Flight from London?

In this article series, RBC Investor & Treasury Services explores potential destinations for London-based asset managers and financial services providers seeking to retain access to EU markets and clearing activity, post-Brexit. Market coverage includes Dublin, Frankfurt, Luxembourg and Paris.

The UK's withdrawal from the world's largest trading bloc poses a significant challenge for London's asset management industry

On March 29, 2017, the UK formally triggered Article 50 and initiated the two-year process of negotiating its exit from the EU. During its 44-year membership in the EU, Britain established itself as a global financial leader with GBP 1.2 trillion of assets managed within the UK on behalf of EU investors.¹ The UK's withdrawal from the world's largest trading bloc poses a significant challenge for London's asset management industry.

After voting to leave the EU in a national referendum in 2016, Britain had hoped to achieve a free trade agreement in parallel to its exit negotiations. However, the European Council has ruled out the possibility of discussing any future trade deals until after Britain has finalized its withdrawal from the EU.² As a result, when the UK formally exits the EU, it will likely have limited access to the European Single Market and the Customs Union.

In light of the expected protracted UK/EU renegotiations, asset managers and financial service providers currently based in London are concerned about the potential impact on their access to EU financial 'passports'. These passports grant firms the right to seamlessly trade financial instruments across the European Economic Area (EEA), within a unified regulatory framework.

The question of MiFID

The EU's regulatory framework for trading financial instruments is complex and multifaceted. The Markets in Financial Instruments Directive (MiFID) framework introduces a standardized ‘single passport’ procedure for cross-border activities (e.g., reception and transmission of orders (RTO), execution of orders, portfolio management, investment advice), and requires the establishment of branches across the EU.

London's status as a global leader in finance could be affected

Should UK-based financial firms lose access to their MiFID passports, London's status as a global leader in finance could be affected. As many as 70 percent of UK-based financial professionals now expect Britain's withdrawal from the EU to result in asset managers losing their passport.³ Some financial firms are looking to hedge against this risk by establishing operations in both markets to ensure that whatever bespoke agreements are put in place between the UK and EU, they are as prepared as they can be to comply with MiFID requirements and retain their passporting rights.

Access to EU mutual funds

A key driver behind the success of London's asset management industry has been the EU-wide framework for UCITS funds. The UCITS vehicle accounts for more than 30,000 funds across the EU, with total assets exceeding EUR 8.8 trillion in value. In combination, UCITS, along with the Alternative Investment Fund Managers Directive (AIFMD), have granted London-based financial service firms access to more than EUR 14 trillion of assets across Europe.

In 2016, the European Securities and Markets Authority (ESMA) issued advice indicating that it was open to the potential for non-EU managers to sell funds within the European economic bloc.⁴ However, following the UK's decision to exit the EEA, ESMA stalled plans to broaden access to non-EU fund managers.⁵

Britain's departure from the European Single Market would mean that the UK may have to trade financial instruments with EEA states under new and as yet undefined frameworks. At this time, asset management firms operating within the UK are unclear as to whether their existing operations will be viable beyond March 2019.

Existing frameworks and third country equivalence

London-based firms hoping to continue trading financial instruments across the EU after 2018 will need to comply with the third country regime under MIFID II which allows third country firms to:

• establish an authorized branch in any EU Member State in order to provide services to retail and elective professional clients
• conduct regulated business with professional clients and eligible counterparties from their home country by following the cross-border model (subject to registration with ESMA and a positive equivalence decision by the European Commission)

UCITS and Alternative Investment Funds (AIFs) currently domiciled in the UK may need to reconsider their domiciliation

UCITS and Alternative Investment Funds (AIFs) currently domiciled in the UK may need to reconsider their domiciliation. Opting to remain domiciled in the UK would disqualify funds under UCITS and AIF regimes and could either limit or eliminate their ability to service clients in the EU market.

Preparing for life outside the EU

With uncertainty mounting over the UK's future access to European markets, asset managers, hedge funds and private equity firms have begun scouting alternative locations on the Continent to use as a base for their operations. As many as 85 percent of UK-based financial service providers now believe that at least some of their operations will need to be relocated in order to continue trading EU assets.⁶

Already, US insurer AIG, investment group M&G and private equity firm Blackstone Group have announced intentions to relocate to Luxembourg.⁷ Dublin, Paris and Frankfurt are other likely destinations.

Each of these cities is vying to attract London-based firms and establish themselves as Europe's alternative finance capital. As major financial firms from London decide to seek new pastures, a new question emerges: which city they will choose?

Next in RBC Investor & Treasury Services' Flight from London series: Dublin

Sources

1. Financial Times (December 11, 2016)  EU rivals eye £1.2tn asset pot in UK as Brexit looms
2. Council of the European Union (March 31, 2017)  Draft guidelines following the United Kingdom's notification under Article 50 TEU
3. Financial Times (December 4, 2016)  70% of asset managers fear Brexit fund passport loss
4. Lexology (May 17, 2016)  Update on Status of AIFMD Implementation and Passport for Non-EU Funds
5. Financial Times (March 26, 2017)  The five big questions Brexit poses for fund managers
6. Financial Times (December 4, 2016)  70% of asset managers fear Brexit fund passport loss
7. Reuters (March 14, 2017) Blackstone picks Luxembourg for EU base - Luxembourg official says