Among Commonwealth members are some financial heavyweights (Australia, Canada, India, New Zealand, and South Africa) as well as certain rapidly developing nations showing high growth and savings rates spread across Asia, Africa, and the Americas. The crown dependencies of Jersey, Guernsey, and Isle of Man as well as larger autonomous territories such as Cayman Islands and Bermuda are financial centres of note that the UK can leverage to a much greater degree outside of the EU than within.

It’s also worth noting that many of the Commonwealth states are similar in terms of legal basis and systems of business to the UK, so it’s not inconceivable that the UK could coordinate a passport fairly quickly.

3. Alignment of UK with US Clearing standards

There has been significant debate about the appropriateness of retaining Euro clearing in the UK post-Brexit. But there is a wider debate between the US and the EU regarding clearing standards. The CFTC, the US OTC and clearing regulator has grown increasingly agitated with the EU as it tries to harmonize the rules to the benefit of global trade. The EU does not consider many US central clearing counterparties to be “equivalent,” causing issues for US OTC brokers wishing to trade with EU counterparties. The EU has proposed significantly enhanced requirements on the supervision of third-country CCPs. The CFTC said they believe this “unilateral change by EU authorities to the CFTC-EC Equivalence Agreement to be a violation of trust and cooperation between the US and Europe.”

In a post-Brexit world, the UK would be free to move its rules to match that of the largest OTC trading bloc (the US) to foster increased activity between both countries on trading (likely to include Europe also) rather than try to appease the EU solely.

Here’s a look at some key Brexit dates:

Brexit timeline