Guest comment by Gavin Haran and Alex Amos, Macfarlanes
The loss of fund and business passporting rights and the imposition of a hard border between the EU and the UK post-Brexit has required many UK sponsors to find new ways to raise funds and market their products to investors in EU jurisdictions.
With the receding hope of mutual equivalence agreements between the EU and the UK to permit easy market access and an unhappy collision of regulations, some marketing models have become uncertain. Now increasing tension between EU and UK policymakers means that these uncertain models are facing growing scrutiny – and a potential regulatory backlash.
From the end of the Brexit transition period on 1 January 2021, the Alternative Investment Fund marketing passport has only been available to EU domiciled managers (AIFMs). UK AIFMs that formerly marketed their funds in the EU are forced to apply to individual EU member states to market their funds to local investors under so-called ‘national private placement regimes’. The local rules across EU countries vary widely, from restrictive to relatively open regimes.
Further, UK sponsors of EU AIFs with EU AIFMs may previously have had EU Markets in Financial Instruments Directive passports pre-Brexit. Post-Brexit, any such passports are no longer available and consequently the sales/distribution teams of any such UK sponsors need to consider whether their marketing of EU AIFs in the EU constitutes a regulated activity, notwithstanding that the EU AIFM itself can obtain an AIFMD marketing passport in relation to such AIFs.
To add to the confusion, following Brexit, the EU has introduced the Cross-Border Distribution of Funds Directive, which took effect in August 2021. The new rules permit asset managers to ‘pre-market’ their funds to EU investors, testing demand for investments before beginning to market a product properly to investors (albeit with some stringent conditions attached).
The particular marketing challenge is driven by MiFID II, wide-ranging legislation that governs the EU’s financial markets. In some member states, marketing a private fund is deemed to be a MiFID activity. Policymakers designed the specific rule, the receipt and transmission of orders or RTO, to regulate the activities of broker-dealers executing trading orders on behalf of their clients.
But some EU regulators have deemed the rule to be applicable to asset management entities in the context of certain aspects of marketing and closing a private fund, such as receiving subscriptions from investors and transmitting those ‘orders’. Reverse solicitation, whereby an investor contacts a firm on their own initiative, is an exception to the RTO rule. However, EU regulators have been concerned that UK firms have been falsely relying on reverse solicitation to get around marketing rules after Brexit.
The upshot is that in respect of both pre-marketing and marketing, UK sponsors have had to adopt one of a number of models in order to be able to continue their EU marketing activities. As a result, marketing funds into the EU can be both onerous and costly compared with the pre-Brexit situation.
UK asset managers have adopted five broad models to market their AIFs into the EU.
First, establish (or staff up) an EU AIFM or an EU MiFID entity with the required sales/distribution personnel. The full fat option. In this case, the manager can benefit from the EU’s marketing and pre-marketing passports. However, this option is clearly time-consuming and requires longer-term investment.
Firms that are marketing frequently into the EU might establish an EU entity that becomes a tied agent of a regulated firm that has MiFID permissions. For instance, service providers are now establishing MiFID regulated entities in countries such as Malta and Portugal to offer this service to managers.
Some firms have opted to second marketing staff from a UK sponsor to an EU AIFM or MiFID entity. This might enable continued marketing if local substance requirements are met. In other words, if the secondment is not merely on paper and the relevant secondees are spending an appropriate amount of their time in the EU.
Appointing UK sales/distribution individuals to GP or fund boards in order to carry out the relevant marketing and closing activities is another option.
Finally, chaperoning has been deemed a possible solution. UK marketing staff might engage with EU investors while accompanied by EU domiciled staff, with the latter facilitating engagement, for example by arranging meetings and acting as the point of contact. For all intents and purposes, the local staff would be regarded as undertaking the regulated activity.
These possible solutions have different costs and benefits. On a sliding scale, option 1 is the more costly but certain in regulatory terms, while option 5 is the least onerous but sits on shakier regulatory foundations and is already beginning to face regulatory scrutiny. Different models will work best for firms with different structures and with a desire to access investors in different member states.
The Central Bank of Ireland and the Netherlands’ AFM have expressed concerns about chaperoning. Primarily their worry is driven by the notion that some firms are using chaperones in name only: the real marketing work is being done by UK staff, meaning that some firms are circumventing the rules.
But there is a broader and highly political context. Since the Brexit vote, there has been a concerted push by some member states to use financial regulation to redomicile financial services from London to the EU. Asset management is a high-value activity. Some policymakers argue there is no reason why London should be Europe’s asset management hub after Brexit any more than it should be the primary domicile for Euro clearing. Marketing activities in relation to private funds, although somewhat ancillary to the core service of asset management, are still potentially caught by this post-Brexit uncertainty and regulatory scrutiny.
Less political, regulators are concerned that some UK managers providing products and services into the EU pose risks to local investors. The European Securities and Market Authority has noted “questionable practices”, while an overriding concern has been to ensure sufficient “substance” within the EU to provide risk oversight and local accountability.
Over the coming year, the EU is due to conduct legislative reviews and potential reforms to the AIFMD, MiFID II and UCITS regimes. Asset managers and investors should expect more scrutiny and, in turn, this could mean more restructuring and higher costs. As debates about mutual equivalence are yet to begin in earnest, Brexit’s impact on asset management is far from finished.