Cautious Pessimism on Brexit
Nearly one-third of market participants believe it is somewhat likely that some European funds will lose access to the UK market once the country leaves the European Union according to a survey by Brown Brothers Harriman.
Readers of Brown Brothers Harriman’s ontheregs.com blog were asked how they thought the result of the Brexit referendum in June will affect financial regulation. Sean Tuffy, head of regulatory intelligence at Brown Brothers Harriman in Dublin, said in the blog: “The respondents to our survey can be described as “cautiously pessimistic” about the Brexit negotiations.”
In the survey 31% of respondents believed it is at least somewhat likely that EU Ucits funds will lose access to the UK while 42% though this is somewhat unlikely.
The Ucits regulation aimed to create a single market for collective investment funds and allows Ucits fund authorized by one EU regulator to be sold across the trading bloc. Ireland and Luxembourg are the most popular domiciles used by asset managers for their Ucits funds so they can sell them abroad. Tuffy explained that the big difference between the Ucits and other financial services passports is that it is regulated at fund level, and not the manager level. Therefore the passport is based solely on the domicile of the Ucits fund.
“This is a crucial point and means that the calculus around Brexit and the Ucits passport is very different from the other passports,” said Tuffy. “Local regulators are responsible for approving Ucits funds and unlike, for example, the Alternative Investment Fund Managers Directive, in the Ucits framework there is no distinction between EU managers or non-EU managers.”
He continued that the bigger question is whether Brexit will end the reciprocal access between the UK and the EU. If UK Ucits funds are not granted access to EU investors, they have to be classified as alternatives by the European Union and governed by AIFMD instead.
“This classification could have huge implications on fund distribution because most alternative funds cannot be sold to retail investors,” said Tuffy.
So asset managers who use Ireland or Luxembourg as fund domiciles may have to set up UK domiciled funds in order to pursue UK investors and vice versa, or may abandon the UK completely so investors will have fewer choices.
A briefing from the European Parliament on Brexit and EU financial services said the City of London is the second largest global centre for hedge funds after New York City and is the largest centre of asset management in the EU with a market share of 37%. In addition 65% and 22% of cross-border funds are domiciled respectively in Luxembourg and in Ireland.
In the Brown Brothers Harriman survey 44% thought it is somewhat likely that UK will be granted equivalence under MiFID II and nearly 30% expect it is somewhat unlikely. MiFID II, regulations covering EU financial markets, will come into force at the start of 2018. Under equivalence, which exists in MiFID II and AIFMD, the EU would have to formally designate the UK’s regulatory regime as equivalent to the EU.
Tuffy said: “Taken together, the responses show that the industry anticipates that the UK is probably heading towards a medium-hard Brexit.”
A medium Brexit is a bespoke arrangement between the EU and the UK giving the country restricted access to the single market where UK financial services are equivalence by EU regulators. However the UK would have to ensure its regulatory regime keeps pace with any changes in the EU or equivalence could be revoked.
Tuffy explained that asset managers would be able to operate as they do today, except possibly with Ucits, which does not have an equivalence regime within the existing regulations. “As such, a new agreement would have to be drafted as part of the Brexit negotiations,” he said.
A hard Brexit means that the UK would leave and have no access to the EU single market and equivalence would not be an option. Tuffy said this would be the worst outcome for asset managers as the UK would have to negotiate a trade deal governed by World Trade Organization rules.
Unlike Ucits, AIFMD directly regulates alternative asset managers, rather than funds, so UK managers will be classed as non-EU alternative managers. As a result they would have to be regulated by both an EU regulator where it is selling funds, as well as the UK Financial Conduct Authority.
In addition losing access to the AIFMD passport means UK alternative managers have to rely on the national private placement regimes to sell their products in the EU, and these are due to be abolished in 2018.
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