Over 300 management companies operate in Luxembourg, under a UCITS, AIFM or even a combined licence. Over 20 of them were created in just one year. And this number is likely to grow in the wake of Brexit. We’re analysing what’s at stake for ManCos and which models are likely to emerge in a post Brexit world.
Why Brexit poses questions to UK Management Companies
Last year, there were 166 UCITS and 411 AIFM ManCos in the UK. Together, they were managing respectively 1tn euros and 354bn euros of assets. In the long term, Brexit could have a large impact on the freedom of services implemented through the UCITS or AIFM directives as there will be a loss of automatic passport of services between UK & EU. Thus, UK based managers won’t be able to distribute their funds across Europe. The same will apply to their fund structures and management models.
Here’s what Brexit means in detail to ManCos based on their licence:
As a UCITS fund and its ManCo must be domiciled in the EU, UK-based asset managers would need to set up UCITS-compliant funds in a EU jurisdiction, such as Luxembourg or Ireland, or using a UCITS management company based in those territories to target European investors. UK UCITS managers could alternatively appoint a third party management company in an EU domicile, most likely Luxembourg or Ireland
With Brexit, the UK will be considered as a third country for the purpose of the AIFMD. All third countries are subject to an ESMA led equivalence evaluation. Without it, UK-based AIFMs would need to re-domicile themselves and their AIFs in the EU.
In case of equivalence and of a third country regime, UK-based AIFMs can access the EU professional investor base directly.
Also, a UK-based firm providing portfolio management to professional clients in the EU will be entitled to offer MIFID services in the EU if it registers itself with ESMA. UK-based portfolio managers would need to comply with local third country rules to continue EU portfolio management activity. Alternatively, a new portfolio management entity could be established in an EU Member State, with substance likely to be delegated back to the UK, depending on substance rules determined on a country by country basis.
What’s in it for EU funds selling into UK?
Another question that emerges is how EU funds will be distributed in the UK. In a post Brexit world, current passport privileges will not exist anymore. So, both EU and UK funds won’t have automatic access to their respective markets. In such circumstances, the UK has the upper hand. Indeed, 340 UK funds are sold into EU while 6,000 EU funds are sold into the UK.
Options for EU funds selling into UK include:
- Being granted an Overseas Designated Scheme by the Financial Conduct Authority.
- Creating a standalone UK fund range, mirroring Luxembourg and Ireland range. This option assumes portfolio management delegation survives. For instance, French fund managers holding Luxembourg fund, creating a UK fund, would want to delegate portfolio management back to France. In practice, many UK Open-Ended Investment Companies already delegate portfolio management outside UK and outside EU.
- Designing a feeder fund in the UK. This option implies a grandfathering of existing investors in the Luxembourg and Ireland UCITS, otherwise the complexity of transferring those investors to the feeder opens the challenge of tax crystallisation.
Surely, the ideal outcome would be to have passporting rights. And, it could be a compromise of agreeing on such a continuation for UCITS in return for the UK to be granted equivalence for third country passporting of investment services on segregated mandates, and for ongoing portfolio management delegation to UK.
Luxembourg gentle approach
So far Luxembourg has taken a gentle approach – promoting cooperation to minimise disruption. In the meantime, the CSSF has developed clarity on substance rules for legal entity establishment in Luxembourg with delegation back to the UK. In substance, it includes locating authorised management, key functions and IT platform producing daily financial – to name but a few – in Luxembourg.
What model is emerging?
Virtually, most UK ManCos are planning for hard Brexit. In practice, there will be a loss of automatic passport of services between the UK and the EU. Of particular relevance this will include fund distribution and cross border investment services. Currently, there’s been a lot of discussion around relocation of ManCos – or adding at least substance – from the UK to Luxembourg with some concrete announcements. Another trend is the appointment of a third party ManCo to manage Luxembourg product while getting a PSF entity to be MiFiD II compliant in the EU. One thing is sure, most UK fund managers with an EU distribution strategy are Brexit proofed.
The ability for an EU fund to delegate portfolio management to UK entities will survive, provided substance to oversee and retain responsibility is compliant. So equivalence is likely to replace compliance, but it may not be immediate. Indeed, firms will increasingly use EU entities to contract with EU clients, transferring contractual relationships accordingly and creating the substance where necessary to comply. The UK will retain and maintain a regulatory framework substantially in line with the EU to maximise chances of delegation and equivalence.
Key take-aways of what ManCos should be doing now
- Understand the Overseas Designated Scheme and advise investors of this option
- Make sure to have a Brexit “task force” focused on the implications for Asset Managers
- Design a client communications strategy
- Consider re-papering for agreements with clients where certain of the services are provided by UK, e.g. cash, FX, securities lending and collateral management.
- Make proactive impact assessments on top clients
Discover our ManCo Index to get a full view of their activities in Luxembourg.