A narrow victory for the “Leave” campaign on 23 June 2016 took the financial markets by surprise, resulting in a plunge in the value of Sterling to a three decade low against the dollar and a dramatic fall in share prices. Yet, the UK Government’s decision to delay triggering Article 50 of the Lisbon Treaty (which codifies the formal withdrawal process) has ushered in a period of relative calm, during which the markets have rebounded and Sterling, although remaining depressed, has stabilised. For now at least it appears to be “business as usual” for alternative investment funds industry with the majority of existing deals continuing to completion. Yet uncertainty persists, and will continue to do so for so long as the shape of Britain’s future relationship with the EU and the timing of the Brexit process remain unclear.
Forward-thinking participants in the funds industry have been busy capitalising on the current lull in political and market turbulence, using the hiatus to draw up plans for how best to respond to the challenges and opportunities posed by Brexit. Yet, as evidenced by the many articles and commentaries published since the referendum, a lack of clarity over the timing and probable outcome of the Brexit negotiations means that it is extremely difficult to predict what the future holds with any conviction, both for the UK and for the Eurozone as a whole.
The shape of the future?
The general consensus at present is that post-Brexit UK/EU relations will take one of the following forms:
1. Membership of the EEA (the Norwegian model)
After joining the European Free Trade Association (“EFTA”), the UK would apply to join the EEA. This option represents the lowest level of impact vis-à-vis the UK’s current relationship with the EU, with the UK retaining access to the single market in exchange for agreeing to make financial contributions to the EU budget, observe EU laws and (perhaps, most significantly) accept the free movement of people. Given that a significant proportion of the pro-Brexit vote appears (in one form or another) to have been driven by a desire to curb the free movement of people, it seems likely that re-creating the Norwegian model will prove unacceptable to a large percentage of the UK electorate. Furthermore, with the UK having voted to surrender its seat at the EU negotiating table, a scenario in which the UK agrees to adhere to the full range of EU laws, despite having no hand in shaping them, is likely to prove politically and socially unpalatable.
2. Customs Union
Replicating the relationship between the EU and Turkey, this option would result in the UK and EU forming a customs union characterised by the removal of internal, and the imposition of common external, trade tariffs. However, a customs union affording the non-EU partner full access to the single market is without precedent, and it seems probable that such access would come at the price of financial contributions, compliance with EU laws and (quite possibly) limitations on the control of the free movement of people.
3. Bilateral Agreements (the Swiss model)
This option would involve the UK negotiating a range of bilateral agreements with the EU, having first joined the EFTA. Whilst offering the UK greater control over the free movement of people, the task of negotiating and implementing the range of bilateral agreements required is daunting. With it seeming likely that no material discussions will take place prior to Article 50 being triggered, many have questioned whether the UK has the necessary strength and depth of resource and expertise to complete negotiations within the two year exit period specified by Article 50. Significantly, Switzerland does not enjoy a bilateral agreement with the EU in relation to financial services, so the negotiation and nature of any such agreement is without precedent. Suffice to say that it is likely that the UK will be required to make financial contributions to the EU purse and accept a significant quantity of EU law in return for gaining access to the EU market.
4. Bespoke Trade Agreements
Also known as the “Canadian Option”, the view is that this option would deliver mutual market access whilst minimising trade tariffs. This approach would, arguably, give the UK the greatest degree of latitude to become increasingly international in its trade relations, giving it scope to develop economic ties with international business partners free of any constraints imposed by EU policy. However, commentators have noted that negotiating bilateral agreements is a time-consuming process, raising the question of what interim measures would apply pending the resolution of such negotiations. Fears have also been expressed over the quality of the terms that the UK, operating outside the EU economic block and lacking a wealth of experienced trade negotiators, would be able to secure when greater economic / bargaining power rests with the counterparty.
The future of the UK as the world’s leading global financial centre may be in doubt (the possibility of a significant migration of managers and funds to Ireland and Luxembourg and investment banking operations and staff to Paris has been well documented), but with a range of fund structuring options at their disposal there is no reason to believe that fund managers will not continue to offer their investors creative structuring and financing solutions and compelling returns.
The Channel Islands of course remain a popular fund structuring option, offering political and economic stability together with a well-developed and internationally recognised regulatory environment. Enjoying access to the EU market via standalone bilateral agreements, the Channel Islands have been (and should remain) largely insulated from the direct implications of Brexit. It is, of course, possible that the Channel Islands could indirectly benefit from Brexit, which may ultimately prove to be the event that “unlocks” the long-awaited AIFMD third country marketing passport. Indeed, it is hard to identify a legitimate legal or regulatory basis for denying the UK access to a third country passport. Were this to happen, there is no reason why passports for the Channel Islands (which were publically approved in principle by ESMA in summer 2015) would not quickly follow suit.
For alternative investment fund managers, the prevailing lack of certainty means that making decisions on future fund raising, fund structuring, debt issuance, acquisition and exit strategies and the growth and development of existing investments is challenging, to say the least. However, as evidenced during the financial crisis, alternative investment funds are nothing if not robust, adaptable and inventive, and managers will no doubt continue to identify opportunities and realise value whatever the prevailing political and financial environment might be.
Interestingly, certain commentators predict a relatively minimal impact at the extreme ends of the market, with smaller UK-centric alternative investment houses seeing little effect on domestic business and larger international houses weathering the storm thanks to their global footprint, ready access to the best financing terms and the diversity of their investment portfolios. Perhaps those most susceptible will be mid-market funds with a significant UK exposure, who may face challenges when seeking to attract international investors, secure competitive financing and value UK assets. It is of course easy to be overly pessimistic however; assuming that the UK experiences a recession, resilient sectors such as healthcare and utilities are likely to withstand a market downturn, and a weak pound and depressed pricing will create an environment in which bargains can be found.
It is important to remember that, until the Brexit process is completed, the UK will continue to comply with EU law. This presents a two-fold challenge for fund managers and administrators, who must do business with one eye on the ever-evolving regulatory landscape of the EU whilst simultaneously future-proofing against a post-Brexit environment. For so long as the nature of the UK’s future relationship with the EU remains unsettled, one can expect fund managers to increasingly gravitate towards the entrepreneurial administrator who can offer the flexibility, proactivity and intellectual capital required to understand, keep pace with and adapt to an evolving regulatory landscape and prevailing market demands. Administrators who are unable to take a holistic view of the changing regulatory environment, find themselves hamstrung by an inflexible institutional approach, have a “one-size” fits all mentality and/or a predisposition for a particular jurisdiction can ultimately expect to lose out. For fund managers, choosing the right administrator has rarely been more important.
previous comment / James McCarthy
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