With Brexit negotiations under way, is it a good time to move your funds? Chisomo Kaferawanthu provides some insights.
The choice of where funds are domiciled is vital as it can affect a fund’s ability to raise capital, its performance, operations and ultimately its sustainability. The jurisdictions that provide the infrastructure for efficient markets are attractive to investors and investment managers, as they usually have specific expertise and stable operational costs, which can all contribute to a fund producing higher returns.
The specific benefits and expertise differ between locations but the most notable fund jurisdictions such as London, Luxembourg, the Channel Islands and Dublin have access to significant markets and they have a distinguished record of attracting large institutional and retail investors. With article 50 having been triggered, Britain stands to lose, or have limited access to, the single market.
The outcome of the negotiations is unpredictable. In its bid to achieve sovereignty by repatriating powers from Brussels, it is crucial that Britain achieves an outcome that does not see any significant funds under management being re-domiciled to the EU. It will require a concerted effort by the British government, investment associations, regulatory authorities, fund managers and service providers to maintain a fair share of the current investment activity, which represents £1.2trn worth of assets under management for EU investors. The UK needs to maintain its strong position to attract existing and new funds. The priority is to be the preferred choice for overseas financial institutions and investors while retaining the capital invested in the UK. But what operational matters could affect a fund’s location and which could be impacted by Brexit?
Capability: The UK is a leading financial centre with a diverse range of experienced investment managers and investment professionals from all over the world. Regardless of the outcome of the Brexit negotiations, the UK, led by London, will still be well placed to lead European investment market capabilities.
Access: The major issue that will affect a fund’s location is access to the single market. Following Brexit, UK funds will not be Undertakings for Collective Investment in Transferable Securities (UCITS) funds, and will lose rights to be freely marketed to retail investors in the European Economic Area (EEA) under fund passporting unless the UCITS status is maintained after negotiations.
In the event that UK funds become non-EEA Alternative Investment Funds (AIFs) under the Alternative Investment Fund Managers Directive (AIFMD) following the negotiations, it is highly likely that they would have to comply with the EU’s Third Country Regimes (including private placement) and passporting for cross-border access to EU-markets. The key question is whether the UK is prepared for compliance with such regimes and whether, as a ‘third country’, the UK will be able to benefit from efficiencies it currently enjoys.
The key to whether UK funds remain in the UK depends on the negotiations and the impact on market forces that will automatically determine jurisdiction efficiencies, which incorporate factors including capability, capital and returns.
Tax initiatives such as Base Erosion and Profit Shifting (BEPS) and other EU incentive regimes may also have an impact on these decisions. If the UK government can negotiate a mutually beneficial access arrangement with the EU, there will be less demand for a fund’s relocation. Failing a favourable outcome, investment managers may need to consider their corporate structure and where management sits, setting up subsidiaries and branches in the EEA, which could be regulated by EEA local authorities. This may have an increased impact on the UK’s capability to service its industry in the long run.
Regulations: Brexit does provide a unique opportunity for the UK to revisit its regulations that impact the operations of UK funds. The UK may focus on only maintaining those regulations that enable efficient markets and preserve market integrity through targeted reforms of the existing directives. As a result, the UK may prove to be an attractive jurisdiction for funds as market participants will already understand the existing regulations and appreciate such practical improvements. This will, however, be a fine balancing act against any successful negotiation of single market access for UK funds or the impact on having to comply with the Third Country Regimes.
Infrastructure: This is a distinct advantage for the UK market as it already has unrivalled existing infrastructure including product platforms, legislation, regulatory authorities and a powerhouse of a financial system. The key for the UK regulators is to maintain relationships with their EU counterparts and collaborate on industry matters.
Business model: The location of post Brexit funds will depend heavily on cross border investment services and the ability of these to be undertaken by current AIF and UCITS managers in the UK, including delegated functions as set by passporting provisions within MiFID, UCITS and AIFMD or under the current national private placement regimes.
One would hope management company passporting is available with the EEA after Brexit to facilitate the continued ability to sell UK funds to EU retail investors. What is clear, however, is that the UK industry should also focus on the increased opportunity for selling UK Funds to other countries outside the EEA by offering incentives to these new retail investors.
So how does Brexit impact the other fund jurisdictions, some of which are closely aligned with Britain’s current relationship with Europe? The Channel Islands provide such an example. Although Crown Dependencies to the UK, the Channel Islands are outside the EU and have built successful fund regimes with deep expertise by accessing European markets through the third country and national private placement regimes. Both Guernsey and Jersey have also received European Securities and Markets Authority’s recommendation to be in the first wave of third counries to receive the AIFMD passport. Growth, both in the number of funds and in the value managed by those funds has been consistent in the Channel Islands and it was recently announced that Jersey would be the domicile of Softbank Vision Fund, which is expected to be the world’s largest fund at an eventual $100bn.
Despite Brexit uncertainty, there does not appear to be any current focus on the re-domiciling of funds away from the Channel Islands, notes Roland Mills, a PricewaterhouseCoopers partner in the Channel Islands. He also highlights the largest fund promoters operating in the Islands have again chosen them for their latest fund launches, proving with the right legislation, an engaged regulator, a constructive relationship with Europe and the right local expertise fund that jurisdictions outside of the EU can thrive in managing European investors’ capital. So the UK can expect to continue its success with funds outside of the EU.
However, it is also clear that negotiating improved mutual access with the EU would cement the UK as one of the preferred locations for investment funds. Complacency should not set in and it is important that the industry, its regulators and service providers consider the options available to the UK funds industry given the potential protracted debates to follow, especially as German chancellor Angela Merkel said that trade negotiations will only come after exit negotiations.
Paul Garbutt, a partner and head of UK financial regulation at Grant Thornton in London, explains: “While Brexit remains a crucial strategic consideration, the level of uncertainty is still so great that it is not leading firms yet to take radical actions. People are preparing ‘insurance’ against worst-case outcomes and keeping those radical steps under review. Most do not expect though to have to make radical short or medium term change.”