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The Brexit pause

Brexit delay offers continued uncertainty for UK investment management industry

The European Council’s agreement to delay Brexit eliminated the immediate risk of a potential no-deal withdrawal; however, the United Kingdom’s (UK) investment management sector continues to plan for either scenario. The industry has already invested significant resources in preparation for Brexit.

An uncertain political future

Key insights

  • Temporary financial services agreements have been struck to cushion the blow of a no-deal Brexit but are not seen as sustainable, long-term solutions
  • Fund managers have led the flight from the UK, with dozens setting up offices in Dublin and Luxembourg
  • Political uncertainty is hampering the UK’s hopes of renegotiating the WA and a new financial services trade deal could be years away

On April 11, 2019, the European Council granted the UK’s request for a further extension of the Article 50 notice period, delaying Brexit until October 31, 2019. The decision specifically references the terms of Article 50(3), which allows for an earlier exit should both the European Union (EU) and the UK complete their ratification of the Withdrawal Agreement (WA). Until then, the UK remains an EU member with full rights and obligations.

The UK government’s WA has been defeated three times in Parliament since January 2019. With continued political uncertainty following Prime Minister Theresa May’s June 7, 2019 resignation as leader of the Conservative Party, the potential for a no-deal Brexit remains. With no deal, the UK will become a “third country” according to EU law, meaning investment firms will lose passporting rights into EU member states.1 In preparation for this possible scenario, many firms have been establishing parallel structures to support a more seamless transition. Firms with existing offshore capabilities are already well positioned.

Regulators strike temporary agreements to cushion no-deal impact

The long-term consequences for the UK’s GBP 7.7 trillion asset management industry remain uncertain, deal or no deal. The WA established the framework under which the UK would exit the EU, and so does not include details regarding the eventual playing field for UK and EU-based fund managers seeking to passport into each market. It does, however, set a transitional period until December 31, 2020, in which the terms of the future UK-EU relationship are to be agreed. During this transitional period, the UK will still be regarded as part of the customs union and the EU’s Single Market, meaning “business as usual” for UK and EU-based asset managers.2 A no-deal Brexit would have more immediate and far-reaching consequences, however regulators have been working on strategies to minimize the impact. The European Securities and Markets Authority (ESMA) and the UK’s Financial Conduct Authority (FCA) agreed in January 2019 to allow the continuation of so-called delegation rights that allow funds to be marketed and sold in one country and managed in another.3 In February 2019, they also signed memoranda of understanding to coordinate oversight of investment funds in the event of a no-deal withdrawal, although with most having only a two-year shelf-life.

While the industry may feel it is moving fast towards a hard Brexit, circumstances and positions can change rapidly

The EU may revisit how it defines a third-country regime at its next review of regulations governing the sale and management of mutual funds across borders, which could alter the agreed delegation rights.4

“While the transitory agreements may not be sustainable in the long term, they do offer a short-term solution to get past the deadline,” said David Petiteville, Director, Regulatory Solutions at RBC Investor & Treasury Services.

Preparing for change

While a no-deal Brexit remains a potential outcome, market participants have been encouraged to prepare accordingly. The Conservative leadership election will conclude in mid-July, leaving little time for May’s successor to renegotiate with Europe. In any case, Brussels may not be receptive to revising the terms of the current WA. “There is clearly a dichotomy of opinion, with Europe reinforcing that there is no or limited place for negotiation, whereas there are political constituents posturing their intentions to renegotiate,” said Petiteville. “While the industry may feel it is moving fast towards a hard Brexit, we have seen that circumstances and positions can change rapidly.”

The reality is that
a new UK-EU trade
deal for financial
services could be
years away

The Investment Association, a trade body for over 200 UK-based asset managers, has urged its membership to be ready to implement their no-deal contingency plans. Many have already done so. Assets worth approximately a trillion pounds are moving from London to EU hubs, with the parallel shift in jobs likely to top 7,000 according to a report by EY in March 2019.5 London-based think tank New Financial said in a separate report in March that 269 UK-based financial firms had reacted to Brexit by setting up new hubs, moving staff, or rebasing assets elsewhere in the EU.6 Fund managers have been the most proactive, with 69 shifting operations to Europe, and the overwhelming majority setting up shop in Dublin (30) and Luxembourg (24).7

“It is clear that London is shedding, and will continue to shed, a significant amount of its financial service offerings and specialties to other European financial centers as a result of Brexit,” Christopher Giancarlo, chairman of the Commodity Futures Trading Commission (CFTC), said in June.8

UK financial industry wary of ceding regulatory control to EU

The UK financial industry’s efforts to secure its Single Market privileges post-Brexit have so far been unsuccessful, with the EU rebuffing a proposal for “mutual recognition” brought by a united front of asset management, insurance, and banking lobby groups. This has resulted in the Treasury Department seeking advice from prominent global banks directly. The banks have hired consultants to devise solutions and options to make the EU’s existing equivalence system more workable.9 The industry is split over how far to embrace the equivalence regime, given the potential to require ceding control to Brussels, effectively making the UK a financial regulation “rule-taker”.

Many firms have been establishing parallel structures to support a more seamless transition

The reality is that a new UK-EU trade deal for financial services could be years away, and its completion will be highly dependent on the political situations in both Europe and the UK. Temporary agreements are in place that have allowed the UK’s clearing houses and share trading firms to continue to deal with euro products but the withdrawal of these privileges post-Brexit could affect Britain’s standing as a global financial hub. “If we reach a point where the UK cannot clear euro-type products, or offer UCITS, then the impact will certainly be significant,” said Petiteville.

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