The last post laid out the purpose and structure of the asset management industry. It also showed how the UK companies had benefitted from being a member of the EU, managing to accumulate a disproportionate amount of the region’s assets.
It illustrated how, as a member of the EU, the UK was able to sell and market investment funds around the EEA using London-domiciled funds as well as sales and marketing teams.
This post will start to explain what changes the industry has had to make now it’s outside of the EU as well as examining what additional changes could be in the pipeline.
The importance of regulation
If you are not familiar with the financial service sector, it can be hard to appreciate the burden of legal requirements. Asset managers operating in the EEA face both stringent local regulators as well as detailed rules from the EU.
These regulations are necessary both to prevent consumers from losing their life savings as well as to ensure the stability of financial markets. Asset management companies risk being fined if they fail to comply with these rules and view non-compliance as a serious reputational risk.
What being outside the EU means for the asset management industry
Now we have established how important it is for companies to play by the rules, we can discuss in greater detail the changes companies have had to make now they are outside of the EU.
While there are six key regulatory frameworks which govern how the asset management business operates in the EEA, we will focus on two. The first to be discussed is Ucits – the Undertakings for Collective Investment in Transferable Securities Directive.
What is Ucits and why is important?
The Undertakings for Collective Investment in Transferrable Securities Directive pre-dates the single market and was developed to allow for the management and sale of investment funds to individuals.
A key Ucits requirement is for the investment fund – the collection of individuals’ capital which is then used to buy assets like equities and bonds – to be domiciled in the EEA. The company which manages these funds also needs to be domiciled in the EEA.
Now the UK is outside the EU, it can no longer sell UK-domiciled funds in the EEA, using the Ucits passport, nor use UK-based management companies
To overcome this hurdle, many asset managers have domiciled both investment funds and management companies in the EU, principally in Dublin and Luxembourg.
Regulators have started to crack down on what they deem ‘brass plate’ operations – where management companies are established with minimal staff and requiring firms to establish proper operations in these jurisdictions.
Domiciling investment funds and building management companies within the EU is an additional expense and added complexity for asset managers.
At the moment, local regulators determine the appropriate level of governance, local substance and oversight for the Ucits funds they authorise. Once authorised by an individual regulator, these funds can then be sold throughout the EEA.
In other words, it’s not necessary for those who manage the portfolio – those who decide how the capital collected from individual investors should be invested – to be located in the EU.
As a result of Brexit, however, Europe is reviewing its delegation and substance rules for Ucits funds. The delegation rules govern what asset management activities can be done outside of EU, while substance rules outline how much local presence is required to oversee delegation arrangements.
The major fund domiciles, Ireland and Luxembourg, have both increased their local substance requirements in recent years – requiring companies to establish proper operations in their jurisdictions not just ‘brass plate’ operations.
The European Commission could also look to tighten the delegation requirements, especially around portfolio management, for Ucits funds. It’s unlikely all portfolio management operations would have to be located in the EU as this would have as big an impact on US as UK asset managers.
But increasing the delegation requirements could still have a major impact on the industry requiring more staff and assets to be located within the EU, says Sean Tuffy, head of market and regulatory intelligence, Citi Securities Services, in his 2021 FinReg Outlook.
The next post will examine the impact of no longer being covered by another EU regulatory framework as well as the impact of divergence on the sector.