The relationship between the UK and the EU is extensive and the outcome of Brexit negotiations will impact everything from agriculture to financial services. How big the ultimate impact is depends on the type of agreement that is cooked up in the negotiations – a soft, medium, or hard Brexit. The burning question on asset managers’ lips continues to be what level of access, if any, will the UK have to the EU single market and its financial passports such as UCITS and Markets in Financial Instruments Directive (MiFID 2)?
A soft Brexit would be the closest to the status quo. In this scenario, nothing would change for asset managers. They would still have access to the financial passports and maintain market access for their UCITS funds through the European Economic Area (EEA) framework. The downside to EEA membership is that the UK would be compelled to implement all EU regulations for financial services, while no longer having a say in the formation of new rules. This is the industry's preferred outcome. However, since negotiations began in earnest on 19 June, stance and posturing by both sides suggests a soft Brexit may no longer even be on the menu.
A medium Brexit would be a bespoke arrangement between the EU and the UK. The UK would have some level of restricted access to the EU single market. For financial services, this likely means accessing the EU through equivalence regimes, rather than the full passports.
Under equivalence, which exists in the Alternative Investment Fund Managers Directive and the MiFID 2, the EU would have to formally designate the UK's regulatory regime as equivalent to the EU's. Over time, this could be a challenge because the UK would be required to ensure its regulatory regime kept pace with any changes in the EU. Equivalence is not an ideal scenario for the UK because it is only temporary and can be revoked without notice at the discretion of the EU.
A significant area of EU regulation which does not countenance the concept of equivalence is the UCITS Management Company passport. In order to maintain status quo, a new and bespoke agreement would have to be drafted for UCITS funds and management companies as part of the Brexit negotiations.
Equivalence may suit the EU in the short to medium term, however since negotiations thus far have not progressed to the extent hoped for, it is hard to foresee an agreement within the EU’s timetable.
In June, the European Securities and Markets Authority published opinions on Brexit relocations. The opinions provide insight into the EU regulator’s thinking on equivalence and market access of non-EU third country firms. The opinions are framed with a hard Brexit in mind and set a high bar for UK firms wishing to continue to conduct regulated activities with or within the EU post Brexit.
A hard Brexit means the UK would be completely separate from the EU, with no negotiated access to the EU market. If this were to happen, the UK would have no access to the EU single market and equivalence would not be an option. The UK would have to negotiate a trade deal with the EU, which would be governed under the World Trade Organization rules.
A hard Brexit is the toughest possible outcome for asset managers. It results in the loss of both the management company and MiFID passports. This necessitates the establishment of an EU regulated entity. It also throws doubt upon continued access of EU UCITS funds into the UK market.
The biggest risk of a hard Brexit is that it could be completely unorganized. If there is no progress on the various elements under discussion, then a clean break between the UK and the EU is possible. If that were to come to pass, the divorce would happen more quickly than the two years envisioned in Article 50, leaving asset managers (and everyone else) unprepared.
So, What’s Next?
The final Brexit deal will come down to how much either side is willing to compromise. To date, confusion rather than compromise have dominated the negotiations. Even to eternal optimists, a soft Brexit was always unlikely, but now appears unattainable. The best-case scenario for asset managers is some form of medium Brexit, although that is beginning to look unlikely as well.
Asset managers should take a “prepare for the worst, hope for the best” attitude. It is looking more like a hard Brexit will be served, so asset managers should prepare for some level of disruption.
So, who wants breakfast?