As the industry collectively continues to navigate the COVID-19 pandemic, thoughts have started to turn to consideration of back-to-office protocols and at last it seems that there may be some light at the end of this long, dark tunnel. The pandemic continues to take a significant toll on society and the asset management industry while absorbing an immense amount of time, energy, and resources, drawing focus away from other important areas. One area that has fallen down the list of priorities is Brexit.
Brexit is not all that is back on the agenda, so too is the looming shadow of a no deal Brexit. Just last week in the UK, the governor of the Bank of England, Andrew Bailey, urged firms to bolster their preparations for a no-deal in advance of the yearend deadline. If a no deal Brexit is increasingly likely, then it is important to have robust contingencies in place in advance as the theory turns to practice on January 1, 2021.
To briefly recap, Brexit has already happened since the United Kingdom (UK) left the European Union (EU) on January 31, 2020. We currently reside near the midpoint of the agreed one-year transition period, meaning that the practical impact of the post-Brexit relationship will truly come to light on January 1, 2021. As the industry starts to refocus upon the United Kingdom’s exit from the European Union, both of the following statements have a high degree of certainty attached to them:
- Brexit will happen when the current transition period expires
- A “No Deal” Brexit is increasingly likely
It is wise for asset managers to revisit and finalize their contingency plans and begin to prepare for life after Brexit beginning on January 1, 2021. With 207 days remaining on the Brexit countdown clock, once more we raise the question: Are you Brexit ready?
Current Status of Negotiations
Brexit negotiations resumed in earnest on March 18, 2020 with the exchange of legal texts between the UK and EU on their future relationship. Soon after the COVID-19 pandemic struck and with lockdowns in effect, there was a short hiatus. However, the negotiations have continued via video conferences, adding an even higher degree of difficulty to an already ambitious diplomatic negotiation program. Never has such a significant or technically complex diplomatic assembly been conducted from the respected parties’ living rooms and kitchens.
In terms of progress, most public reports suggest that significant gaps remain on important matters of principle. David Frost, the UK’s chief negotiator, said after the last round of discussions: “We made very little progress towards agreement on the most significant outstanding issues between us.” His counterpart, Michel Barnier in a UK newspaper interview last week suggested that the "the UK has taken three steps back from the commitments it originally made." Overall, it appears that on matters of principle and the fact that there is very limited time left to bridge the divide, we are increasingly moving towards a “No Deal” hard Brexit.
The possibility of a further extension, at least until July 1, theoretically exists, however the UK has categorically ruled this out when asked. The current UK government were elected very much based on a “Get Brexit Done” mandate. Again, David Frost’s most recent comment leaves no ambiguity on the UK’s position on further delays "We are not going to ask for an extension, and if the EU requests one, we will not accept it.” There is an upcoming summit where the leaders of the EU and UK will have one last chance to either delay or cancel Brexit. After this summit, both parties should have a better idea on whether negotiations towards a deal should continue, or instead attention and resources should be shifted towards preparations for a “no deal” parting of ways.
The final critical point for asset managers on the negotiations is that financial services have not played a significant part in the deliberations to date. Given all the other factors, it appears doubtful that any specific arrangements for asset management will be made before year end.
Proactive UK Regulators
While the political negotiations have been somewhat stilted, the UK policymakers have not rested on their laurels and there has been a lot of work put in to deal with the status of UK regulated firms in a post-Brexit environment. The FCA have continued to work closely with the UK Treasury and the Bank of England to prepare for a range of scenarios and ensure as smooth a transition as possible. Building on its successful Temporary Permissions Regime (TPR) that has existed from the beginning of the transition period, several helpful measures have been put in place to allow for life after Brexit, including:
FCA Temporary Transitional Power (TTP)
At the end of April, the FCA published a statement on the proposed use of the Temporary Transitional Power (TTP). In effect, the TTP freezes existing regulation applicable in the UK, much of which is currently based on EU-wide rules. The FCA has confirmed that it will apply the TTP on a broad basis to grant relief for a period of 15 months from January 1, 2021 until March 31, 2022.
Essentially, many (but not all) regulatory obligations will remain the same until March 31, 2022 and UK regulated firms will not need to implement changes in UK law arising from the end of the transition period by December 2020. It is also hoped that this “freezing” of regulation may be beneficial to any equivalence decisions that arise between the EU and UK.
There are certain areas where the FCA stated it will not grant TTP relief such as transaction reporting, short selling, EMIR reporting, securitizations, benchmarking, Bank Recovery and Resolution Directive (BRRD) and credit ratings –each of these categories are of interest to asset managers and should be reviewed.
Overseas Fund Regime
The UK is currently consulting on a proposal to frame new rules to allow for the continuation of non-UK funds, particularly EU funds like UCITS and money market funds (MMFs) into the UK with a light-touch registration process. The previous concern that UCITS might be “cut off” from selling into the UK because of a hard Brexit seems a lot less likely now. However, UK domiciled funds won’t get the same market access rights to market their funds in the EU.
On March 11, the UK revealed a new process for the continued access of non-UK funds into the UK in its Overseas Funds Regime (OFR).
The OFR foresees equivalence on an individual country basis. The UK Treasury will be tasked with granting such equivalence to an applicant country. There is no reciprocal arrangement with the EU or anyone else and currently the OFR is a one-way street. The OFR also specifically carves out money market funds for special attention, given the UK does not have locally domiciled MMFs currently and would like to maintain its nexus to the EU funds many of which are UCITS domiciled in Ireland presently.
To be deemed equivalent, UK Treasury must be satisfied that the regulatory regime of the other country meets the required standard on an “outcomes basis”:
- It must have the same or similar investor protection to comparable UK funds
- With respect to MMFs, the regulatory regime must be at least equivalent to the UK
- Treasury must also believe there will be reasonable supervisory cooperation arrangements between the FCA and other country’s regulator. (Overall OFR sets a low but subjective bar and many feel its framed to allow unfettered UCITS access to the UK)
- Once equivalence is granted, retail funds (UCITS) will need to register with the FCA to gain recognition
No Deal Brexit: Impacts on UK Asset Managers
With a No Deal Brexit becoming increasingly likely by the day, all asset managers should be refocusing on their no deal contingency plans. We previously outlined these in our Considerations for Asset Managers in a No-Deal Scenario, and they each hold true. With operational resilience, pandemic-fueled market volatility, and a host of other considerations to manage, it is important to once more ensure that the effects of Brexit do not further constrain your business model. The most material impacts to UK asset management firms will be:
Loss of Passports
UK based firms cannot act as UCITS management companies as there is no third-country regime. UCITS self-managed investment companies remain a viable option, however, the increasing time requirements to prove regulatory substance in both Ireland and Luxembourg is constantly increasing and many managers are engaging third party management companies or using third-party fund platforms to alleviate the EU substance problem. Even then, certain MIFID related marketing constraints may remain.
Marketing & Distribution
The capacity of UK firms to market their funds across the EU becomes severely impacted by a hard Brexit. UK firms, even those with UCITS or EU AIFs, may find that although they have the correct product range with passporting attached, the lack of a MIFID authorization means that they cannot market their own products instead having to rely on third parties who do have a MIFID license to sell their product. In the case of UK AIFs, their funds won’t have passporting rights across the EU27 member states and funds might need to rely on the shaky foundation of national private placement and reverse solicitation regimes for continued sales.
MIFID Third Country Regime
Possibly of greater concern and impact, is the loss of a MIFID investment portfolio management authorization. Due to the current third country regime being far from ideal and the open consultation on MIFID third country regime, there are suggestions that the EU plans to make third country access under MIFID an even more onerous regime to comply with. Since it is based on EU equivalence determinations; such permissions remain uncertain and can be withdrawn on short notice.
Under the pending new proposals, UK firms offering investment services into the EU face increased supervision, including the possibility of onsite inspections and significant reporting obligations. With the revised MIFID rules, UK firms that have EU-based branches servicing EU retail or professional investors will be required to report annually on the branch’s services and activities. ESMA even retain the right to temporarily block a UK firm from providing services to EU investors if they find any violations in their supervised activity.
Although third country investment firms can provide services to retail and opt-up professionals based in the EU, they can only do so if they set up a branch in the EU. Third country firms who do not set up an EU branch may be able to rely on individual national regimes allowing them market access, until ESMA determines whether their jurisdiction is “equivalent.” However, if the UK is designated as equivalent under MIFID II, UK fund managers would be able to continue to manage the assets of EU professional clients.
Some Hard Questions Remain
In conclusion, for asset managers impacted by Brexit the following five questions provide a solid basis for initially assessing how a No Deal Brexit will impact our business:
- Have we restarted our Brexit contingency project?
- Do we need to change anything based on the latest evidence that no future deal is increasingly likely by the end of the transition period?
- Have we considered how the UK’s Overseas Fund Regime will impact our funds?
- Have we considered all additional rules we have to comply with post-transition period?
- Have we a full understanding of how the end of the transition period will impact on our distribution strategy for our funds sold across the EU27?