Although the risk has slightly reduced recently, at the end of this month the UK could leave the European Union (EU) without a deal, If a deal is agreed, there will be a transitional period whereby existing funds’ industry legislation and practices will continue to apply until December 2020. Irrespective of this, many firms are still preparing for a no-deal scenario. As Brexit creeps closer, INDOS Financial takes a look at some of the issues facing the industry.
Temporary permissions regime for EU firms
In December 2017, the UK Government announced it would introduce a three year temporary permissions regime for inbound passporting EEA firms and investment funds.
Under a no-deal Brexit, the temporary permissions regime will ensure (subject to FCA notification) that EEA firms and investment funds can continue operating in the UK within the scope of their current permissions while seeking full UK authorisation. It will also allow investment funds with a passport to continue temporarily marketing into the UK.
Retention of AIFMD and the depositary requirements
While some firms had hoped for a dismantlement of EU legislation after Brexit, this was out of sync with the UK government’s thinking. EU legislation is being transposed into UK law including the Alternative Investment Fund Managers (Amendment) (EU Exit) Regulations 2018. As a result, AIFMD will continue to apply to UK managers. The affirmation that AIFMD will stay in place confirms there will still be a role for depositaries in a post-Brexit regulatory environment. This was not unexpected as the FCA had previously stated depositaries are an important component of sound fund governance.
Prime brokerage post-Brexit
Post-Brexit, a UK-based prime broker will not be able to leverage its MiFID (Markets in Financial Instruments Directive) cross-border permissions to conduct business inside the EU. This has prompted some prime brokerage providers to relocate operations into other EU jurisdictions. Whilst UK based managers of UK or non-EU funds should not be directly affected, there could be some knock-on effects such as contractual repapering.
Dual listings in a bind
EU asset managers could be precluded from purchasing shares in approximately 90 London-listed companies, which are also listed on EU exchanges. As things stand, EU firms can only trade shares in those impacted companies on EU exchanges, despite London venues being larger, more liquid and offering better pricing than their EU equivalents. This impasse also risks putting EU firms in breach of their MiFID II requirements to obtain best execution.
While a number of EU institutional investors have lobbied the European Securities and Markets Authority (ESMA) to rethink this policy, the Paris-based regulator is reportedly under significant political pressure to hold its ground. This uncompromising position, however, may prove to be self-defeating for the EU as a number of lawyers have suggested that affected companies may simply jettison their European listings in favour of London.
A clearer picture
Conscious a failure to find tacit agreement on CCP (central counterparty clearing) recognition risked causing enormous disruption to European derivatives’ markets and adding to companies’ margining costs, an MOU (memorandum of understanding) has been reached between ESMA and the Bank of England (BOE), in what should soften the blow of a no-deal Brexit by giving UK CCPs recognition. In February 2019, ESMA confirmed LCH, ICE and LME would be allowed to continue offering services into the EU even if there is no deal. ESMA followed this up with an announcement in March 2019 that the UK CSD, Euroclear UK and Ireland will be recognised as a third-country CSD to provide services in the EU.
Fund managers access rights
A multilateral MOU was reached between market regulators inside the EU and the FCA covering supervisory cooperation, enforcement and information exchanges related to investment management under a no-deal Brexit. The multilateral MOU also enshrines the continuation of delegation of portfolio/investment management into the UK. This MOU came nearly seven months after the FCA announced its Temporary Permissions Regime.
Brexit reaching its conclusion
While many financial institutions in the UK and EU would have preferred a well-laid out and orderly transitional arrangement to prevail come-March 29, there is a sense of relief nonetheless that some agreements and MOUs have been reached to mitigate the risk of a no-deal in key areas such as CCP recognition and delegation of investment management.