Are You Ready for a No-Deal Brexit?

September 13, 2018

Preparing a Contingency Plan for the UK Leaving the EU on 29 March 2019

The UK Government’s White Paper The Future Relationship Between the UK and the EU, published on 12 July 2018, was intended to signal a new pragmatic approach to secure a settlement this Autumn, building on the deal agreed in principle earlier in the year to leave existing arrangements in place until 31 December 2020. In essence, the UK was proposing a modified approach to financial services (reduced access based on enhanced equivalence rather than mutual recognition) in return for free trade in goods and ongoing cooperation in security and other institutional arrangements.

Unfortunately, the hard-won compromise achieved within the UK Cabinet at its so-called “Chequers’ weekend” lasted less than a week, ending in the resignation of several pro-Brexit government ministers. Prime Minister May’s difficulties were further compounded by a statement on 20 July by Michel Barnier, the EU’s chief Brexit negotiator, which maintained a highly critical stance regarding the UK’s revised proposals.

It is not too much of an exaggeration to view these developments as triggering a sharp reversal in the expectations of most observers in the past two months: from a central forecast of a pragmatic EU/UK deal (even if kicking the most controversial issues further down the road), to growing fears of a “hard” Brexit in just over six months’ time. This has been reflected in the key USD/GBP barometer – at the time of writing some 10% off its twelve month high (seen back in April).

What Should Clients Do in Response?

Some of our clients have already prepared contingency plans for a hard Brexit and many more will have considered a range of scenarios in an attempt to future-proof their livelihoods. ACA cannot, of course, advise here on the specific impacts for every single business model, any more than we can predict with certainty what will happen between now and next March. However, we can highlight some of the likely problem areas that we see arising for our clients, particularly in the alternative investment management sector. What are the Chief Problems Under a Hard Brexit for Each Category of Investment Manager?

The following table summarises the key impact areas for the principal categories of UK investment managers, and may be used as the basis for contingency planning and further discussions with your professional advisers:

Type of FirmKey Potential ImpactsPotential Actions
UK MiFID FirmLoss of MiFID passporting rights
Disruption of sub-delegation arrangements with EU platforms
Establish an authorised MiFID firm in the EU, or a third country branch under Art. 39 MiFID II Reliance on reverse solicitation provisions
UK AIFMLoss of AIFMD marketing passport (EU AIFs only) Loss of EU AIF status (UK AIFs only) Reliance on NPPR: Art. 36Establish an AIFM/ redomicile AIF inside the EU and re-apply for marketing passport Replace with Art.42 (revised Annex IV reporting requirements)
UK UCITS Firms and Management CompaniesUK funds lose UCITS status (becomes an AIF) UK Mancos lose UCITS status Disruption of sub-delegate arrangements with EU MancosRe-domicile Fund and Manco in the EU (using passport if not in same state) Establish an authorised MiFID firm in the EU, or a third country branch under Art.39 MiFID II

To What Extent Will There Be a Legislative and/or Regulatory Cliff-Edge Next March?

Whatever else happens in the wider world if Brexit occurs next March, this will not affect the fundamental regulatory constructs already in place in the UK. The European Union (Withdrawal) Act 2018 provides for the conversion of existing directly applicable EU legislation into UK law (e.g., short selling regulation, EMIR and MiFIR), and the preservation of existing UK laws which implement EU obligations (e.g., AIFMD and MiFID II). The FCA has also been working hard to be in a position to convert its Handbook to reflect this overall framework, if required. An update from the FCA on this work, together with a consultation on changes proposed is expected in the autumn.

Will I Be Able to Attract and Retain the Best Staff from the EU?

The UK Government has gone out of its way to reassure firms and individuals of the continuity of existing arrangements for EU citizens (and their families) living in the UK. Under an agreement already reached with the EU, those having lived in the UK for five years will automatically be able to apply for “settled status”. Those having lived in the UK for less than five years will be able to apply for “pre-settled status”, which permits them to stay for a further five years, at which point they can apply for settled status. In neither case is there a requirement to do anything until 1 January 2021.

Although the longer term picture is less clear (for EU citizens arriving after 1 January 2021), we find it hard to envisage an outcome where the UK government did not seek to preserve the financial sector’s ability to attract top worldwide talent.

What Will Be the Impact of the End of the Current MiFID Passport Regime?

The UK government has already conceded that the current passporting regime for UK firms will end – albeit that the cessation date will be brought forward to 29 March 2019, instead of 31 December 2020 under the provisional transitional deal. UK firms relying on the passport must thus seek to mimic this arrangement by either creating an entity inside the EU or transferring certain operations to existing EU affiliates or third party EU platforms. Otherwise they risk business disruption in the event that the UK fails to secure co-operation agreement(s), and whatever else may be necessary with the relevant EEA Member State(s), to permit the cross-border provision of investment services (to the extent they are unable to rely on ‘reverse solicitation’ carve outs).

Note also that the FCA is committed to providing a Temporary Permissions Regime to allow EEA firms to continue to provide investment services in the UK for up to three years after Brexit. We envisage that such an arrangement could become semi-permanent given the UK government’s commitment to financial services.

In practice, reliance on the passporting of investment services is uncommon in an alternative investment management context. The marketing of hedge funds in the EU for example, is commonly handled within National Private Placement Regimes (NPPRs), albeit that this is not straightforward in many jurisdictions. Given that the domicile of such funds is, typically, outside of the EU, this may mean that the existing NPPRs will remain viable for UK AIFMs post Brexit, albeit with changes owing to the UK AIFM being based in a ”Third Country”. A notable exception to this from an AIFMD perspective is the provision of sub-delegated investment management to a Luxembourg entity (cross border), where the regulator insists on the (MiFID) passport.

There has been some discussion about whether MiFID II’s newly established regime for third country firms provides a potential route for UK firms wishing to continue to passport their services within the EU. However, similar provisions in other European financial legislation, including EMIR and AIFMD, have shown this to be a highly complex and politicised process. It is very hard to envisage this happening in the short term following a no-deal Brexit.

How Does This Affect My Distribution Strategy?

For firms managing AIFs, the main impact will be to UK AIFMs marketing EU AIFs; specifically, the AIFMD marketing passport will no longer be available to such firms.

UK AIFMs marketing non-EU AIFs, as noted above, will see procedural changes and challenges. Firms marketing AIFs under Article 36 will have to move these AIFs to Article 42 status, though the ability to do so will require the implementation of cooperation agreements (between the UK FCA and the relevant member state authority). The disclosure and reporting requirements under both regimes is similar albeit multiplied (for example, Annex IV reports would need to filed in each jurisdiction where a fund is marketed). In the longer term, a question mark remains as to the political environment and mainland Europe’s traditional antipathy to the alternative management sector.

The position of UK UCITS, and UK UCITS management companies has yet to be fully clarified but, essentially, they lose their “UCITS status” on the day of Brexit. As we understand it, many such firms affected by this have already taken steps to side-step this eventuality by the creation of EU based affiliates or through engagement with UCITS management “platforms”, typically located in Ireland, Luxembourg or Malta. Indeed, we are likely to see the growth of AIFMD and MiFID platform businesses.

Will I Be Able to Provide Delegated Investment Management Services to Entities Inside the EU?

This may be the hardest risk to quantify for many firms. On a worst case scenario, UK managers currently acting in a sub-delegate role within an EU-based structure would no longer be able to provide this service unless some alternative legal basis is established such as an ‘equivalence’ determination. Options for firms finding themselves in such a scenario, absent such a determination are outlined in the table above. In sum, this may mean reliance on limiting reverse solicitation provisions, or the establishment of a branch or directly authorised subsidiary in the EU27.

In recent months, the European Commission and ESMA have made noises from time to time about clamping down on so-called letterbox entities – delegated investment management structures where the substance of investment management takes place in London or other international centres. Frankfurt and Paris (to name the obvious examples) are also known to want to attract money managers as well as other financial service providers.

In favour of the status quo are Ireland, Luxembourg and Malta, all of whom have firmly entrenched vested interests at stake. Note for example Circular 18/698 from Luxembourg’s CSSF, issued on 23 August 2018, which seeks to consolidate the requirements for local UCITS management companies and AIFMs into a single framework. On balance, our core expectation is no change to the delegation model, but clearly firms should remain alive to other eventualities.

Where are the Problem Areas in Terms of Market Infrastructure?

MiFID II requires that EU firms trade financial instruments on EU trading venues, except where there have been equivalence determinations. Although these are in place for most international venues, there could be a hiatus in the short term following a hard Brexit which, in turn, could affect the liquidity of UK markets.

The UK government has already invited EU market operators who undertake regulated activities in the UK to seek recognition as Recognised Overseas Investment Exchanges. It has also taken steps to allow both UK and non-UK firms authorised as Credit Rating Agencies and Trade Repositories to convert this EU status to FCA authorisation.


Where Can I Find More Information About Specific Issues?

In April 2016 we published Looking across the Brexit void: what will happen to your business if the UK votes to leave the EU – the main conclusions of this introductory survey still, we believe, hold good. The FCA has created a page on EU withdrawal on its website, including links to a useful summarising speech by Nausicaa Delfas (July 2018). Many industry bodies, notably AIMA, plus law firms have produced several useful overviews. Finally, the UK Government has published several helpful guides, most recently “The UK Government’s preparations for a ‘no deal’ scenario” on 23 August 2018, including a sector analysis for financial services.

For More Information

If you have questions about this email please contact Bobby Johal, Martin Lovick or your regular ACA consultant.