In five months, the UK will not be a member of the European Union (EU), of which there are likely to be two potential conclusions. The first Brexit scenario – assuming a Withdrawal Agreement is clinched over the coming weeks by negotiators on both sides – will provide a transitional arrangement for UK financial institutions lasting until the end of 2020 or possibly longer, during which “business as usual” shall stay unchanged. An orderly and systematic Brexit is certainly the preferred option for many financial services’ participants.
An alternative no-deal would result in a cliff-edge exit, potentially costing UK asset managers their cross-border market access and passporting rights with immediate effect. The UK government is conscious that market stability must be preserved and disruption to end investors minimised, so it is busily transposing EU law into UK legislation ahead of March 2019. This, the government hopes, will enable for continuity to be preserved should negotiators fail to reach a sensible or timely agreement.
While some managers had hoped for a dismantlement of EU legislation after Brexit, this is clearly out of sync with the UK government’s thinking. In addition to granting EEA managers the right to access UK investors through a three-year temporary permissions regime under a no deal scenario, the UK government also released a document – “Alternative Investment Fund Managers (Amendment) (EU Exit) Regulations 2018” – in October 2018 confirming that European law would be retained for domestic and EU managers operating inside the UK.
Depositary status quo
The UK government’s affirmation that AIFMD will stay in place clarifies the medium term role of the depositary in a post-Brexit regulatory environment. The announcement is a welcome one although not an entirely unexpected development as the UK government had made clear it did not intend to deviate from EU legislation. Recent history suggested a departure from AIFMD’s core principles was unlikely anyway, as the FCA has previously acknowledged depositaries are an important component of sound fund governance.
Depositaries have a duty to safeguard the interests of investors, and it is a concept which fund allocators increasingly value. Pre-crisis, some investors incurred losses as a result of asset managers either straying from their stated investment objectives, suffering from operational deficiencies; or engaging in fraudulent activity. The depositary is pivotal to the integrity of the industry and customer protection, and any abandonment of this oversight requirement by the UK would have been a backward step for the asset management sector.
Evolution of the depositary
Neither the UK government nor the EU has given any firm indication that they plan to require EU-regulated asset managers to appoint truly independent depositaries, although this could well change. A number of asset managers are re-evaluating their depositary arrangements amid concerns that some providers may be conflicted. This is because many depositaries are affiliated to fund administrators, raising questions about their neutrality and incentive to flag problems arising at their parent company’s administration arms.
Even if regulators do not mandate managers appoint independent depositaries, the shift is happening organically amid pressure from investors. Due diligence teams at institutional allocators have become shrewder about depositaries and are seeking assurances that providers are carrying out their roles to a high standard and in an objective, impartial manner. Engaged corporate governance is also driving change, as directors are increasingly scrutinising depositaries’ behaviour, and pivoting generally towards the independent model.
Depositary: Here for the long-term
It was no secret that many asset managers in the UK hoped Brexit would deliver them a purge of regulations, with some even openly questioning whether they needed to implement incoming EU legislation like MiFID II and GDPR. In reality, the UK is not going to change much for the foreseeable future and it is certainly indisposed to rolling back on depositary practices. If anything, the role of the depositary is going to grow over the next few years, buoyed by investors, directors and potentially regulatory intervention.