Although the UK is set to secede from the EU in less than a year, there is very little which can be ascertained with definite certainty. The Financial Services Industry is probably the industry which stands to gain or lose the most in this political squabble.
Many are viewing this issue as the EU’s ultimate bargaining chip, however a number of political parties in the UK have staunchly reiterated the view that the UK’s future is outside the customs union. This stance would not only have adverse effects on the financial centres located in the UK and the EU, but also on third party financial centres which have relied on London to passport their products into the EU, including New York and Japan. Should this route be taken, the EU will lose the UK’s portfolio management expertise, but stands to gain significantly in terms of skilled migration.
Before this historic leap, asset managers should prepare themselves and explore potential routes that may very well become their reality in less than a year.
EU Commission Notice to UK Asset Managers
On 8th February, 2018, the European Commission issued a notice to stakeholders regarding the withdrawal of the UK and how this will impact the field of asset management. In this notice, the Commission highlighted that since there are still a number of uncertainty, most notably with the content of the possible withdrawal agreement stakeholders, including managers of investment funds and investors were reminded of legal repercussions which need to be considered when the United Kingdom becomes a third country.
Subject to any transitional arrangement that may be contained in a possible withdrawal agreement, as of the withdrawal date, the EU rules in the field of asset management, particularly the UCITS and the AIFM Directives no longer apply to the United Kingdom.
This will bear a number of consequences for UK asset management companies, most notably the loss of the so-called ‘EU passport’. UK asset managers will be treated as third-country AIF managers and thus will no longer be able to manage and market funds in the EU.
• UCITS investment funds and their managers will need to be established and registered or authorised in the EU to manage and market funds to retail and professional investors across the Union.
• AIF managers need to be established and authorised in the EU to manage and market AIFs to professional investors in the EU.
Consequentially, all Collective Investment Schemes which are registered or authorised in the UK will become non-EU alternative investment funds.
This applies to:
Undertakings for Collective Investment in Transferable Securities (UCITS)
- Alternative investment funds (AIFs);
- European Venture Capital Funds (EuVECA);
- European Social Entrepreneurship Funds (EuSEF);
- European Long Term Investment Funds (ELTIF); and
- Money Market Funds (MMF).
Individual member states may opt to allow AIF managers who are not established and authorised in the EU to market EU and non-EU AIFs inly in their territory under the so-called National Private Placement regimes (NPPR), in line with the Alternative Investment Fund Managers (AIFM) Directive (Directive 2011/61/EU). It is at the discretion of each member state to activate NPPR and allow for stricter rules in addition to the minimum requirements contained in the aforementioned directive.
UCITS Management Companies and AIF managers authorised by any of the 27 national authorities which are subsidies of entities established in the UK may continue to operate on the basis of their authorisation as UCITS management companies or AIF managers in any of the 27 Member States, so long as they are legally independent companies which were established in the Member States.
Branches of UK managers which have a permanent presence in the EU, but which are not legally independent from the AIF manager will be treated as branches of a non-EU AID managers as of the date of withdrawal onwards, and will be subject to the requirements of NPPRs, where available.
UCITS and AIFs authorised or registered in the UK will be considered as non-EU AIFS, therefore EU UCITS management companies managing schemes which were formerly UK-authorised UCITS will need to obtain an authorisation according to Article 6 of Directive 2011/61/EU to manage non-EU AIFs.
AIF managers which are established and authorised in the EU and that manage non-EU AIFs which are not marketed in the EU will need to comply with the AIFM Directive, save for depositary and annual report rules. They will also need to adhere to cooperation agreements for exchange of information between EU competent authorities and the relevant third country authorities.
How will Brexit affect asset managers vis a vis their investors
In line with the rules on disclosure to investors, in line with the AIFM Directive and the UCITS directive, UCITS management companies and AIF managers will need to undertake a number of steps to inform investors of the consequences of Brexit.
AIFMs will be required to:
• Include any material changes in the annual report to the information to be disclosed, including new legal implications of their contractual relationship
UCITS Management Companies will be required to:
• Prepare a Key Investor Information Document whose essential elements must be updated, including with information on Member States in which the management company or authoritised, where the UCITS is managed or marketed cross-border.
Both will be required to:
Evaluate and assess whether the change in the legal status of the investment fund will still be compliant with the investment strategy of the fund as relayed previously to investors. EU investors will need to assess whether the change to a non-EU AIF instead of a UCITS will still fall in line with their investment criteria.
The UCITS and the AIFM Directives do not prohibit investment in eligible assets which are located outside of the EU, however, restrictions to fund-of-funds structures will apply. Most notably, UCITS which are authorised in the 27 member state must assess the eligibility of former UCITS authorised in the UK.
Certain operation functions may be delegated to providers established in the UK so long that such providers comply with the AIFM and the UCITS directive. If such functions include portfolio management and risk or investment management which are being carried out by an undertaking established in a third country, a cooperation agreement between the national competent authorities and f the home Member State of the UCITS management company or AIF manager and the supervisory authority of the undertaking carrying out the delegated function in the third country must be in place.
The European Securities and Markets Authority (‘ESMA’), has also issued an opinion on the matter wherein it specified that the use of outsourcing arrangements or non-EU branches for the performance of functions or the provision of services to EU clients may lead to a number of letter box entities. ESMA has warned that fund managers will need substance, or so called boots on the ground in the offices where funds are domiciled if they want to enjoy delegation rights. The use of non-EU branches needs to be based on objective reasons linked to the services provided in the non-EU jurisdiction and may not result in a situation where such non-EU branches perform material functions or provide material services back into the EU
Depositaries of EU AIFS and UCITS which are authorised in the EU must be located in the home Member State of the fund, owing to the delicate function performed by depositaries. The UCITS and AIFMD directive lay down the requirements for delegation of safe keeping functions established to third parties.
Where such safekeeping functions are delegated to entities established in the UK, the following applies:
• UCITS depositaries need to demonstrate objective reasons for delegation and to ensure that in the event of an insolvency of that third party, the assets held in custody are unavailable for distribution among, or realisation for the benefit of, its creditors;
• Non-EU AIF managed by an AIF manager established and authorised in the EU can appoint a depositary in the third country of the non-EU AIF subject to specific requirements.
