Any faint optimism that a memorandum of understanding between financial services regulators might fill in gaps in the Brexit Trade and Cooperation Agreement were dashed this week when the text was leaked. In the fund sector, attention now turns to the extent to which UK and EU decision makers will use product and marketing rules to further their political-economy agendas.
Rather than the ambitious ‘equivalence’ measures hoped for by optimists, a leak on Tuesday 30 March of the four-page UK-EU regulatory MoU contains very little. It commits to creating a regulatory forum which will meet ‘at least semi-annually’. At these meetings the parties will ‘endeavour to pursue a robust and ambitious bilateral regulatory cooperation.’ The lowest common denominator text added: ‘forum activities may include dialogue on the participants’ autonomous decisions to adopt, suspend or withdraw equivalence relevant to one or the other side.’
For the foreseeable future, it appears the industry will rely on ad-hoc measures to govern cross-Channel financial services cooperation. The state of play for funds was reviewed by a panel at the ALFI European Asset Management conference on 17 March. They considered both the product rules that make the fund acceptable to local regulators, and the licencing requirements that apply to marketing entities. UK and EU regulators are taking different approaches of how to replace the passporting arrangements that used to govern flows.
UK relatively open
The UK has so far taken a relatively open stance. ‘We had two temporary permission regimes in the UK corresponding to product rules and firm licencing rules,’ said Phil Bartram, partner with UK fund services firm Travers Smith. EU asset managers that managed to register before the 31 December 2020 deadline have been able to continue selling into the UK as they did before Brexit. These arrangements are due to be extended for five years with a piece of legislation currently going through the UK parliament.
Problems arise for new funds and firms that missed the deadline. In particular it will be much more complicated to sell to individual investors. ‘You can sell to institutions, but it makes it very difficult to get it to retail investors, and that includes all human beings irrespective of their net worth or sophistication,’ said Bartram.
All news funds are AIFs
‘All EU funds, whether they’re UCITS or AIFs are now treated as if they were alternative investment funds under retained AIFMD rules,’ Bartram explained. Registration procedures are not particularly tough, he said, with a Luxembourg fund needing to be distributed under the UK national private placement regime. ‘That’s a quick and simple same day process,’ he said. However there will then be an added layer of (annexe 4) reporting to the UK regulator, as well as normal filings to the CSSF. At the moment this is not too onerous as these forms ask for virtually the same information, with the UK version requiring more data in some cases.
It appears that the UK authorities are alive to the risk of savers being deprived of access to new funds, a particular concern with the continued rise of passive and ESG strategies. ‘The UK is working on something called an overseas funds regime,’ explained Rupert Rossander, general counsel with the asset manager Invesco. ‘This will introduce a new way for overseas funds to be sold into the UK to retail investors, and there will also be a special regime for money market funds,’ he added.
Retail access addressed
Yet even so, politicians will have their say. ‘For retail, this regime will require our UK Treasury [the finance ministry] to make an equivalence determination about a particular EU market and the vehicle,’ he said. The ministry would also have powers to impose top-up requirements to close any perceived gaps between any Luxembourg, Ireland etc rules and any UK domestic rules. ‘There ought not to be any or many of those today, because we haven’t diverged yet,’ he remarked. Then an application would need to be made to the FCA which would rule on a case-by-case basis, but Rossander foresees a quicker and simpler approach than the current recognition regime. Yet it remains to be seen the extent to which time-to-market will be affected.
There are potential marketing trip-wires too. A Luxembourg fund management company, for example, would need to conduct its marketing from the Grand Duchy into the UK cross border. ‘After COVID, don’t arrange a deal or investor subscription whilst your people are physically present in the UK, otherwise, this might trigger a licencing requirement,’ Rossander noted.
Also, there is the possibility that overseas funds might not be eligible for the UK investor compensation scheme. Much on this side of the relationship needs to be developed. ‘I do think there is the risk that at the very retail end of the market, this could become increasingly UK-product focused,’ he said. ‘It’s possible that continental European firms will be forced to set up ranges in the UK,’ commented panel moderator Jérôme Wigny, partner with the law firm Elvinger Hoss Prussen.
UK into EU
For UK funds seeking EU investors, few industry players expect equivalence measures for products or marketing in the foreseeable future. ‘If UK funds want to access EU markets, they can either use a national private placement regime if there is one, or they need to consider setting up a Luxembourg or an Irish vehicle with a Luxembourg or an Irish manager, and then delegate portfolio management to the UK,’ said Bartram. Of course, this depends on EU politicians being willing to permit delegation to the UK as they do for US and Swiss managers.
‘The bigger issue is the role of UK-based investor relations or business development professionals: people who clearly live in the UK, but who have all of their contacts and investors in EU markets,’ Bartram noted. Rossander agreed: ‘it’s very challenging because the law is far from clear and it varies from country to country,’ and even between lawyers in the same country. He said discussions are on-going with ESMA about this in the hope of achieving a degree of pan-EU clarity. This is in particular a concern for US and other international managers which used London as their access point to the single market.
Some work-arounds
Ideas around secondment of professionals from the UK were discussed, and initially the CSSF appeared open to these thoughts. However the panel noted this interest has since cooled. The industry is also investigating other work-arounds, such a techniques like ‘chaperoning’ or using ‘tied agents’. Alternatively, several managers have found it easier to move or beef up operations in the EU to avoid these complications.