The asset management community faces significant disruption should the UK leave the EU, though it seems some firms are actively supporting the move.
With negotiations in Europe completed over the weekend, UK Prime Minister David Cameron has set a referendum on European Union (EU) membership for 23 June 2016. While many business leaders have warned against opting out, the asset management community has shown more mixed views on membership of the EU.
A report published in November 2015 by Morgan Stanley warned Brexit could have a material impact on UK UCITS managers, as the majority of their assets are derived from EU investors. UCITS by law must be domiciled and managed in the EU and any exit could result in a swathe of re-domiciliations.
The Morgan Stanley report highlighted a Brexit could result in higher transaction costs and a need for more investment staff. It could also impact distribution across the EU. Should Brexit occur, UK UCITS may need to formalise new country-by-country distribution arrangements, which could be expensive, particularly as distributing any EU UCITS already is quite costly despite the introduction of UCITS IV.
One lawyer said a Brexit would force UK-based UCITS managers to adopt a similar structure to those used by US managers with UCITS. US UCITS managers usually have delegated managers of EU domiciled funds, often established in Ireland or Luxembourg.
“I cannot see a huge amount changing in terms of the funds’ structure, as many UK managers running UCITS already manage UCITS funds domiciled in Ireland or Luxembourg. It would simply be a case of the UCITS manager being replaced by another EU-based UCITS manager, such as one of the platform managers, with that EU UCITS manager delegating fund management to the UK manager entity,” said the lawyer.
There appear to be a number of fissures among asset managers around whether to remain or leave the EU. The founders of Winton Capital and Egerton Capital have publicly donated significant sums to campaigns devoted to keeping the UK in the EU. Others, including Crispin Odey, founder of Odey Asset Management have voiced support for the EU Out campaign.
Proponents of Brexit argue EU regulations such as the Alternative Investment Fund Managers Directive (AIFMD) and the Markets in Financial Instruments Directive II (MiFID II) are shackling the industry and adding enormous costs. Some believe that BREXIT would enable the UK to develop its own onshore fund structure. Other managers simply do not have that many EU clients preferring to market into the US and APAC. As such, these organisations feel they are hampered by EU regulations with limited discernible benefits.
Equally, a number of managers do have significant EU client interests and are understandably nervous about the disruption leading up to the referendum and what a possible Brexit will bring.
“It ultimately depends on the exit arrangements that the UK secures. If the UK elects to remain part of the European Economic Area (EEA), it will be business as usual insofar as AIFMD and MiFID II will continue to apply. If the UK left the EEA and became a non-EEA third country, it would result in the UK being in a situation similar to that of the US or Hong Kong in respect to EU regulation,” said Neil Robson, regulatory compliance partner at Katten Muchin Rosenman in London.
The latter scenario could result in issues for UK AIFMs, many of whom have availed themselves to the pan-EU AIFMD distribution passport – particularly in the retail space. A Brexit could render the passport obsolete for UK AIFMs. This could cause enormous challenges for fund managers and considerable uncertainty with it.
“As a non-EEA jurisdiction, the UK would have to wait for the European Securities and Markets Authority (ESMA) to grant it an AIFMD distribution passport in the way that it has said it is minded to for Guernsey, Jersey and Switzerland. These only come about as a result of ESMA assessing a particular jurisdiction as being of equivalence – as ESMA is doing at present with a host of other countries, including the Cayman Islands and US,” said Robson.
However, the UK has implemented AIFMD into national law and in theory should not face any questions about not having equivalent status. The same cannot be true of jurisdictions such as the Cayman Islands, which has been forced to introduce laws allowing for a dual funds regime which is more in line with AIFMD.
Nonetheless, the passport approval process has been slow. Guernsey, Jersey and Switzerland were all told by ESMA they met equivalence to utilise the passport last summer yet the European Commission (EC) has not passed a Delegated Act formalising it. Given any UK exit negotiations could take up to two years, it might leave the fund management industry in limbo for quite some time.
Another consequence could be if EU authorities such as ESMA decided not to grant the UK equivalence. “This is a potential scenario but I suspect pragmatism will prevail. I would like to think that the rest of the EU needs access to the UK’s capital markets so I doubt that will occur,” commented Robson.
Managers appear confident the UK will remain in the EU. A survey by Aviva Investors of 26 fixed income asset managers running a combined total of $2 trillion globally found every single one was poised that Brexit would not happen. However, Aviva Investors also found that 20% of equity managers felt a Brexit would occur.
The overall financial implications of Brexit are hard to gauge. However, a note by Societe Generale said there was a 45% probability of a Brexit, which it acknowledged could lead to significant financial damage. The French bank estimated Brexit could see the UK’s annual GDP falling between 0.5% and 1% for at least a decade, while the Eurozone could incur output losses of 0.1% to 0.25%.