A UK withdrawal from the European Union (EU) following the 23 June 2016 ‘Brexit’ Referendum has potential implications on the existing requirement for UK Alternative Investment Fund Managers (AIFMs) to appoint, in certain circumstances, a depositary under the Alternative Investment Fund Managers Directive (AIFMD).
To recap, AIFMD introduced a requirement for certain AIFMs to ensure that a depositary is appointed to perform a fiduciary oversight role over the Alternative Investment Funds (AIFs) which they manage. The depositary requirements for UK AIFMs can be summarised as follows:
- Smaller, sub threshold AIFMs (i.e. less than €100m of gross assets for open ended funds, and less than €500m for closed ended funds not employing leverage) are not subject to the depositary requirements.
- Full Scope AIFMs (i.e. those above the small AIFM thresholds) are required to appoint a single ‘full’ depositary for each AIF domiciled in the EU. AIFs domiciled outside of the EU are required to comply with the so-called ‘depositary-lite’ regime if they are marketed in the EU on a country by country basis through private placement. Any depositary to EU AIFs (with some temporary limited exceptions) must be located in the same domicile as the AIF. Under depositary-lite, there are no depositary domicile requirements.
- If the AIFMD marketing passport is extended to non-EU AIFs, and UK AIFMs wish to avail themselves of the passport, AIFMs will need to move from a depositary-lite to full depositary model. In these circumstances, the depositary needs to be domiciled in the home EU member state of the AIFM (i.e. currently the UK), or the domicile of the AIF (subject to meeting equivalence tests).
- UK AIFMs of non-EU AIFs that are not marketing in the EU (for example those that market in the two common jurisdictions of the US or Switzerland) are not subject to any depositary requirements and there are unlikely to be any changes resulting from Brexit to access these markets.
While the UK remains in the EU and subject to existing EU rules, there is unlikely to be any change to the current depositary requirements.
The longer-term implications on depositaries will depend on the outcome of the UK-EU negotiations, as well as the policy position taken by the FCA.
For example, if the UK opts for the Norway model, the UK would stay in the single market for goods and services subject to on-going compliance with EU legislation including AIFMD. Norway is a member of the European Economic Area (EEA) and the Norwegian AIFM Act governs Norwegian domiciled AIFMs of Norwegian and foreign domiciled AIFs. It also legislates on the marketing in Norway of Norwegian or foreign domiciled AIFs. The depositary requirements under the Norwegian model are broadly the same as the UK requirements.
If the UK is no longer part of the EU or the EEA, UK AIFMs would become so-called ‘third ‘country’ non-EU AIFMs.
It is likely the FCA would retain the bulk – if not all – of AIFMD within UK legislation. This is partly because the UK (like any other non-EU domicile) would need to demonstrate equivalence with EU rules for UK AIFMs to be able to access EU markets, and particularly through the AIFMD marketing passport.
UK AIFMs in this scenario will be no different to non-EU AIFMs (such as managers domiciled in Jersey, Guernsey, Switzerland or the USA) today. Depositary requirements do not apply to non-EU AIFMs except if AIFs are being marketed in Germany and Denmark (two countries which have ‘gold-plated’ Article 42 of the AIFMD). If the AIFMD passport is extended to non-EU AIFMs and / or non-EU AIFs, then the full depositary will need to be domiciled in the EU Member State of Reference (MSR) of the non-EU AIFMs managing and marketing the AIF. Alternatively AIFMD also states it should be possible for a non-EU AIF to have a depositary with its registered office or a branch in the relevant third country of the AIF if certain equivalence conditions are met. Very few depositaries currently operate outside the EU from the domicile of the AIF but we could see an expansion as a result of Brexit.
The MSR is intended to be the EEA State with which it has the closest connection and is commonly viewed as the country where most marketing activity will take place. For as long as the UK is in the EU the MSR would most likely be the UK for many managers but there would be no obvious common alternative elsewhere in the EU.
The two year exit process presents a dilemma for non-UK depositaries that currently act for UK AIFMs managing non-EU AIFs, as well as UK depositary-lite businesses. If the UK ceases to be part of the EU, a UK depositary will not meet the domicile requirements for non-EU AIFMs to access the AIFMD passport.
However the AIFMD marketing passport could be introduced for certain third countries by early 2017 prior to any UK exit. During this period firms will most likely need to appoint a full UK depositary to access the passport. Some non-UK depositaries had started the process to obtain FCA authorisation but may now reconsider their position. As a result, some managers looking to access the passport may need to change depositary provider to a UK firm, at least for the interim period. Depositaries with an existing footprint in the UK – as well elsewhere in the EU – will be at a competitive advantage.
There have been calls for the introduction of a European depositary passport and these calls may gather some momentum over the coming months as a result of Brexit. This would enable a depositary in any EU member state to act for a non-EU AIFM marketing via the passport regardless of its MSR. This would address the depositary domicile issue.
If the marketing passport were to be extended to the UK once outside the EU, the UK would possibly follow the route being taken by Jersey, Guernsey and Switzerland in terms of a parallel, optional AIFMD opt-in regime if UK managers wanted to access markets in the EU more broadly. AIFMD also envisages in due course all national private placement rules in the EU would be switched off (although this is likely to be 2020 at the earliest) and so all non-EU managers would have to fully comply with the AIFMD, including the full depositary and depositary domicile requirements, in order to access EU markets.
From a broader policy perspective, the FCA has publicly stated it views the depositary as a cornerstone of good fund governance. Investors are also increasingly recognising the value of additional oversight which the depositary brings to a fund’s governance structure.
It is therefore unlikely the FCA would remove the existing requirement for UK AIFs to appoint a depositary. It is also conceivable the FCA would continue to require UK AIFMs marketing in the UK to comply with the existing depositary-lite requirements albeit non-EU AIFMs marketing in the UK are not currently required to do so.
Removal of the requirement to appoint a depositary would likely be viewed as a backward step at a time when the UK will be seeking to retain its status as a leading domicile for hedge fund and private equity management businesses through a strong regulatory framework that protects the interests of investors.
It will be some time before the dust settles on the outcome of the referendum and there will be much debate about its eventual impact on the UK financial services industry. At present, it will be business as usual for depositaries, but they will need to be nimble and ready to adapt to balance the potential short term needs of their clients during the two year transition period as well as in the post EU era.