Alternative investment funds operating in the European Union may lose out to stricter regulations being introduced as part of the Capital Markets Union following the Brexit vote held last week.
The European Commission established the CMU action plan nine months ago as part of a wider attempt to encourage European mid-market companies to seek alternative forms of financing outside of traditional bank lending. Tasked with leading the CMU was Jonathan Hill, the UK commissioner, who confirmed he will resign from the post shortly after the result of the referendum was announced.
The UK is the largest private debt market in Europe and the loss of its voice is a blow to the development of a harmonised regulatory framework, many in the industry say, as pan-European guidelines continue to take shape. Historically, the UK has had a less restrictive approach to regulations and its private debt market is the biggest. Deloitte’s most recent alternative Lender Deal Tracker, published at the beginning of this year, showed that over the previous 13 quarters 274 of the 629 deals completed across Europe were in the UK, a handsome 43 percent of the total.
In February, the EC published a report noting that in 2013 35 percent of small and medium-sized enterprises didn’t get the full financing that they required for growth from traditional banks. Two of the central pillars of the CMU are to remove barriers between cross-border investments across Europe and to diversify the number of funding sources that SMEs can tap into for capital.
Both ideas appear to be undermined by Brexit. While it is unclear what the UK’s relationship with the EU would look like once negotiations over a departure have been completed, voices are already being raised about the increasingly stricter border arrangements between the UK and the continental mainland.
Jirí Król, deputy chief executive of the UK-based trade association Alternative Investment Management Association, said that the vote could result in a double loss, where it “could potentially result in European businesses being deprived a source of capital and UK funds being deprived of opportunities in Europe”.
He said that the CMU could now potentially take a different direction following Hill’s resignation. As a potential regulatory framework is discussed by the member states, the UK’s absence may mean it won’t be involved in shaping it. Król pointed to the more restrictive regimes introduced in Italy and France recently, which contrasted with the UK’s more liberal approach to regulation.
In Germany, the view is one of disappointment. Patricia Volhard, partner at law firm P+P Pöllath, said that the “UK had always taken a reasonable view on regulation by accepting that it is needed and useful but that it should be applied in a proportionate way which would not harm the business as such. Germany (and Luxembourg) had a similar perspective on regulation, but because the UK input may be missing, the CMU may be shaped by other member states that have a stricter view on regulations”.
She added that the UK offers experience in working with nascent markets and assisting in their development and growth, as non-bank lending has developed since the global financial crisis.
Diala Minott, partner at law firm Ashurst, agreed that it would be disappointing not see the UK have a say in the development of the CMU. “The UK not having a voice in the creation of the CMU undermines the idea of allowing more non-bank lenders to enter the market.
“The UK has a history of lending to SMEs and has a more relaxed approach to regulation. EU member states tend to have a suspicious view of ‘shadow banking’, which is unclear to me because these lenders are working with institutional investors. And the effect of increasing regulations on private debt funds essentially lumps them in with banks, which is unfair because these are sophisticated investors and it is not their deposits being used.”
She added that the UK led the way in developing the private debt market, and countries such as Ireland, France and Italy have followed by developing their own markets. However, she is wary that the more prohibitive elements of the regulations introduced by certain member states may contribute to shaping a more restrictive regulatory regime for alternative investment funds.
The EC has moved quickly to appoint the former Latvian Prime Minister Valdis Dombrovskis to the Financial Stability, Financial Services and Capital Markets Union portfolio.
A European-wide regulatory framework is still in the process of being developed and it was only in April that the European Securities and Markets Authority published its report on a number of issues the EC will have to assess before moving forward.
The EC’s response was due in the fourth quarter of this year, but that may be in disarray as the EU may be concerning itself with negotiating the UK’s withdrawal, a process that is expected to take two years once article 50 of the Lisbon Treaty is triggered.