Asset management regulation in the U.K. and the EU will inevitably diverge after Brexit, with potential changes to the UCITS framework for selling funds across Europe a particular area of concern, according to experts.
The divergence will happen not because British rulemakers will deliberately seek to move away from European law, but rather due to the natural course of things, lawyers and compliance officers told the City & Financial's virtual Regulation of Asset Management 2020 summit on Oct. 14.
"We are not going to see a wholesale bonfire of the regulations in the U.K. [or] a day-one program of deliberate divergence for the sake of it," as neither the industry nor regulators want that, said Michael Collins, director of government affairs at investment firm M&G.
But divergence is "inevitable" over time, and in five years the U.K. and the EU will likely have moved apart through the operation of their own legitimate processes for establishing policy, he said.
Divergence
The asset management industry should prepare for that reality because "continued convergence on every last dot and comma" is not a credible or realistic outcome for regulation, Collins said.
"I think it's perfectly natural that over time, the U.K. would diverge," said Sean Tuffy, head of market and regulatory intelligence at Citigroup EMEA.
There has always been a slight divergence between the U.K. and EU "when the rubber was going to meet the road" in the framework for Undertakings for the Collective Investment in Transferable Securities, or UCITS, and the delegation regime in asset management, Tuffy said. Following Brexit the gap may widen as U.K.-based firms are decoupled from the EU UCITS framework, which allows for the sale of funds across Europe.
The European Securities and Markets Authority, or ESMA, has recently proposed a review and harmonization of delegation rules for alternative investment fund managers and UCITS. Delegation is widely used in asset management to market fund services across jurisdictions. This model allows fund managers in one EU member state to outsource their services to other member states. U.K. asset managers use the same model to service their EU-based clients.
Delegation model challenge
Post-Brexit, U.K. firms will not be able to be classified as UCITS and market freely to retail investors, and their management companies would not be able to act as management companies of EU-based UCITS. The only way U.K. fund and investment managers could continue providing portfolio management services to EU UCITS will be on a delegated basis, which depends on their compliance with the UCITS delegation regime.
The potential UCITS framework changes are an area of great uncertainty for the U.K. asset management industry and one that the sector is watching very closely, the panelists said.
In a letter to the European Commission, ESMA flagged an idea for quantitative along with qualitative measures for delegation, Tuffy said.
"No one knows what that means, but it spooks everybody," he said. A push to create third-country roles in the UCITS framework could lead to U.K. fund managers having to hold more substance within the EU, he said.
The U.K. formally left the EU on Jan. 31 and the post-Brexit transition period will end Dec. 31. After that, U.K. financial firms will no longer be allowed to use passporting rights to sell their services into the EU single market. Negotiations between the two sides on a trade agreement hit the rocks earlier in October with U.K. Prime Minister Boris Johnson warning businesses to prepare for a no-deal Brexit.
The asset management industry is "as prepared as it can be" for any outcome after Dec. 31, the panelists said.
Soon after the Brexit vote in June 2016, the industry gave up on the there being any passporting rights or real broad equivalence following the U.K.'s departure from the EU, Tuffy said. Over the last few years, U.K.-based asset managers have been figuring out what substance they need in the bloc to continue their fund operations, and have chosen local bases, mostly in Ireland and Luxembourg, he said.
Ireland has attracted most of the financial services companies making post-Brexit moves, with 35 announced moves and relocations so far, according to S&P Global Market Intelligence research published Oct. 13.
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Investment firms including Aberdeen Standard Investments, Ashmore Group PLC, Legg Mason Funds Management Inc., Hermes Investment Management Ltd. and Legal & General Group PLC among others, have chosen Ireland. Luxembourg, alongside France, is the third most popular destination to which to move operations, and the preferred continental European center for BlackRock Inc., 3i Group PLC and American International Group, Inc.
Despite being prepared for a no-deal, cliff-edge scenario, from a current perspective, the asset management sector could be hit by a slew of new challenges after the end of the transition period as equivalence with the EU has always been a "pipe dream," the panelists warned.
Still time for 'plot twist'
"There is still time for a plot twist, given that there is the great poker game going on in respect of the political negotiations," Simon Crown, partner at law firm Clifford Chance, said during the panel. Financial services could be affected not only by what the two sides might agree upon but also by "new views or even nuances that come out of guidance from regulators over the next month or two," he said.
The U.K.'s position that it may unilaterally alter compliance with the withdrawal agreement "has really soured some relationships, and has potentially hardened some views in the EU," Crown said.
Earlier during the conference, Nick Miller, head of asset management at the U.K.'s Financial Conduct Authority, said now that it had left the EU, Britain will not adopt the new Investment Firm Regulation and Investment Firm Directive that will be implemented in the bloc from June 2021. Instead, the U.K. will develop its own regime that should be implemented by June, Miller said.
Panelists at the conference noted the uncertainty U.K. companies face in that regard.
Tim Fassam, director of government relations and policy at the U.K. Personal Investment Management and Financial Advice Association, said the regime cannot be finalized before the scope of the deal between the EU and U.K. is clear.
From the current standpoint, it is very difficult to know how much leeway the FCA will have to create a U.K.-specific regime. The framework will call for fundamental changes, some of which may not be implemented by June 2021, he said.
"There is a real question mark whether that deadline is sensible or even practically possible," he said. The EU directive will require some investment firms to be subject to the same prudential rules as banks, specifically in terms of capital, consolidation, reporting, governance and remuneration.
"The skinnier the deal the U.K. and the EU sign up to, the greater the sovereignty and the inevitability of diverters [in regulation]," M&G's Collins said.