How Brexit could affect investment fund 'passports'

UK-based asset managers are not expecting major upheavals to EU-domiciled funds from the country’s departure from the EU, according to experts.

As UK prime minister Theresa May today begins the two-year process of negotiations with her EU counterparts, the country’s financial services sector is bracing for fundamental changes to its relationship with its biggest overseas market.

Data from trade body the Investment Association (IA) showed that UK investors had £105.3bn (€121.3bn) invested in non-UK domiciled funds at the end of January. Ireland and Luxembourg are the primary homes for these funds. Meanwhile, non-UK investors had £67.6bn invested in UK-domiciled funds managed by IA members.

However, commentators have played down the impact of Brexit negotiations on cross-border investors.

David Suetens, managing director of State Street in Luxembourg, told IPE it could prove difficult post-Brexit to sell funds domiciled in Luxembourg or Ireland into the UK if fund passporting rules are affected. However, the global appeal of these funds could mitigate this effect, he said.

“Luxembourg and Irish funds are for the most part cross-border products recognised and distributed worldwide,” Suetens said. “Even if the passport were lost, regulations will nevertheless still be aligned, which should allow for sale into the UK as is already the case in other non-EU states. Luxembourg funds are registered for distribution in 70 countries worldwide.”

For EU investors in UK funds, Suetens said there could be “some re-shuffling of products and investors”.

“Promoters will most likely re-direct EU investors to EU-based vehicles and keep OIECs [UK investment vehicles] as local distribution products,” he said. “This said, to the extent regulatory frameworks for funds remain comparatively equivalent between the UK and the EU, and consumers are still allowed to purchase cross border… the choice ultimately will still reside with the investor who will ultimately set the course.”

State Street recently helped M&G – the asset management arm of British insurance giant Prudential – set up a Luxembourg SICAV to help distribute its products on the continent. Suetens said the process – which began before June 2016’s historic referendum – was unaffected by the Brexit-related uncertainty.

“Once the decision was made to set up a cross-border platform outside the UK and specifically in Luxembourg, the rules and process to follow were quite clear,” he said.

Julian Korek, global head of compliance and regulatory consulting at Duff & Phelps, said the success of EU fund domiciles such as Luxembourg and Ireland meant there was “no real need for managers to move wholesale operations abroad” from the UK.

However, Diala Minott, corporate finance partner at law firm Paul Hastings, said some asset managers still faced the task of convincing important staff to move away from London.

“We have seen some regulatory arbitrage ‎occurring in the industry with managers worrying about how they will convince their best talent to move way from London,” she said. “In most cases, the decision will come down to personal preferences as well as what historical infrastructure asset managers have in certain European jurisdictions.”

Cutting ties with Europe could open more opportunities for the UK asset management sector to sell its own funds into other markets outside Europe, Duff & Phelps’ Korek added. He highlighted Hong Kong, Singapore, Canada, and India as four markets with which he expected trading flows to strengthen.

However, Michael Collins, CEO of private equity trade body Invest Europe, urged his members to prepare for a worst-case scenario.

“The Brexit negotiations will be unprecedented in their complexity and even if all the issues cannot be settled in two years an extension of the talks or a transitional deal is far from guaranteed,” Collins said. “We advise all our members to consider the consequences for their activities of a UK exit from the EU in March 2019 without a deal on the future relationship.”

Fund passports for alternatives – introduced under the EU’s Alternative Investment Fund Managers Directive – could be affected by Brexit, he added. “An investor in one of the 27 remaining EU countries wanting access to UK-based funds might consider drawing up a contingency plan,” he said.