Before we focus on what we believe the UK government should be doing, we, of course, need to consider what impact the UK's future relationship with the EU will have on our ability to shape the regulation of the asset management sector going forward.
It is now clear that the UK will be regarded as a "third country" under EU financial services law following the end of the Brexit implementation period.
As the debate over the future trading relationship with the EU continues over the remainder of 2020 (and potentially beyond), in the financial services context, a lot has been, and will continue to be said about whether the UK will have (or be deemed to have on a continuing basis) a legal and regulatory framework "equivalent" to the EU in all respects under all relevant EU financial services laws. Most notable, in the alternatives asset management context, are the Alternative Investment Fund Managers Directive (AIFMD) and the Second Markets in Financial Instruments Directive (and Regulation) (MiFID II).
It is worth considering how important maintaining an equivalent status really is and what the implications would be if we were to seek equivalence at all costs.
Starting with the latter question, if we assume that the EU will not accept that equivalence in our regimes today will constitute equivalence for a set period (the EU's current position), the UK may well be required to update its own law and regulation to track future changes to EU law (to some extent). This may not be something the UK wants to do bearing in mind it will not be "in the room" when it comes to agreeing such EU legislation. Indeed, seasoned (and for that matter Europhile) UK representatives who represented EU institutions in the UK's prior life as a full member state have publicly stated that the UK acted as a sensible brake on a number of pieces of existing legislation that could have otherwise potentially damaged the industry. There are any number of areas that could come within the scope of new or refined EU legislation in the future (not all of which the UK asset management industry will approve of) – pay regulation for asset managers and the financial transactions tax to name but two. As such, maintaining equivalence is not without its risks, so what is the benefit?
Equivalence may be important to the alternatives asset management sector in the event that the AIFMD "third country passport" is turned on in the future. The advantage of accessing the marketing passport, if it is ever turned back on, will be accessing EU professional investors without having to navigate the various private placement regimes in place across member states. However, a UK manager that accessed the third country passport would also become subject to oversight of an EU regulator and be subject to the full scope of applicable AIFMD rules. There is an open question on whether the passport will ever be made accessible to managers located in third countries but assuming it is, would this really make a material difference to how UK based managers are operating already?
Whilst access to a marketing passport would have benefits around ease of marketing throughout the EU, the prolonged Brexit process has meant that most UK domiciled managers have already put in place arrangements to replace the loss of the marketing passport for UK regulated entities following the end of the implementation period. This has been achieved through the establishment of an AIFM within the EU (most commonly in Luxembourg or Dublin) or relying on relevant national private placement regimes (which have proven satisfactory for US and Channel Islands funds). While there are still complications that are being worked through (including the roles of sales/IR teams located in the UK), neither of these models should be directly impacted by any ruling of (or absence of) equivalence between the UK and EU regulatory regimes.
On balance, to the extent there is a third country passport under AIFMD in the future, it is something the UK should look to access. But, we would argue, this should not be at all costs, particularly in terms of any changes the UK would be required to make to its post-Brexit regulatory regime. In any event, we would hope that negotiations on the UK's future relationship do not become so contentious that UK asset managers are treated any differently to, for example, asset managers located in the United States or the Channel Islands in terms of their access to the national private placement regimes.
However, in order to avoid a significant outflow of business from the UK, it is essential that UK firms are able to provide advisory and arranging services (and increasingly delegated portfolio management services) to EU AIFMs. The current expectation is that UK affiliates of EU AIFMs will continue to be able to provide advisory and arranging services to the EU AIFMs within their corporate group, given that most member states do not require a licence for this (although this could change in the future). The position may differ in respect of advisory and arranging services provided to a third-party manager that is not an affiliate. Further, while there may be regional variations, it should generally be possible for a UK firm to be appointed as a delegated discretionary portfolio manager by an EU AIFM, provided that a memorandum of understanding (MoU) is in place between the UK and the AIFM's home jurisdiction. In this respect, the recent announcement of an agreed MoU between the UK and ESMA is to be welcomed.
As such, it is not currently expected that the delegation of services to UK firms is under threat, but the EU's default position could change in the future and this would have a significant, adverse effect on the UK alternatives industry. This risk would be largely mitigated if the UK were to secure MiFID II third country equivalence (as well as removing some practical hurdles that are likely to need to be addressed in the context of the provision of services from the UK to the EU, including in respect of the delivery of certain marketing activities related to funds under management).
It is worth noting that views on the importance of equivalence will vary across the wider UK asset management industry. For example, in the context of the mainstream, retail investment market, any UK/EU treaty should ideally ensure that the UK UCITS funds continue to be recognised as suitable investment vehicles for retail investors and the existing passporting rights available under UCITS are retained. Further, in the alternatives sector, the entry into EU cross border derivates will certainly be simpler in the event that equivalence is maintained.
To the extent that the wider industry does require equivalence, we would argue that the UK regulatory regime should provide sufficient flexibility for UK alternatives asset managers to not have to comply with aspects of the regulatory regime that are solely there to enable an equivalence agreement with the EU (i.e. they only comply with relevant additional requirements if they want access to a passport). If UK managers do not require access to the passport, the UK should provide a specific and tailored regime that is attractive to alternatives managers around the world which provides investors and counterparties with protections that are effective but are not regulation for regulation's sake. Our suggestions on what this could look like are described below.