The UK could run a two-tier regulatory regime for alternative fund managers once it leaves the European Union. The UK would seek to apply the Alternative Investment Fund Managers Directive only to those funds seeking to market funds to EU investors. It could opt for a lighter-weight regime for funds run out of London but marketed outside the EU, said regulatory consultants and alternative fund management experts.
"There could be circumstances where there is an AIMFD stamp for funds being marketed into Europe, but it wouldn't be necessary to apply this to all funds that aren't being marketed into Europe. That dual regulation is perhaps a valid approach and the UK might look at if it wants to change the regulatory environment and still maintain those rights," said Tim Thornton, chief operating officer for fund services at MUFG Investor Services.
A two-tier approach to regulating alternative investment managers could help the UK retain some of its clout as a fund management hub once it leaves the EU.
Widespread tinkering with EU financial regulation is not expected, because many UK-based firms will want passporting privileges to sell products and services to EU customers. However, when it comes to the AIFMD the case for all UK-based managers to adhere strictly to the directive is less clear, especially if their investor base is based solely in the UK or outside the EU.
Moreover, alternative fund managers are likely to lobby the Conservative government for concessions on the regulation of parts of their businesses in light of the vote to leave the EU.
AIFMD Passport Difficult to Deny, in Theory
In theory the granting of a third-country AIFMD passport to UK managers should be fairly automatic upon departure from the EU, given the regulation has already been adopted and implemented. However, as many commentators have noted, third-country passports are a privilege for the EU to grant, not a right.
It will be very hard for ESMA to deny a passport to the UK given the regulatory regime is identical at the moment. Only if post-Brexit or during the negotiation period the UK were to change the regime could ESMA justify not granting passporting rights. Otherwise the UK would have a strong case for legal appeal due to uncertainty about jurisdiction of courts here," said Thornton.
ESMA taking its Time on Granting AIFMD Third-Country Passports
Only five of the 12 non-EU countries assessed – Canada, Guernsey, Japan, Jersey and Switzerland – received unqualified positive advice that the Third Country Passport should apply to them. The US, Hong Kong, Singapore, Australia, Bermuda, Cayman Islands and Isle of Man received qualified advice, and will likely be subject to further assessment.
"Whilst ESMA's views on deemed equivalence highlight some issues (including legal, regulatory and political) that the UK may face in the mid- to long term following any Brexit event, the advice suggests that the extension of the Third Country Passport to the UK, as a non-EU country, should be relatively simple to obtain, assuming that the UK's AIFMD regime, as implemented, remains in place," wrote Ashurst's regulatory team in a recent briefing.
However it is far from clear when third-country passports will be activated, because ESMA has not followed the procedural requirements under the AIFMD. ESMA's advice on passports came almost a year after the deadline set out in the directive and only covered 12 of the 22 countries that were expected to be assessed.
"Within three months of receiving the 'positive' advice and an opinion, the Commission must adopt a delegated act specifying the date the relevant legislative provisions in the AIFMD will become applicable and whereupon the Third Country Passport will be extended…" wrote Ashurst.
However, whether the Commission will go ahead and activate the passports for the five countries ESMA deemed equivalent is not a certainty. It could conclude ESMA's advice does not contain a positive assessment of enough third countries. It could wait for ESMA to assess more countries positively or wait for the planned review of AIFMD in 2017 to clear up problems and press on with passport activation.
"With all these open-ended questions on the assessment and the timing of the activation of the Third Country Passport, the serious implications of termination of national private placement regimes, and the political, economic and regulatory uncertainty of Brexit, the Commission may follow the ESMA approach of sitting on the fence, and defer the implementation of the Third Country Passport. … In short, the Third Country Passport activation does not appear to be on the immediate horizon," said Ashurst.
Managers should engage a wait-and-see approach to Brexit's impact on passporting while making some contingency plans for future business. They will want to consider how these issues could pan out and therefore how to domicile the fund and the management company for that fund.
"If the primary investor base for a fund is Europe, companies may be better off to hedge their bets and set up funds and companies in Ireland or Luxembourg where there won't be any issues. with passporting. Conversely if managers are setting up a new fund and the primary investor base is in the UK, they would want to be in the UK. If you're split between the two, you need to make a judgment call about where you want to set up" said Thornton.
Existing funds and managers should keep a watching brief as the situation unfolds. Certainly they should have contingency plans to move or have a route into Europe if passport is not extended.
"That could be setting up branch offices in new jurisdictions or establishing relationships with third-party management companies in Dublin, Luxembourg or other jurisdictions if in the event of an exit they needed to have an AIFMD management company and the UK didn't have passporting rights," said Thornton.