Alexandros Seretakis (Trinity College Dublin)
Following the decision by the UK to leave the EU, the European alternative investment fund industry has been confronted with legal uncertainty regarding the post-Brexit relationships between market participants in the EU and the UK. The UK’s asset management industry is the second largest in the world and the largest in the EU managing approximately £9 trillion of assets. Investment fund managers utilise the UK as a hub out of which they market their funds to investors across Europe. Brexit threatens to upend the European fund industry choking off the access of European investors to the UK’s investment fund industry. In case of a Hard Brexit the UK will automatically be classified as a third non-EU country and alternative investment fund managers (hereinafter “AIFM”) based in the UK will lose their access to the management and marketing passport introduced by the Alternative Investment Funds Managers Directive (hereinafter “AIFMD”). The AIFMD introduces a third country regime which allows non-EU AIFMs to access the European market. The AIFMD’s third country regime, which allows non-EU AIFMs to access the European market is not based on equivalence, but rather in the authorization of non-EU AIFMs within the EU. Nonetheless, non-EU AIFMs seeking to target EU investors and access the European market must abide by burdensome operational requirements.
An alternative strategy for UK AIFMs to access the European market in case of a Hard Brexit is to relocate their operations to Europe and delegate certain functions back to their UK units. In such a scenario the UK AIFM will establish a structure in the EU and delegate certain functions, such as portfolio and risk management, back to the existing operations based in the UK. However, the extensive use of delegation arrangements gives rise to the risk of regulatory arbitrage. UK managers could incorporate so-called letter box entities in the EU with minimal personnel and operations and delegate most of their functions back to the UK units. While delegation is permitted under the AIFMD, the AIFMD imposes rather strict requirements on the use of delegation arrangements in order to tackle the risk of regulatory arbitrage and the phenomenon of letter box entities. In its July 2017 Opinion (ESMA, “Opinion to Support Supervisory Convergence in the Area of Investment Management in the Context of the United Kingdom Withdrawing from the European Union”, ESMA35-45-34), ESMA sought to clarify the requirements imposed by the AIFMD and also introduced additional requirements regarding the assessment of delegation arrangements. Most importantly, in an effort to curb the emergence of letter box entities, ESMA stressed that authorised AIFMs may not delegate investment management functions to such an extent that exceeds by a substantial margin the functions performed internally. What is more, portfolio management and risk management cannot be delegated in their entirety. With respect to relocating entities, ESMA stated that relocating entities must transfer a sufficient amount of portfolio and/or risk management functions to their new home Member State. Relocating entities cannot maintain substantially more portfolio and/or risk management functions and the concomitant resources in a third country than in their new home Member State. In addition, AIFMs must have sufficient resources and expertise in order to monitor delegates. As a result, reliance on extensive delegation of tasks may not qualify as a long-term solution.
Overall, a Hard Brexit would have significant consequences for AIFMs based in the UK. Certain proposed alternative strategies, such as the extensive use of delegation, are not providing full access to the European market and/or are imposing significant financial and organizational burdens on managers.
The views expressed in this article reflect the position of the author and not necessarily the one of the Brexit Institute Blog
Alexandros Seretakis is Assistant Professor in European Financial Law at the Trinity College Dublin School of Law