Having gained parliamentary approval, Prime Minister Theresa May now looks set to initiate a so-called hard Brexit in March, meaning the UK will likely lose access to the single European market. European Union (EU) rules give her two years to conclude a deal.
The wolves are already circling London’s financial services industry. Germany’s financial regulator met over 20 foreign banks at the end of January to market Frankfurt as an alternative base to London. A delegation from across the English Channel also tried in February to convince London-based financial firms that France's labour laws and tax rates were friendlier than they seemed.
London-based fund providers are also nervously watching developments.
Fund managers in Europe have long favoured the UK capital and fund structures — namely funds covered by the European Directive on Undertakings for collective investment in transferable securities (Ucits) and Alternative Investment Funds (AIFs), which are not. Ucits, in particular, have been sold throughout Asia too. That includes $91.3 billion of the funds sitting in Singapore, Hong Kong, South Korea, and Taiwan, according to Ernst and Young.
In both cases, marketing efforts have relied on the regional passporting regime that allows funds approved in the UK to be sold across the EU and also allows managers to offer their services across the bloc. London-based private banks, meanwhile, rely on the Markets in Financial Instruments Directive (Mifid) passport to provide investment advice to their European clients.
A recent State Street survey found that 80% of investors thought Brexit would affect their operating models. Some hailed from Asian managers and private banks. How worried should they be?
Limited funds impact
Those using Ucits structures to market funds into Asia should be safe. Most such funds are registered in Luxembourg or Ireland — both EU countries — with a sub-adviser back in Asia providing the investment advice. As long as this doesn’t change, the Ucits kite mark remains available to them.
The few Asian managers distributing offshore funds into Europe, or advising European funds, should also be broadly unharmed. Most regional managers selling hedge fund or private equity funds to EU investors target Switzerland and the UK, said Effie Vasilopoulos, a partner at law firm Sidley Austin in Hong Kong. To do so they use the private placement regime of the Alternative Investment Fund Managers Directive (AIFMD), the EU law covering alternative investment managers.
Here, regulated managers from approved Asian jurisdictions are granted permission from EU regulators via mutual recognition of their home country’s regulatory standards to market offshore funds, which are typically domiciled somewhere like the Cayman Islands or Singapore, into the relevant EU country.
Most Asia-sourced applications using AIFMD’s private placement regime seek to gain access to the UK, which will be unaffected by Brexit, said Leonard Ng, co-head of the EU financial services regulatory group at Sidley Austin.
Data from the European Securities and Markets Authority show there were 26 AIFMs active in the UK in the fourth quarter of 2014, versus just one across seven other EU countries.
Financial services fallout
Asian private banks offering wealth management services through London may be less fortunate.
Those servicing individual EU clients through a regulated UK arm provide investment management and advisory services under the Mifid passporting regime. This will be withdrawn following Brexit.
The UK government’s February white paper laying out its Brexit strategy offers scant help. It stated that the government will aim “for the freest possible trade in financial services between the UK and EU Member States”, including “strong cooperative oversight arrangements.” But the paper contains no detail on how it will do so.
The danger is that the final deal will fail to protect the passporting regime after Brexit and could end the regulatory equivalence between the UK and the rest of the EU. That would leave firms unable to service their EU clients once the UK leaves, said Ng.
“Asian firms’ London offices that wish to continue servicing clients in the EU need some sort of contingency plan,” he said. This means setting up a presence somewhere else in the EU.
While larger players such as HSBC and Lombard Odier already boast such a presence, lawyers and custodian banks that service Asian fund managers report that a ‘wait and see’ approach prevails among many of their clients.
That could yet prove short sighted. Europe’s 27 other member states will be in no rush to commit to a deal on financial services until they see what they are being offered on access to UK sectors such as automobiles or farming. The EU bloc has a rich history of running important negotiations down to the wire, as Asian owners of Greek debt during multiple last-minute bailouts will testify.
‘Wait and see’ is set to be a white-knuckle ride.