The UK is one year away from becoming a ‘third country’ under the AIFMD and UCITS regimes, creating potentially significant problems for those wishing to distribute their funds freely across the EU.
As they reach a fork in the road, UK managers will need to decide whether to build a management company in Europe and in doing so replicate their existing infrastructure. This will require sourcing talent and building sufficient substance on the ground. With ever increasing regulatory pressure for more substance, gone are the days of letterbox entities. A viable alternative is to appoint a third party ManCo. How, though, would this integrate to their existing framework? What does this do the fixed cost loss and margins of the business? And less considered, but what tail risk and additional regulatory risk does this new geographic exposure bring?
June 2016 was certainly a pivotal moment in European history. The Brexit vote opened up Pandora’s box. The initial reaction among UK asset managers was to wait and see. This steadily progressed towards considering contingency measures and now, with the clock ticking, there’s a collective need to take action.
This stems from a number of factors. One is that ongoing political turmoil, thanks to infighting within the ruling Tory party, is creating real uncertainty over the type of Brexit deal the UK ends up with, and whether steps will be taken to guarantee passporting rights for its financial services industry.
A second, more pressing need for action emanates from the recent letter sent by the French regulator, the Autorité des Marchés Financiers (AMF) to UK fund managers asking them to lay out their intended post-Brexit plans. The letter requests that the AMF be informed of the steps “that your company intends to take, to anticipate and prepare for the termination of the aforementioned passport mechanisms”. The stances from other member states are more conciliatory, but uncertainty remains on positions that may emerge.
This letter is basically an ultimatum that says, ‘We notice you sell your funds in France so you’ve got two options: one is to let us know what you plan to do about deregistering your funds. The second is to let us know what legal structure you intend to use to remain in full compliance with rules applicable in France for managing or marketing investment funds.’
This, combined with CBI, CSSF, ESMA and other regulators indicating they will need time to process all applications, brings the build or hire decision into sharp focus.
EU national regulators are advising that UK managers need to find a solution by October 2018 because the regulators will need sufficient time, ahead of the 1st March deadline, to handle applications.
Not that this is a one-way problem. Equally, European managers wishing to market into the UK post-Brexit will need a solution continue marketing under what will likely be a national private placement regime arrangement.
One of the problems that political uncertainty generates in the minds of UK fund managers is that, were they to decide to set up an EU-based AIFM/ManCo, and spend substantial capital on a full infrastructure solution, it might be rendered pointless if regulation softens in future. Or a new arrangement is agreed.
To illustrate the point, a manager with EUR15 billion in total AUM would need to allocate EUR3 million of operating capital. They would need to source and hire local talent in Luxembourg or Ireland, for example, perform all of the AIFM/ManCo obligations under AIFMD such as risk management and regulatory compliance, as well as select a multitude of service providers to the AIFM/ManCo.
However, whilst it is important that UK managers formulate an action plan, there is no need to throw the baby out with the bathwater. There are other options, most notably the outsourced AIFM/ManCo route.
There are many benefits to using a third party AIFM/ManCo. It avoids any potential conflicts of interest and managers have the reassurance that fund governance is the focal point of the specialized, hosted AIFM/ManCo. Not only can it overcome the substance issue, providing robust IT infrastructure, staff, operating capital and proper controls, it can also provide the necessary risk and compliance framework, thereby mitigating any regulatory risk to the manager.
Partnering with the right AIFM/ManCo to develop a Brexit relocation plan, help with the RFP process for selecting service providers and sourcing the right office space for those wishing to set up their own long-term AIFM/ManCo entity, can make all the difference.
Given that the AMF has issued its letter, one should assume that other EU countries will follow suit. The EU will not countenance more favourable access to one market over another.
After all, ESMA is keen to ensure there is no opportunity for regulatory arbitrage.