The Great British Break Off: Key considerations for AIFMs preparing for a “no deal” Brexit

This article looks at the latest guidance published for asset managers (and financial services firms, generally) in relation to the UK’s departure from the European Union and the preparation for a “no deal” scenario, as well as the key issues that AIFMs should be considering in the context of their contingency planning.

The reality is that the UK might leave the EU without a Withdrawal Agreement in place (and hence without a transition period). For AIFMs, this will mean an automatic loss of their AIFMD marketing and management passports with effect from 30 March 2019. From that point, UK AIFMs would also be treated as third-country AIFMs and AIFs authorised or registered in the UK under AIFMD would be categorised as ‘third country’ or non-EU AIFs from that date.

According to a recent FT article, nearly two-thirds of asset managers are now allocating significant time and resource to preparing for a “no deal” Brexit. And
if the European Commission and the UK government agree on anything, it is the need for all firms to plan for this worst case scenario.

The European Commission

On 8 February 2018, the EU Commission released an official notice to asset managers of both UCITS and AIFs, highlighting the expected impact of Brexit on issues such as authorisation, cross-border distribution and delegation in the event of a no deal. In particular, it highlights that:

• To continue managing and marketing AIFs to professional investors across the EU, AIFMs may need to consider relocating and obtaining a new authorisation dependent on their business strategy.
• To continue pursuing their current activities across the EU as far as EuVECA is concerned, both UK managers and UK funds may need to consider relocating their operations to an EU Member State and obtaining the new relevant authorisations.
• Subsidiaries of entities established in the UK that are already authorised by a EU27 National Competent Authority would be able to continue to operate in the EU based on their authorisation as AIFMs. However, branches of UK AIFMs based in the EU would be treated as branches of a non-EU AIFM as of the withdrawal date and would be subject to the requirements of the National Private Placement Regimes, where available.
• AIFMs will need to inform investors of the consequences of Brexit (this would impact, for example, the content of the AIF’s annual report) and assess whether the change in legal status of the fund would still enable them to comply with the investment strategy as originally communicated to investors.
• When delegating certain operational functions to entities located in the UK, AIFMs would need to demonstrate that their delegation structure was based on objective reasons and did not include material functions or services.

This was followed by a call from the European Commission on 19 July 2018 for all firms (and Member States) to step up their preparations for the immediate loss of single market access in the event of a “no deal” Brexit.

The UK government

Despite remaining stoically of the view that it “remains unlikely” that the UK will leave the EU without a Withdrawal Agreement in place, the UK government has published has series of “no deal” technical notices. These are intended to help businesses and citizens understand what they would need to do in a “no deal” scenario, so they can make informed plans and preparations.

As far as asset management is concerned, this technical notice addressed to the banking, insurance and other financial services sectors is not particularly technical, or enlightening. It does, however, seek to give some comfort to UK firms that they should be able to continue performing portfolio management under the delegation model post Brexit.

Portfolio management post a “no deal” Brexit

Many UK AIFMs are concerned that in a "no deal" Brexit scenario, they would be unable to continue managing EU AIFs from the UK under the existing delegation model. To do so would require a bilateral regulatory co-operation agreement to be place between the FCA and the regulator where the fund is registered, or client is located.

According to the UK government’s technical notice, “The UK authorities are ready to agree cooperation arrangements with their EU counterparts as soon as is possible, which is a technical exercise to bring the UK into line with other third countries. Unless the EU confirms it does not intend to put such arrangements in place, asset management firms can continue to plan on the basis that the delegation model will continue.”

For the majority of AIFMs, Ireland and Luxembourg are the key EU jurisdictions. Currently, neither the Central Bank of Ireland (CBI) nor the Commission de Surveillance du Secteur Financier (CSSF) have entered into a co-operation agreement with the FCA. Unfortunately, any desire on their part to move quickly on this to avoid the cliff edge effects of a ”no deal” Brexit are hampered by the need for ESMA approval of such arrangements. Without any certainty on whether an agreement will be signed, UK managers potentially face the costly and time-consuming process of delegating management functions to the various centres around the world (for example, Australia, U.S., Singapore and Hong Kong) that do have co-operation agreements in place. That's not an easy exercise to document and would require regulatory approval. Time is running out to put such arrangements in place.

Placing funds post a “no deal” Brexit

Following a “no deal” Brexit and the potential loss of the AIFMD passport, UK-domiciled AIFMs may be able to use the National Private Placement Regimes (NPPRs) (where available) to distribute their funds across the EU (assuming of course that the UK signs a co-operation agreement with each of the Member States, as discussed above).

According to recent statistics, only 3% of EU AIFs are registered for sale in more than three member states. In Ireland, the Nordics and Benelux, where the NPPR process is fairly straightforward, using the NPPR is likely to provide a cost and time-efficient method of marketing.

Whether or not the activity of placing funds falls within the scope of MIFID is likely to come under increasing regulatory scrutiny – some larger EU investors have already queried the regulatory status of certain UK-based managers’ marketing teams. In a “no deal” Brexit, both the MiFID and AIFMD passports would fall away. Assuming there is no relevant equivalence decision by the European Commission, UK firms would need to think about whether their fund placement activities in EU member states were caught by MiFID (i.e. transmission of orders) and would therefore require compliance with local regulation.

UK firms and funds: seeking to relocate?

On 12 July 2018, ESMA urged UK entities wishing to relocate to as part of their Brexit preparations to submit their application for authorisation as soon as possible to allow it to be processed before 29 March 2019.

A number of asset managers have outlined plans to increase their presence in, or move part of their operations to, Dublin or Luxembourg. The message from the CBI and the CSSF is clear: you must engage with the regulator a soon as possible. On 25 July 2018 the CSSF issued a press release reminding firms that the time required for analysing authorisation requests can be substantial. Similarly, the CBI’s Brexit FAQ advises firms which have yet to proceed to the application
process to be mindful of the authorisation timelines.

AIFMs also need to be aware of local “substance” requirements and any requirements as to the delegation of key functions, the allocation of tasks between the manager, its delegate and investment advisers, and the governance/organisation of any established investment committee.

On 23 August 2018, the CSSF published a new circular (18/698) (currently only available in French) regarding the authorisation and organisation of investment fund managers incorporated under Luxembourg law. The circular provides clarification on the authorisation conditions relevant to Luxembourg UCITS management companies, self-managed UCITS, AIFMs, and authorised internally-managed AIFs. This includes, in particular, requirements regarding the shareholding structure, capital, management bodies, central administration and internal governance arrangements, and the rules governing the management of delegations.

A temporary permissions regime for EEA-domiciled funds marketing into the UK

For EEA-domiciled funds who wish to continue to access the UK market following a “no deal” Brexit, they will be able to do so under the proposed temporary permissions regime (TPR). Provided the FCA has received notification prior to 29 March 2019, UCITSs schemes and AIFs can continue to be marketed in the UK during the regime (which is expected to be in place for a maximum of three years). During that time, EEA funds will be required to obtain separate authorisation or recognition in the UK.

The FCA expects to start accepting notifications in early January 2019 and will be consulting on the rules of the proposed TPR this Autumn.

Firms are advised to take the necessary preparedness actions and to take them now

Whilst there is desire on all sides to avoid a “no deal” Brexit if possible, there is still no certainty that the proposed transitional arrangement will come into effect. Fund managers that currently rely on their EU passporting rights should be giving serious thought now to what alternative options might be available to them in the event of a “no deal” Brexit, and putting in place any necessary contingency plans sooner rather than later.