After several delays and nearly three and a half years of deliberations, the UK has finally entered the Brexit transition period. But while that brings some political certainty at long last, the same can’t be said for asset managers operating across Europe.
Whereas the UK will continue to follow EU rules during the transition period, this all changes on 1 January 2021, when the official transition period comes to an end. The results from yet more negotiations will emerge this year, the outcome of which will have a major bearing on fund houses in both the UK and EU.
What are some of the likely outcomes? And what should firms be planning in order to be prepared for the changes ahead? AQMetrics shares its insights, as well as key learnings from the marketplace from UCITS management companies.
To move or not to move?
In the wake of the Brexit referendum, many firms wasted little time in deciding to redomicile. That process wasn’t easy, but for most of these firms at least, the redomiciliation of funds and registration of management companies is now finally nearing completion.
Given that decisions on whether or not to redomicile were mostly made early, the rate of change for redomiciliation has predictably slowed down lately. In fact, the total number of UK firms redomiciling has perhaps been lower than initially anticipated, with just 12 out of 165 UK authorised UCITS management companies, or roughly 20%, seeking authorisation in Europe post referendum. Others, it seems, were content to take a “wait and see” approach.
What’s become clear now is that for newly registered ManCos and Super ManCos in Ireland, Luxembourg and elsewhere, the authorisation requirements have been more arduous than expected. The six key functions must be obviously present in order to demonstrate substance, and there is zero tolerance from the regulators for skeleton designated person structures or brass plaque operations. In Ireland, in particular, the requirements for demonstrating substance under CP86 has become front and centre for these newly authorised management companies.
Meanwhile, for the UK UCITS funds that elect to remain in the UK following the completion of the transition period, they will not be authorised to manage and market their funds within the EU itself. It will be interesting to watch whether they will manage and market to the EU solely from their UK bases under an equivalent regime, or whether they will seek to appoint an EU ManCo.
All about equivalence
By far the most crucial concern for UK UCITS funds in the upcoming negotiations will be any equivalency. As noted, under the current arrangements, a UK-domiciled UCITS fund will automatically become a non-EU fund and lose its passporting rights unless a regulatory equivalent is reached before 1 January 2021, or it redomiciless to the EU.
The same largely applies for EEA firms passporting into the UK. Such firms will lose access to the UK on a passported basis, with their ability to be sold into the UK instead subject to local rules which the UK may impose on such funds.
Fortunately, the FCA has created the temporary permissions regime (TPR), with UCITS being allowed to be sold in the UK until new rules are applied next year. It’s also worth noting too that the 1 January 2021 deadline can be extended by another year if absolutely necessary.
So, what are the odds that a deal can be reached? It’s still mostly up in the air. For UK asset managers to be granted equivalence, the UK will need to remain closely aligned with EU regulations, something that Brexiteers, and the Tory party in particular, have been opposed to in recent years.
However, there was more clarity on 27 January, when the Department for Exiting the European Union published a letter from MP John Glen, the Economic Secretary to the Treasury, to the European Union Committee, that outlined the amenable position of the government.
‘We believe that a deep and comprehensive future relationship with the EU remains the best way to further [our] shared goals, including through arrangements that encourage us to work together constructively to stabilise the current equivalency framework,’ Glen wrote. ‘This will help to ensure strong ties to preserve market integration, financial stability and investor protection.’
The Government will start equivalency assessments from 1 February, and hopes to conclude these assessments by the end of June 2020. The next few months are therefore crucial.
Preparing for change
Despite the rosier outlook in recent weeks, UCITS firms that are passporting into the EU or UK can ill-afford to be complacent, as a neat resolution is by no means assured.
In recent meetings with a host of UCITS management companies and Super ManCos in both North America and Europe, AQMetrics has seen a strong consensus view that some sort of equivalency deal will be reached – a position that appeared to be reinforced with Glen’s letter outlining the government’s intentions.
That would certainly be welcomed by most of the industry. But while that is most firms’ base case at this stage, it would be wise to prepare for other arrangements, as a range of potential outcomes is still on the table.
As Greg Sachrajda, the FCA’s Head of Development for International Delivery, cautioned on 31 January: ‘as things currently stand, firms should anticipate a range of potential outcomes at the end of the implementation period, including the possibility that the activities that you conduct might not be covered by whatever is agreed between the UK and EU.’
He added that, ‘during the course of this year, as matters develop, firms will need to consider how the end of the implementation period may impact you and your customers, and what action you may need to take to be ready for 1 January 2021.’
What should you do?
Looking ahead from a regulatory standpoint, this means that upcoming rules, including the ESMA and FCA liquidity stress testing coming into force in September, will continue to apply and have a lasting impact in 2021 and beyond. Firms should thus prepare as if the existing regime will continue to be enforced. And the same applies for AIFM managers for which the Super ManCo provides oversight.
Encouragingly, AQMetrics has seen UCITS management companies, both within the EU and UK, starting preparations for the upcoming liquidity changes later this year.
As always, AQMetrics will be keeping a close eye on this for our customers in the coming months, monitoring and participating in ongoing dialogue with the regulators. While some sort of equivalency is likely in our view, the inherent uncertainty of Brexit so far means that UCITS firms can ill-afford to become complacent, especially now that it’s become clear that the UK is leaving the EU.