Investment managers and Brexit – knowns and known unknowns

United Kingdom

This article was produced by Nabarro LLP, which joined CMS on 1 May 2017.

Summary and Implications

References to Donald Rumsfeld′s famous “known unknowns” permeate commentary on many things at the moment, and the label can certainly be used in the context of a hypothetical Brexit′s hypothetical impact on the regulation of investment managers in the UK. This briefing picks out a couple of knowns, before discussing the unknowns, in relation to three key areas for asset managers and fund managers (Investment Managers): the UCITS Directive, AIFMD and MiFID.

Known knowns

One known is that Investment Managers′ businesses have been comprehensively re-shaped by a steady flow of regulation from the European Union, particularly since the global financial crisis. The EU has increased the compliance burden for Investment Managers, imposing on them greater reporting, transparency and corporate governance requirements (although the UK might have implemented similar regulations had it not been in the EU, particularly as many of these regulations stem from G20 commitments). But it has also created EU-wide “passports” aimed at reducing the cost of licencing and cross-border marketing of funds within the single market. The UK′s membership of the EU has arguably allowed its Investment Managers to share in these burdens and benefits alike.

A second certainty is that a referendum vote in favour of Brexit would not mean the instant evaporation of EU financial services regulation in the UK. Article 50 of the Treaty of Rome specifies a two-year negotiation period during which the UK would remain within the EU. This means that Investment Managers would remain subject to EU rules until an alternative settlement was negotiated or the two-year period (plus any extension) expired.

However, the extent and detail of Brexit's impact on the regulatory environment for Investment Managers remains unknown. At one end of the scale would be the UK potentially joining the EEA1 and the EFTA2, whilst the other extremity could see no new agreements with the EU or its members whatsoever (see our article on potential exit models). But we simply do not know the terms of the divorce yet, and we may not know them for some time. However, we can identify the key issues that UK Investment Managers would be watching closely during any hypothetical Brexit negotiations - the unknowns they would like to know.

Passports – the most important known unknown

Broadly under the current EU system, EU Investment Managers wishing to provide their services across Europe must first become authorised by a member state regulator, before applying for a “passport” allowing them to manage and/or market their products across the EU.  An un-negotiated Brexit would relegate UK Investment Managers to the status of “third country” managers. This would mean they would need to obtain new licenses, in some cases to build or restructure networks of EU branches, and in others to stop doing business in the EU.

An example of the challenges that might face any Brexit negotiators here is that if the UK exercised its hypothetical new-found freedom to cherry pick aspects of EU legislation and discard the aspects it did not like (for example the FCA has serious misgivings about some areas of MiFID II), then the resulting UK framework might not pass the “equivalence” test (whereby Investment Managers from non-EEA countries can only access the EU if their home jurisdiction has a regulatory regime that is deemed substantively equivalent to that of the EU). Taking the example of AIFMD, no third country passports have yet been granted3, and even the US has “failed” the equivalence test for now. Some cried “politics” in that case, and the politics at play would be even more complex during any Brexit negotiations. This is the largest known unknown, and applies across the regulatory landscape for Investment Managers. Now let′s look at some specifics.

Retail funds and UCITS management companies

A Brexit with no specific re-negotiation of the status of UCITS management companies would presumably mean that UK UCITS would no longer be authorised under the UCITS Directive. This would automatically bring them under AIFMD rules on non-EU managers. They would then no longer be available to European retail investors, because AIFMD funds may on the whole only be sold to “professional” investors (and certain high net worth individuals). If a UK UCITS management company wanted to retain access to EU investors, it would therefore have to change its whole strategy to exclude retail investors (and effectively change industry) or move its domicile to the EU.

Some UK UCITS would not be heavily affected because they are marketed primarily within the UK. But a large number of UK UCITS do use the passport to operate across the EEA. These UK UCITS would like to know whether the UK would be able to agree a framework under which UK management companies could continue to provide their services to EU retail investors, or whether they would have to move to the EU. The chances of either outcome remain unknown.

Alternative investment funds (AIFs) and AIFMs

AIFs (private equity, hedge, real estate and other private funds) targeting professional investors are regulated under AIFMD. Once an EU AIFM is authorised under the AIFMD, it simply notifies its home state regulator that it wishes to manage/market a fund in the EU and then, after a maximum of 20 working days, it qualifies for a passport to access capital from professional investors across the EU.

A Brexit with no new negotiated terms would cause UK AIFMs to become non-EEA (or “third country”) managers, for whom there is no passport (yet). Instead, in order to market to EU investors, they would have to make notifications to each member state regulator and comply with those Member States′ local regulations under the national private placement regimes (NPPRs). The other option would be to rely on “reverse solicitation”, but this is not a marketing strategy. Regardless of the lack of an AIFMD passport, UK managers seeking European capital would still have to comply with the AIFMD transparency and reporting requirements.

Meanwhile, the UK would join the queue of hopeful passport applicants, alongside currently the Cayman Islands, Bermuda and others (including the US, which as mentioned above, was rejected on the first attempt). The timing of AIFMD passports being extended to third countries, whether the UK would be amongst the third countries to whom the passport is extended, and how long the NPPRs will remain available, are all unknowns.

Other investment products and MiFID investment firms

MiFID investment firms have for a decade been using the MiFID passport to provide their services to clients around the EU.  An un-negotiated Brexit would invalidate UK firms′ MiFID passports. If ESMA (the European regulator) eventually assessed the UK as an “equivalent” jurisdiction to the EU, then “third country” rules would apply, meaning investment firms would need to register a branch in the EU with a member state regulator or ESMA (depending on the type of investors). This would take time, and there could well be a period during which firms would neither qualify as MiFID investment firms nor be able to obtain a passport. This would mean they were unable to access regulated markets, central counterparties and clearing systems in EU member states.

Assuming the UK was granted a passport, UK firms wanting full access to the EU would then need to set up subsidiaries (which would be costly) or move parts of their operations to the EU. This would work both ways, with similar issues for EEA firms currently “passporting” into the UK. The unknown is whether the UK would be assessed (or perhaps pre-assessed?) as equivalent.

The further unknown is how MiFID II will impact this process, especially given the new regime is now due to come into effect shortly before the hypothetical negotiations on Brexit draw to a close (if they are not extended). MiFID firms will be in limbo: they will have to implement MiFID II without knowing how the UK′s relationship with Europe will be revised.


The “passporting” of non-EU Investment Managers′ services around Europe depends on the “equivalence” of regulation in the manager′s home jurisdiction, compared to that of the EU. The UK might have to decide between losing access (or at least Europe-wide access), or complying with the EU′s rules. Alternatively it might succeed in negotiating special treatment, whereby UK Investment Managers would not have to comply with all the EU′s rules, but could still access EU investors (and eligible counterparties etc.).

The likelihood of the UK securing such special terms, somewhere between those applicable to third countries and those applicable to non-EU EEA countries, is hard to judge and highly uncertain. The US has not managed to find such a path on AIFMD, whilst EEA countries′ Investment Managers comply fully with the EU rules.

Therefore the future regulatory frameworks for UK Investment Managers could depend on whether the EU is viewed as an important enough market to warrant full compliance, knowing that the FCA′s influence (currently large) in forming the rules is likely to be reduced, if not ended. And this article only touches the surface on the repercussions of Brexit on the financial services sector.

But all we really know for certain is that the regulatory status of UK Investment Managers following a Brexit is unknown. Good ol′ Rumsfeld.

[1] This “freedom to provide services” is one of the famous “four freedoms” on which the Single Market (and the EU) is founded.

[2] European Economic Area – the EU plus Iceland, Liechtenstein, Norway and Switzerland.

[3] March 2016