AIFMD – the Brexit effect

Fund managers are waiting for bated breath as Brexit negotiations continue – what will affect fund status very much depends on whether the UK government can achieve the hard Brexit it initially proposed. Politically, this looks increasingly difficult to deliver, as industry bodies push to retain access to the single market, with all its benefits.

In financial services, a soft Brexit would mean the asset management industry would retain all the passporting rights it currently enjoys for EU-domiciled funds. Under a hard Brexit, the loss of access to the single market – investors’ biggest fear – would result in UK-domiciled UCITS and AIFs having to leave those frameworks and being treated as third-party funds. It’s possible that this could only be a temporary blip, but in the interim funds would be subject to national private placement regimes (NPPRs) – these would have to be negotiated individually with each EU member state and not all NPPRs are the same.

The European Securities and Markets Authority (ESMA) is working on creating a framework for third-country passporting. Not long after the UK’s referendum, it advised the European Parliament on AIFs, noting that there might be relative ease for UK-domiciled funds to access a passporting scheme. There is already a precedent that enables non-EU fund managers to establish AIFs in the EU while the portfolios continue to be managed in their own domicile. However, this could be threatened if EU regulators tighten the rules.

Investors who have invested in AIFMD compliant funds are increasingly nervous, as recent surveys indicate they would actively withdraw assets if the UK regulator reduces protections under a hard Brexit – this is not without substance, given the government would then seek to position UK financial services under a very light regulatory regime tilted towards offshoring. Many investors, particularly institutional investors,  are not mandated to invest in offshored funds. Both investors and fund managers are in agreement that retaining access to the single market is vital and that being outside the UCITS directive would see an outflow of funds from the UK back to the Americas and Asia-Pacific. Markets in the USA are already reducing investment into European funds, because investors’ jitters are translating into not wanting exposure to a post-Brexit economy.

However, in early January, the Financial Conduct Authority announced measures to strengthen protections for investors, including those investing in AIFs. For example, fund managers will be required to appoint at least two independent directors on their boards and will face tougher obligations to act in investors’ best interests. This indicates that the FCA actually has no intention of ripping up the rulebook should a hard Brexit take place, which should reassure nervy investors.

The FCA has also expressed concern about the opacity of private equity and hedge funds, particularly regarding disclosure of fees, and intends to introduce measures to improve transparency. The SEC has already tightened its own regulations on fee disclosures for fund managers. A similar move by the FCA to beef up the regulations in the UK for AIFs would also increase protection for investors.