The United Kingdom (UK) government has today notified the European Council of its intention to withdraw from the European Union (EU), in accordance with Article 50 of The Treaty on European Union (the Article 50 notification). This means that:
- the European Council (on behalf of the EU and having obtained the consent of the European Parliament) and the UK government must now conclude an agreement setting out the arrangements for the withdrawal of the UK from the EU;
- the Treaties (that is, The Treaty on European Union and The Treaty on the Functioning of the European Union) will cease to apply to the UK on the date that a withdrawal agreement is entered into or, failing that, two years after the Article 50 notification, unless this period is extended by agreement between the European Council (acting unanimously) and the UK; and
- at the end of that period, the UK will automatically leave the EU.
This creates a number of challenges for UK-based fund managers because, not only is the timetable for Brexit uncertain, but the terms of the ongoing relationship between the UK and the EU, including any transitional arrangements during the immediate post-Brexit period, remain to be negotiated. And, whilst the UK wishes to negotiate "the greatest possible access" (having regard, for example, to cross-border access for the provision of financial services in the EU), the political will within the EU is such that it will not permit the UK to have an "à la carte" relationship with the EU, that is, to cherry-pick those parts of the Treaties which it favours. For this reason, the expression "hard Brexit or no Brexit" should be of great concern for those involved in the financial services sector.
How does this affect UK-based fund managers and what structuring options are available to them?
Brexit means that funds established in the UK will automatically become "third country" funds and UK-based fund managers will become "third country" managers, for the purposes of the AIFMD (that is, they are not established in an EU Member State), so that they will no longer be able to manage funds which are marketed to EU investors in reliance on an EU-wide marketing passport. Fund managers should, therefore, start to implement strategies which will ensure that they can continue to access the EU market seamlessly following the Article 50 notification and during the negotiating period. These considerations should form part of a long-term strategy for EU market access.
One option would be to re-locate to an EU Member State or to use a so-called "third party management company" in an EU Member State. Luxembourg would be a domicile of choice for UK fund managers reassessing their business models in light of Brexit.
The Grand-Duchy of Luxembourg, being the primary investment funds centre in the EU and the second worldwide, is recognised for its expertise in the funds industry. Luxembourg investment funds originating from UK asset managers today represent the second largest group after those of US managers.
Luxembourg can provide practical solutions to UK managers in order to ensure they retain their access to the EU market:
- by relocating to Luxembourg, UK managers benefit from an EU wide marketing passport allowing the alternative investment fund manager (AIFM) to market units/shares/interests of its alternative investment funds (AIFs) to professional investors within the European Economic Area (EEA), via a regulator to regulator notification process;
- UK AIFMs will also benefit from national private placement regimes (NPPR) allowing AIFMs to market alternative investment funds outside the EEA or within the EEA to other investors not qualifying as professional investors;
- under certain conditions, delegation and outsourcing by the AIFM of certain functions to the UK initiator is allowed by the Luxembourg regulator, the CSSF (commission de surveillance du secteur financier). In practice, this means that UK managers "re-locating" to Luxembourg will not have to move a large portion of their operations and staff out of the UK;
- third party management companies - alternatively, an EU-based AIF managed by a UK manager may also appoint a third party AIFM in Luxembourg. Such a third party AIFM will manage the AIF and enable it to access the EU wide marketing passport. In such a case, the portfolio management function can be delegated back to the UK manager.
The new unregulated "reserved alternative investment fund" (RAIF) and the special limited partnership (société en commandite spéciale), amongst others tools, enable an AIF to be established quickly and efficiently.
Luxembourg's business-friendly and stable political and economic environment, the quality of the "Luxembourg brand" and its worldwide recognition, its unparalleled cross-border fund distribution footprint, together with its strong global links and expertise provide a compelling EU solution Brexit.
Another option would be to re-locate to a third country, such as Jersey or Guernsey. Whilst it may seem counter-intuitive for a third country manager to re-locate to another third country, in the case of Jersey or Guernsey there are compelling reasons for doing so:
- in relation to financial services, the third country status of Jersey and Guernsey vis-à-vis the EU is entirely clear and will be unchanged by Brexit – the Islands offer certain and durable options for structuring funds and fund management operations. As noted above, the same cannot be said of the UK;
- both countries already meet the conditions set out in the AIFMD under Article 36 (being the conditions for an EU manager marketing third country funds in the EU under NPPR) and Article 42 (being the conditions for a third country manager marketing funds in the EU under NPPR). Jersey and Guernsey have been operating successfully within NPPR since 2013;
- cooperation agreements for the purpose of systemic risk oversight to ensure an efficient exchange of information have been entered into with the competent authorities of 25 of the 27 EU Member States (that is, all except Austria and Italy);
- Jersey and Guernsey are two of only five third countries which have, to date, been positively assessed by ESMA for the purposes of extending the AIFMD marketing passport, there being "no significant obstacles regarding investor protection, market disruption, competition and monitoring of systemic risk, impeding the application of the passport" to those countries;
- both countries have already implemented fully compliant AIFMD regimes in anticipation of the availability of the passport, for those Jersey or Guernsey managers who wish to be prepared once a passport becomes available to them, including where a Member States automatically switches off its NPPR;
- importantly, for fund managers who do not wish to access EU investors, being located in Jersey or Guernsey means that they can market their funds outside the EU without being subject to any EU regulation;
- there is a wealth of expertise in the Islands in the areas of portfolio and risk management, compliance and reporting, delegation and outsourcing models and ManCo services - the quality and commitment of service providers is second to none, whether a managed solution or substance office is required. The tax system is straight-forward and not subject to change. Tax neutrality is achieved using familiar vehicles such as limited partnerships and unit trusts, while fund management companies are able to operate on a zero per cent corporate tax basis. Jersey and Guernsey have led the way in adopting global best practice in transparency and anti-corruption, while maintaining confidentiality and privacy for businesses wishing to protect legitimate commercial interests. Furthermore, both Islands are easily accessible from a number of UK airports making access and attendance at board meetings very easy.
The optionality provided by Jersey and Guernsey means that the Channel Islands appeal to fund managers with any number of marketing strategies. They can market to investors in the EU under NPPR – our experience tells us that, in most cases, managers tend to market to investors in only very few EU Member States, so that doing so under NPPR is a straightforward and far less costly option than marketing under an AIFMD passport. On the other hand, a passport may become available in the near future, at which point managers could choose whether to "opt in" for a passport should they wish to market their funds more widely and, in particular, to jurisdictions which do not have workable NPPR. Lastly, for those managers who do not market to investors in the EU (or who have only a few EU investors who approach them on a reverse solicitation basis), Jersey and Guernsey continue to maintain regimes which sit outside of the AIFMD altogether, meaning that a manager established in those countries does not need to comply with the AIFMD at all.
In conclusion, fund managers based in the UK have a number of important structural and strategic decisions to make following Brexit. This briefing sets out some workable options to ensure continued access to international investors.
Please do not hesitate to contact any of our fund specialists, should you wish to discuss any of the matters outlined in this briefing.
 EU Directive 2011/61/EU on alternative investment fund managers.