This INDOS Financial article was first published by HFM Week and can be read here.
Brexit means Brexit, or so it was thought. Nobody quite knows what the UK’s negotiating position will be including possibly the UK government itself. There have been utterances among some in financial services that costly EU regulations could be scrapped or amended post-Brexit. Is it really necessary to curtail fund managers’ remuneration under the Alternative Investment Fund Managers Directive (AIFMD) and UCITS V, or introduce the multitude of new compliance obligations under the Markets in Financial Instruments Directive II (MiFID II)?
Hopes for any bonfire of regulations in the near-term is very unlikely in the UK. Firstly, and most importantly is that the UK continues to be a member of the EU so any regulations or directives will still carry their full weight, something reaffirmed by the Financial Conduct Authority (FCA). The timelines for leaving the EU are theoretical. A two-year window is activated once Article 50 of the Treaty of Lisbon is invoked but the UK government could be forced to consult with Parliament on its negotiating position leading to further delays. If talks between the UK and EU get bogged down in details or acrimony, as they likely will, Brexit could be adjourned for some time. In short, profound regulatory change or liberalisation of rules is not going to happen while the UK is negotiating with the EU.
Assuming Brexit is implemented painlessly, some believe the UK could probably do as it pleased in terms of regulation if it left the Single Market. Early indications do not look promising. The UK’s interpretation of MiFID II’s provisions for unbundling research costs is far stricter than the rest of the EU. If the UK wants to sell into the EU, it needs to have equivalence. The UK has implemented a number of existing regulations, so this should be clear-cut.
But Brexit is politically charged and any number of EU countries could veto the UK’s equivalence. The extent to which EU politicians are simply posturing is unknown but equivalence should not be taken for granted. Moving forward, the absence of the UK in EU policy making will likely result in further protectionism or restrictive practices. If the UK values its membership of the Single Market, it will have to abide by these provisions.
But what are the alternatives? A dual funds regime could be created allowing for managers with EU investors to sell into the EU, but comply with continental regulation, and also enable other firms without EU clients to sell outside of Europe. To make such a regime viable, managers selling globally ex-Europe would need to be subject to a lighter touch regime than that of the EU. Any dual funds regime is likely to borrow ideas from the EU, and this could include the depositary requirements.
However, a dual funds regime is likely to run into problems from EU countries with vested interests, notably Luxembourg or Ireland. Will the EU tolerate the UK creating a lighter touch regime on its doorstep yet retaining the fund passporting benefits? While Guernsey and Jersey have their own dual funds regime and equivalence from the European Securities and Markets Authority (ESMA), it has not been formally approved by the EU. In short, Brexit is unlikely to result in mass deregulation anytime soon.
Events in the US have added another dimension to Brexit. President-elect Trump has indicated UK relations will be prioritised, and he has also hinted that regulations which have stifled financial services may be repealed. Suggestions that Dodd-Frank will be culled are exaggerated although it is possible some elements may be watered down. The inclusion of several hedge fund managers in the Trump transition team may mean rules for private funds could be eased.
While this may be welcome news for US managers, it could complicate the AIFMD equivalence process. There was speculation Brexit would derail AIFMD equivalence approvals for third countries even prior to the Trump election. If the US makes fundamental changes to its regulatory regime, ESMA may be forced to reassess equivalence with the US causing inevitable delays.
Brexit and the Trump election have certainly shaken things up in the funds’ industry. It is still too early to say whether there is going to be a wave of deregulation, but one thing we can be sure of is that there will be much uncertainty for years to come.