“PostBrexit the UK asset management industry will need to look to the AlternativeInvestment Fund Managers Directive (AIFMD) as the basis for trading within theEU market.” Criticallyreview the likely legal and economic positions of fund managers when the UKfinally exits the European Union. Introduction There is no question that the UK asset management industry is a majorsource of wealth for the British economy, being the 2nd mostdeveloped fund management industry worldwide (behind the US) and the mostdeveloped in Europe 1. Currently, as the UK is still a member of the EU, UK fund managers haveto comply with EU legislation in the financial sector, in particular MiFID,UCITS directive and AIFM Directive. The Undertaking for the CollectiveInvestment in Transferable Securities (UCITS) Directive covers all collectiveinvestment schemes 2,specifically speaking, funds that are managed in the retail investor level. The Alternative Investment Fund Directive3regulates the funds where only professional investors can enter, that aredefined by the directives as being “fundsthat are not regulated at EU level by the UCITS directive”4. The majority ofcapital inserted in the fund management industry in the UK comes from these funds(estimated in £2 trillion). MiFID 5allows fund managers, or any other financial firm based in a EU/EEA memberstate, to provide financial services or products freely inside the EU singlemarket, which we call the “passporting rights”, that are also provided by AIFM andUCITS Directives.
However, on 23rd June 2016, the British people voted to leavethe EU, and, on 29 March 2017, the British Parliament has notified the EuropeanCommission that the article 50 of TFEU, that provides for the withdrawalprocedure from the EU, was triggered. Meaning that if there is no binding agreementbetween the UK and the EU before the term of negotiation period, UK fundmanagers, greatly dependent on EU market, will cease to benefit frompassporting rights 6. Given these facts, unless theBritish government manages to secure the access to the single market in theirnegotiations with the EU, Brexit will clearly impact the UK asset managementindustry heavily. Meanwhile, several post Brexit scenarios arebeing discussed during negotiations between the British government and the EuropeanCommission, particularly the signature of the European Economic Area (EEA)agreement, third country equivalence and a bilateral agreement. During these negotiations, thereare political factors that will certainly shape the future relationship betweenthe UK and the EU, by which they will weigh the pros and cons of each scenario. However, before we discuss the most probable scenarioof the relationship between the UK and the EU post Brexit, we will need toassess the UK current legal position within the EU market and the consequencesthat Brexit will have in it (I).
After assessing the current situation of theUK, it is required to analyse and criticize the different potential scenariosbeing discussed in the negotiations between the British Government and theEuropean Commission (II) and finally point out the most realistic and possiblescenario for the UK fund managers after Brexit in 2019 (III). I. Thecurrent legal and economic position of UK fund managers in the EU Until the end of the negotiations periodbetween the British Government and the EU, fund managers in the UK are still inthe obligation to comply with EU legislation and still benefit it from it, theUCITS and AIFM Directives, that apply directly to fund managers and investmentfunds. The AIFM Directive was transposed in UK legalsystem by the Alternative Investment Fund Managers Regulation (2013),introducing the legal categories of Alternative Investment Funds (AIF) andAlternative Investment Fund Managers (AIFM)7. This Directive (AIFMD) was created as aresponse to the global financial crisis of 2007-098by the EU that realized the need to oversee and regulate the activity ofinvestment funds at the time considered to be a part of the “shadow bankingsystem” because it moved great amounts of capital based on speculative activity(hedge funds).
EU regulators saw the danger of such regulatory gap when severalhedge funds collapsed during the aftermath of the financial crisis of 2008.9 This Directive applies to AlternativeInvestment Funds (AIF), that are defined as being the “funds that aren’tregulated under the UCITS Directive”, such as hedge funds, private equity fundsand others. According to the AIFM Directive, it applies not to investment fundsdirectly, but to the fund managers of the alternative investment funds10. This Directive imposes several obligationsupon AIFM’s for them to exercise their activities such as an authorisation froma competent authority in a home member state11,an annual valuation of the assets held by the fund by a valuer12and the requirement of a depositary13. Once a UK or non-EU AIFM obtains an authorisationfrom the FCA or any other competent authority in a home member state to provideservices and products, the AIFM earns automatically the right to exercise hisactivity in any EEA or EU state without having to demand any additionalauthorisation from the host state. This policy is called the passportingpolicy. As we know, the city of London isan international hub of financial services and it was shown by fund managerspoll numbers that 40% of the assets managed by the UK asset management industrycomes from overseas clients and 55% of those assets are directly connected toEU clients, according to the Investment Association14.
Given these facts, it is clearly evident thatBrexit, whether it is a “soft” or a “hard” Brexit, will have a great impact inthese numbers, because by leaving the EU, the MiFID, UCITS and AIFM Directiveswill no longer apply to the UK as a third country and as such the UK fundmanagers will not have access to the passporting rights and will not be able toaccess freely the EU market, being subject to greater expenses to obtain newauthorisations, to comply with other countries requirements, creating otherbranches and also losing EU clients/investors that will redirect to other firmsin the EU. The funds that are now qualified as UCITSfunds, after Brexit, they will no longer be considered as such because thisqualification only applies to funds within the EU. Furthermore, the UCITSdirective doesn’t provide a third country regime, so UK asset managers will beforced to turn to the AIFM Directive which is the only directive that providesthe most complete third country regime15for fund management, so what was previously considered as a UCITS fund in theUK will now be qualified as an alternative investment fund which falls underthe scope of the AIFMD, if the country meets the requirements of the Directiveto obtain the passport. After trigging article 50 of the TFEU, theBritish government has started negotiations with the EU in order to provide atransitional or definitive agreement by the time the UK leaves the EU. During these negotiations, severalpossibilities have been considered as to what kind of relationship the UK andthe EU will maintain, those being the signature of the EEA agreement by the UK,also called the “Norway model” by several authors, the third countryequivalence regime and a bilateral agreement. II – The post Brexit potentialscenarios of the relationship between the UK and the EU The first scenario that isconsidered to have the less impact on the UK fund management industry is thesituation where the British government decides to join the European Economic Area(EEA) agreement or join the European Free Trade Association (EFTA), also calledthe “Norway model”. Bysigning this agreement, the UK would still have access to the single marketwhich encompasses the free movement of goods, capital, people and services.
This scenario would maintain the statusquo without interrupting the current access of UK fund managers to the EUsingle market. Although they would have theadvantage of keeping the access to the EU market, they would still have toaccept the free movement of people into the UK, which is against the currentpolitical position of Westminster, that insists in regaining control of itsborders and escape the jurisdiction of the CJEU. Furthermore, by signing thisagreement, they would be excluded from participating at the legislative processwithin the EU but would still be in the obligation to comply with EUlegislation because most of EU legislation is applied to the EEA agreement16and even make a financial contribution to access the market. This positionwould not be favourable to the UK, given the fact that the UK prefers to adoptan independent stance in terms of legislation, because of the particular needsof the UK economy. In a second scenario, the UK couldseek to obtain third country equivalence, as specified in the AIFM Directive17,in the MiFID II and MiFIR (will only be enforced in January 2018). Theequivalence is granted by the European Commission under the advice of theEuropean Securities and Markets Authority (ESMA) and other Europeanauthorities.The equivalence is assessed througha series of criteria 18and requirements 19but the key question is whether the regulatory framework of the country amountsto the same results as EU legislation, so it is not a matter of formality.However, this process is longbecause other countries have not yet obtained equivalence and there is also thefact that equivalence is an uncertain and fragile regime, because it can beremoved at will by the European Commission on the grounds of bad conduct of afirm leading to the conclusion of a regulatory gap in the country, for example.
In a third scenario, the UK couldsign a bilateral agreement with the EU and EEA members, like Switzerland signedan agreement with the EU that enabled the country to access EU market incertain sectors. However, this type of agreement requires a lengthy process ofnegotiations as we see in the case of Switzerland, that took almost 16 years toachieve a stable agreement (practically impossible to achieve in 2 years forthe UK) due to a series of agreements in specific sectors and it also requireda partial financial contribution20. Meanwhile, UK fund managers would bewithout any legal background to protect their interest in the EU market.In the Swiss approach, the countryhad also to accept the free movement of people, which once again is not inalignment with the political stance of the UK.Another type of agreement is theextensive free trade agreement that was signed between Canada and the EU, alsocalled the Comprehensive and Economic Trade Agreement (CETA). III – The most probable scenario ofUK-EU relationship post Brexit The declarations of the Britishgovernment in late March 2017 have made clear their intentions for the futurerelationship between the UK and EU as they intend to create free tradeagreement that will ensure the access to UK fund managers to the EU market: “Instead, we want a bold andambitious Free Trade Agreement with the EU. This will enable free-flowingtrade in both goods and services, and ensure the freedom for UK companies totrade with and operate within European markets.
“21 In an economic and legalperspective, if this agreement is concluded, UK fund managers interests in theEU market will be guaranteed, so there will be no changes in their actualposition. However, giving the short period of time until the official exit ofthe EU, this agreement will certainly not be concluded before Brexit, becauseit took Canada about 7 years to complete this type of agreement, although itsefficacity. Until the agreement isconcluded, UK fund managers will be in a “legal limbo” after Brexit, unlessthey find ways to secure their position in the EU market through other legalmeans.
Conclusion Until the negotiation period isconcluded between the UK and EU, UK fund managers will be surrounded in aclimate of legal and economic uncertainty, due to the conflicting politicalpositions of each side and the timing of each solution presented, whether it isjoining the EEA/EFTA, acquiring equivalence or creating a bilateral agreement. However, we can clearly observe that the British Government prioritizesthe economical stability of UK fund managers and their position in thefinancial services sector.Althoughthere aren’t any definitive and perfect solutions, fund managers can use otherresources to secure the access to the EU market and reduce the economic impactof Brexit on their marketing services. 1 Gillian Lofts, Paul Stratford, “Theimplications of Brexit on UK asset managers”, Oxford Economics report, EY, 2017 2 Directive2009/65/EC of the European Parliament and of the Council of 13 July 2009 on thecoordination of laws, regulations and administrative provisions relating toundertakings for collective investment in transferable securities (UCITS) (Textwith EEA relevance) 3 Directive 2011/61/EU of the EuropeanParliament and of the Council of 8 June 2011 on Alternative InvestmentFund Managers (AIFM) (Text with EEA relevance) 4 European Commission (website),” Investment funds”, Paragraph 4 (https://ec.
europa.eu/info/business-economy-euro/growth-and-investment/investment-funds_en) 5 Directive 2004/39/EC of the EuropeanParliament and of the Council of 21 April 2004 on markets in financialinstruments amending Council Directives 85/611/EEC and 93/6/EEC andDirective 2000/12/EC of the European Parliament and of the Council and repealingCouncil Directive 93/22/EEC, Article 6. (4)6 Eilis Ferran, “The UK asThird Country Actor in EU Financial Services Regulation”, Legal Research PaperStudies Series, University of Cambridge, Faculty of Law, Paper no. 47/2016, September20167 RodrigoOlivares-Caminal, Marco Bodellini, “The UK Regulation on Alternative InvestmentFund Managers: a Difficult Compromise between two Legislative Approaches”, Macmillan Publishers, 20178 AlastairHudson, “Law of Finance”, 2nd edition, Sweet & Maxwell, p.185,paragraph 7-1019 RodrigoOlivares-Caminal, Marco Bodellini, “The UK Regulation on Alternative InvestmentFund Managers: a Difficult Compromise between two Legislative Approaches”, Macmillan Publishers, 201710 Directive 2011/61/EU, AIFMD, Recital 1011 Directive 2011/61/EU, AIFMD, article 6 12 Directive 2011/61/EU, AIFMD, article 1913 Directive 2011/61/EU, AIFMD, article 2114 Gillian Lofts, Paul Stratford, “The implicationsof Brexit on UK asset managers”, Oxford Economics report, EY, 201715 JohnAdams, « Brexit for Fund Managers: time for coolheads”, 2016, J.I.B.L.R 16 SamKay, Jeremy Elmore, “Legal Brexit”, Chambers Global Practice Guides, 2016,Travers Smith LLP17Directive 2011/61/EU, AIFMD, article 3718 MiFIR(Regulation 600/2014 on markets in financial instruments), arts 46 –48 TitleVIII: “Provision of Services and Performance of Activities by ThirdCountry Firms following an equivalence decision with or without a branch”.19 Scott Morrison, “Third-country equivalence: a Brexit scenario forUK financial services”, I.C.C.L.R, (2018)20 Allen & Overy, “Impact of Brexit on asset and fund managers”,July 201621 Foreign & Commonwealth Office, Home Office, “Exiting theEuropean Union”, 29 March 2017