Brexit Planning for Asset Managers – Market Approaches and Regulatory Developments February 2019

3Linklaters

Contents

Introduction 4

Key Brexit Considerations for Asset Managers 5

Market Approaches to Contingency Planning 6

Looking ahead – what’s next? 13

Key Contacts 14

4 Brexit Planning for Asset Managers – Market Approaches and Regulatory Developments

With weeks to go until 29 March 2019, there still remains considerable uncertainty on what the UK’s future relationship with the EU will look like from a financial services perspective.

The UK investment management industry however has been pressing ahead with contingency plans for a no-deal Brexit.

Drawing on the experience of Linklaters’ UK and European offices, and in conjunction with Arthur Cox, this note revisits some of the initial Brexit concerns faced by asset managers, summarises where firms have landed on their contingency plans and considers what the European asset management landscape stands to look like post-Brexit.

At a snapshot

> Ireland and Luxembourg remain the most popular jurisdictions for establishing an EU base – however in the vast majority of cases, European headquarters will remain in the UK.

> Delegation of EU27 mandates from the EU base to the UK is the primary model being adopted, and some firms have already gone live with this set-up.

> ESMA and the FCA have agreed a multilateral memorandum of understanding to support delegation arrangements, however this has yet to be formally adopted.

> An ‘advisory’ model seems to be the most popular back-up contingency plan to mitigate against this no co-operation agreement risk.

> Staff relocation:

– Portfolio managers: the broad focus has been on enhancing portfolio management oversight by appointing appropriate senior managers in the EU base; in some cases, firms are also relocating a small number of day to day portfolio managers.

– Traders: trading desks are being retained in the UK, with oversight embedded / enhanced within the EU27 base.

– Sales teams: unless historically based in an EU establishment, EU focussed sales teams are more impacted because of their direct client facing roles and are being relocated. However there seems to be tolerance for UK sales staff being involved particularly in an ‘expert’ capacity.

– Back and middle office functions: are generally being retained in the UK, but some are being moved to the EU base to support local substance requirements.

Introduction

5Linklaters

By way of recap, Brexit contingency planning for asset managers has been driven by the following key considerations:

> Ensuring continued access to European clients and investors post-Brexit, without triggering onerous local EU27 licensing requirements. Whilst a few European countries have ‘friendly’ licensing regimes the majority adopt a strict solicitation test – such that the marketing of portfolio management services or funds requires a MiFID / local licence for portfolio management or reception and transmission of orders.

> Maintaining UK and European product marketing rights for funds under AIFMD / UCITS rules – the benefit of marketing passports will be lost upon a hard Brexit, as UK UCITS and AIFs will become third-country AIFs under European law and European UCITS and AIFs will be treated as third-country AIFs under UK law (unless they fall within the temporary permissions regime – see below).

> Ensuring continued access to UK and European brokers and venues without triggering onerous local licensing requirements – in practice this has played out to be less of an issue as firstly asset managers don’t trade on European venues on a proprietary basis (which in some EU27 countries triggers a licensing requirement) and secondly when interacting with European brokers, asset managers are the “client” rather than the person “soliciting” European clients.

In response to the first two risks, the general approach in the industry has been to set-up / enhance a European management entity (with the benefit of European passporting rights) to act as the new EU27 client facing entity. Portfolio management is then delegated to the existing UK entities, subject to MiFID II, AIFMD and UCITS delegation requirements being met (see below).

It is worth noting that a large number of UK asset managers have not been very affected by Brexit and are continuing with their current UK led operational model for the European region – this is particularly the case for many private equity houses and certain UK based firms that manage predominantly UK and non-European mandates. On the flipside, certain asset managers are looking to wind down their UK operations altogether – however these have tended to be global managers with a limited presence in the UK and Europe generally.

Key Brexit Considerations for Asset Managers

6 Brexit Planning for Asset Managers – Market Approaches and Regulatory Developments

Market Approaches to Contingency Planning

Establishment of the EU27 base

The most popular jurisdictions for the new EU27 base, by a significant margin have been Luxembourg and Ireland (particularly for establishing AIFMs / UCITS ManCos). Both jurisdictions have historically been asset-manager friendly jurisdictions and have a well-established infrastructure to support the sector (including specialist service providers and advisors).

The decision to set up / expand an EU base in other EU27 jurisdictions (for example in France, Germany and the Netherlands) has generally been driven by a pre-existing presence in those countries, which helped in meeting local substance requirements. These entities have also tended to be MiFID management entities rather than fund management entities.

Despite the expansion of these European bases, it is worth noting that in the vast majority of cases, the UK still remains to be the primary headquarters within the European region, with firms intending to rely on delegation rights enshrined in European law.

To a lesser extent, asset managers have also had to consider their approaches to ensuring business continuity in the UK post-Brexit (including for their new / expanded EU27 base, particularly with respect to accessing UK investors and clients). The proposed UK temporary permissions regime, discussed below, has somewhat alleviated the urgency of this aspect of Brexit planning. In some cases, European firms have pre-emptively established a UK passported branch to benefit from UK access rights under the temporary permissions regime.

7Linklaters

> There are roughly 47 financial institutions (predominantly asset managers), that have publicly chosen Luxembourg to establish a new presence or to expand their existing presence in order to service their EU client base going forward. These choices are mainly motivated by the strong reputation of Luxembourg as an asset management hub, the comprehensive tax system, the multi-lingual workforce, the excellence of Luxembourg infrastructure, the pragmatic and competent image of the Luxembourg financial sector regulator, and the existing presence of either UCITS ManCos, AIFMs, or funds in Luxembourg.

> While there are limited relocations of day to day portfolio managers to Luxembourg, the majority of firms are seeking to focus on relocating compliance, risk management, middle office functions and oversight of portfolio management to Luxembourg, with the portfolio management being delegated to a firm outside of Luxembourg (notably the UK). Trading desks are also being retained in the UK.

> Mostly asset managers are either establishing a new presence or expanding their existing presence, often with a so-called MiFID top-up licence

for their current Lux fund management entity (enabling them to provide notably discretionary portfolio management or investment advice). Such entities will be able to rely on the European passporting regime to service the EU27, whilst delegating certain functions back to the UK.

> The Luxembourg financial sector regulator (the CSSF) has issued a new Circular on substance requirements for management companies and AIFMs. The Circular codifies existing best practice and reflects the ESMA guidance, while recognising the proportionality principle, and delegation rights.

> Prior to the recent ESMA-FCA announcement on co-operation agreements, the CSSF had issued a press release indicating that they endeavour to have in place required cooperation with the FCA by 29 March 2019, to allow the continuity of current delegations to the UK in the event of a “no-deal” Brexit.

> A pre-draft bill was also recently issued, setting out the Luxembourg government’s intention to establish a temporary contingency regime for financial services for a maximum period of 21 months from 29 March 2019.

Country in Focus

Luxembourg

> Whilst currently we are not aware of any UK asset managers that have publicly chosen Spain to establish a new presence, the Spanish regulator (the CMNV) launched a programme called “Welcome to Spain” for investment firms and asset managers in 2017.

> This programme aims to make Spain the most appealing option for asset managers considering a move from the UK to another EU country. In particular, the CNMV has shown a flexible approach to outsourcing/delegation, stating that “with respect to the possibility of delegating functions or activities, which may facilitate partial relocations on a rapid basis, the CNMV undertakes to adopt the most flexible approach provided that

the relevant Spanish entity is not a totally empty shell and the outsourcing scheme complies with the MiFID requirements:

– the outsourcing entity must retain the ultimate responsibility;

– it must establish reasonable controls over outsourced functions; and

– all the information should be accessible to the CNMV as a supervisor.

As the UK will, in any event, remain a member of IOSCO and signatory of its multilateral memorandum of understanding, the CNMV does not foresee any difficulties in this regard.”

Country in Focus

Spain

Brexit Planning for Asset Managers – Market Approaches and Regulatory Developments8

Delegation Risk

Following ESMA’s opinions from 13 July 2017 (in particular ESMA34-45-344) setting out prescriptive expectations and standards relating to governance, oversight and substance within a delegating European entity, there has been greater regulatory scrutiny of delegation models by even historically light touch European regulators. The European Commission has also published an omnibus legislative proposal which going forward will give ESMA a more central role in relation to authorisation applications relying on delegation arrangements. However, since these developments, recent ESMA statements have suggested a possible softening of approach to delegation.

In practice, the position EU27 regulators have taken on substance has varied depending on the relocating asset manager’s business and operational model, with the substance expectations relatively more exacting with respect to MiFID business run from the EU base rather than fund management business. Firms have sought to meet these substance requirements by building out portfolio management and trading oversight (by appointing appropriate senior managers) and control functions locally rather than relocating their portfolio management teams to the EU base. Some firms are however moving a relatively small number of day to day portfolio managers to the EU base.

The main industry concern in this area in the lead up to the 29 March 2019 has been the legal requirement on MiFID managers, AIFM and UCITS ManCos to only delegate management to a third-country manager (including a UK manager post-Brexit) where a co-operation agreement exists between the regulators of the European manager and the third country delegate (i.e. between European regulators and the FCA). In the case of AIFMs and UCITS ManCos, this requirement applies at a sub-delegate level as well. This concern was alleviated on 1 February 2019 when ESMA and the FCA both clarified that a multilateral memorandum of understanding had been agreed between the FCA and EU27 regulators which would allow delegation of management from the EU27 to the UK to continue. However, please note that this memorandum of understanding has not yet been formally adopted.

Prior to the announcements regarding the multilateral memorandum of understanding, UK managers had been progressing back-up contingency plans, in the event that these co-operation agreements were not in place by Brexit date. In our experience, most firms were proceeding with an advisory model as their back-up contingency plan, given the relative ease and speed of implementing such a model. Under this model, the UK firm would provide investment advice to the European entity on discretionary trades for EU27 clients. This advisory model may still be of relevance in other contexts – e.g. for providing services to Italian pension fund clients (which under local rules are not permitted to have their assets managed by a non-European firm) outside of the potential grandfathering period noted below.

1 It is worth noting that in its onshoring of these European requirements, the UK has also imposed this co-operation agreement requirement on UK managers looking to delegate portfolio management to European managers.

> Whilst the Netherlands has not been a jurisdiction seeing public wholesale relocations from UK asset managers, some are expanding their presence in the Netherlands.

> The Dutch supervisory authorities are happy to welcome UK regulated entities which intend to relocate to the Netherlands, although the Dutch supervisory authorities have not taken an active approach to attract new market entrants.

> According to the Dutch supervisory authorities, the Netherlands will become the centre for financial trade in the EU27 due to the large number of UK trading venues establishing a presence there. The Dutch supervisors expect that between 30% and 40% of the European trade in financial instruments will move to the Netherlands, which is expected to also attract other service providers. Dutch supervisory authorities have emphasised that this strengthens the access of Dutch pension funds and other portfolio managers to capital markets.

Country in Focus

the Netherlands

9Linklaters

> Whilst it is difficult to precisely identify how many asset managers are relocating to or expanding their presence in Ireland, the Central Bank of Ireland (CBI) has indicated that it has received more than 100 applications from firms seeking to relocate to Ireland. In our experience, the majority of these are from firms seeking to establish fund management entities.

> The reasons for firms choosing Ireland as a location vary, but common reasons include an existing Irish presence, positive experiences with the CBI, the common law legal system, Ireland’s English language with close UK and US connections, the tax system and local financial services infrastructure and expertise.

> The type of presence established in Ireland depends on a range of factors, including the type of licence sought (in broad terms a UCITS ManCo with MiFID top up permissions may have less substance than a MiFID investment firm, for example) and AUM (the greater the AUM and complexity the more substance the CBI tends to require).

> In all cases, the CBI requires sufficient substance to be located in Ireland, with a senior management team and control functions on the ground. It is unusual, in our experience, to see trading desks

to be moved to Ireland (these functions tend to be outsourced to the UK). However, firms are moving, at the very least, oversight of portfolio managers to Ireland by appointing a head of investments in Ireland, for example, and in several cases day-to-day portfolio managers are also being moved to MiFID investment firms in Ireland.

> The ability to use a ManCo’s marketing passport is often a reason to establish a ManCo (with MiFID top-up permissions in many cases). Many of these entities will distribution capabilities based in Ireland supported by secondees outside of Ireland or by staff located in EU branches of the ManCo.

> The CBI has been very open to meeting firms considering relocation to Ireland. The CBI was a keen advocate for the ESMA opinions on delegation and of the regulatory convergence agenda more broadly and follows the ESMA opinions closely. The CBI has, however, accepted a number of delegation models, with its overriding focus being that a firm demonstrates sufficient substance on the ground in Ireland to provide effective management and oversight of the portfolio management business operated through the Irish entity. The actual substance required depends on a range of factors and the CBI takes a case-by-case approach to the discussions with firms.

Country in Focus

Ireland (Arthur Cox)

> As far as we are aware currently there are no UK asset managers which have publicly announced the intention to relocate to Italy, although some have considered this option.

> Based on our discussions with the Italian regulator, they would be happy to welcome UK regulated entities which intend to relocate to Italy. At the beginning of 2017, the Municipality of Milan together with the Italian government, the financial regulator, the Bank of Italy, and the Revenue Agency set up a task force to attract UK entities and businesses to relocate to Italy.

> However, in practice they are not taking as much of a proactive approach to attract UK regulated entities as regulators in other jurisdictions.

> One of the key questions specific to Italy, has been whether UK managers can continue to provide services to Italian pension funds (which under local rules must have their assets managed by a European manager only). The Italian Ministry of Finance recently issued a press release stating that it intends to put in place grandfathering arrangements in the event of a no deal that would give UK firms continued access to the Italian market. Although the final proposals have yet to be published by the Ministry of Finance, the expectation is that UK managers should be able to benefit from this grandfathering to continue managing Italian pension funds for this temporary period at least.

Country in Focus

Italy

10 Brexit Planning for Asset Managers – Market Approaches and Regulatory Developments

> Whilst France has not been one of the main jurisdictions seeing relocations from UK asset managers, France is already home to some of the largest EU27 headquartered asset managers and other financial institutions, and has seen many other financial services firms expanding their presence there. Paris currently appears to be one of the largest recipients in the EU27 of financial services roles relocating from London. This is largely due to Paris hosting a significant financial industry already and being the home of many key clients.

> France has been seen by the asset management industry as one of the jurisdictions trying to curb delegation in order to put pressure on UK asset managers to shift staff to new EU27 hubs. However, despite this the French regulator (AMF) have emphasised that they value delegation arrangements and have calmed fears in this regard by emphasising that they expect appropriate MoUs to be in place in time for a no-deal Brexit that would allow delegation from France to the UK.

Country in Focus

France

Marketing

EU27 client focussed sales teams have generally been the most impacted part of the asset management business because of their direct client facing role (due to the solicitation licensing test adopted by most EU27 countries). From a services perspective, most asset managers are intending to have both a UK and EU27 sales and marketing presence to ensure that their services and funds can be marketed without raising licensing concerns.

In a number of cases, UK asset managers already had sales teams servicing E27 clients based within a European branch or entity – where this has been the case, there has overall been less impact, with firms transferring current European branches of the UK firm to the new EU base. Otherwise firms have been relocating their EU27 sales and marketing coverage to their EU base. However, there appears to be some tolerance for UK sales staff still being involved, particularly in an ‘expert’ or administrative capacity.

From a product perspective, EU27 based funds being marketed into the UK have been the focus of more significant planning, given the number of UCITS and AIFs located in Luxembourg and Ireland. Whilst European managers of these AIFs and UCITS can benefit from the UK’s temporary permissions regime, this is not indefinite and only benefits existing funds that have been notified to the FCA by 28 March 2019 (however in the case of umbrella EU UCITS funds, future sub-funds are also covered).

> For European AIFs the situation is less problematic as they are not generally sold to the mass retail market. AIFMs based in the EU27 will still be able to market AIFs in the UK to professional investors and certain limited types of retail investors under the UK’s version of Art. 42 AIFMD and specific UK law exemptions (subject however to a co-operation being in place between the FCA and the regulator of both the EEA AIFM and AIF, if different).

> For European UCITS, there are more difficult issues, as by definition EU27 based UCITS will cease to be a UCITS for UK purposes following Brexit. This results in them being treated as AIFs and subject to the restrictions on marketing to retail investors mentioned above. Marketing to a broader UK retail investor base would require recognition under Section 272 of the Financial Services and Markets Act 2000.

The Section 272 recognition regime is likely to gain more prominence over the coming years and it stands to be seen what approach the FCA and the Treasury will take to the regime going forward – i.e. whether they streamline the process or impose more onerous obligations on incoming European UCITS to create an even playing field with UK authorised fund managers. As a consequence, fund managers need to be strategic about how they access the UK retail market going forward and we understand that many asset managers are exploring the possibility of establishing UK based funds going forward to ensure continued access the UK retail market (particularly if the Section 272 regime becomes more onerous).

11Linklaters

> We are not positively aware of UK asset managers having publicly announced that they will relocate to Germany, however some are expanding their existing asset management presence in the UK. That said, Germany is an important market, in particular with a view to investor clients. We expect that asset managers will apply for the relevant licenses or passports to enter and act on the German market.

> The German supervisory authority (BaFin) welcomes asset managers that intend to apply for a regulatory licence as a consequence of Brexit. In 2017 BaFin has held a Brexit workshop for the asset management sector and informed market participants on various German law matters connected with a potential relocation.

> Prior to the ESMA -FCA announcement on co-operation agreements, in December 2018, the German Federal Ministry of Finance had stated that it expected a Memorandum of Understanding between BaFin and FCA to be in place in due

time and that if not, it did not expect immediate sanctions by BaFin if delegation of portfolio and/or risk management by German asset managers to UK portfolio managers has not been terminated at the time of Brexit.

> As a side note, investment advice (Anlageberatung) and investment broking (Anlagevermittlung) in relation to UCITS investment funds should generally be possible with a mere authorisation under the German Industrial Code (Gewerbeordnung) instead of a full regulatory licence under the German Banking Act (Kreditwesengesetz), provided that the entity applying for such authorisation provides, inter alia, a proof of orderly financial circumstances, a tax clearance certificate and a confirmation of adequate professional liability insurance. In addition, financial investment brokers who perform tasks in the area of financial investment brokerage and advice, must be registered in the Register of Financial Investment Brokers.

Country in Focus

Germany

12 Brexit Planning for Asset Managers – Market Approaches and Regulatory Developments

13Linklaters

Looking ahead – what’s next?

UK

To mitigate risks of a regulatory cliff edge for EU27 firms in the event that no withdrawal agreement is entered into, the UK is establishing a “temporary permissions regime” for firms and funds that currently access the UK market under European passporting and marketing rights. Statutory Instruments have been made to give effect to this regime, and the UK’s FCA published a consultation in October 2018 on the temporary permissions regime. The FCA intends to give feedback on the consultation in early 2019 and publish final rules shortly before exit day.

In order to benefit from the regime, firms must submit notifications to the UK regulators by 28 March 2019 in respect of any funds or European regulated entities they would like covered (provided that relevant incoming UK marketing passports / rights are still held as of that date). A particular point to note about the temporary permissions regimes, is that as well as being able to secure a UK authorisation by notification, firms do not have to comply with certain UK rules where they can demonstrate compliance with rules in their home EU27 state.

We have published a note on how the temporary permissions regime impacts asset managers and funds, a note on the FCA’s temporary permissions regime consultation and a note on the UK regulators’ approach to Brexit.

Longer-term, the FCA will require EU27 firms to establish operations in the UK and be authorised directly by the FCA if they wish to access the UK market, and for their funds to be recognised or marketed subject to UK onshored AIFMD requirements. However, this will be subject to the outcome of Brexit negotiations and what (if any) form of mutual access between the EU27 and UK is agreed.

Europe

Both the EU and individual EU27 states have started putting in place contingency planning measures to mitigate against the effects of a no-deal Brexit. At an EU level, the measures have so far been limited, focussing on issues related to the novation of derivatives, and use of key UK financial market infrastructure. Key issues, such as licensing, remain the competency of individual EU27 member states, and so the approach to no-deal planning in these areas necessarily vary across the EU. Some EU27 states have enacted extensive measures similar to certain aspects of the UK’s preparations, whereas others have been less active. Further detail was provided in our recent note on the topic, although please note that there have been additional developments since that note was published.

14 Brexit Planning for Asset Managers – Market Approaches and Regulatory Developments

Key Contacts

France

Roman HoeckAssociate Tel: +49 69 71003 227roman.hoeck@linklaters.com

Germany

Marc Perrone Partner Tel: +33 1 56 43 58 67 marc.perrone@linklaters.com

Andreas DehioPartnerTel: +49 69 71003 583andreas.dehio@linklaters.com

Dr. Frederik WinterPartnerTel: +49 69 7100 3407frederik.winter@linklaters.com

Michael Kent PartnerTel: +44 20 7456 3772michael.kent@linklaters.com

Peter BevanPartnerTel: +44 20 7456 3776peter.bevan@linklaters.com

Harry EddisPartnerTel: +44 20 7456 3724harry.eddis@linklaters.com

United Kingdom

Spain

Hermann BeythanPartnerTel: +352 2608 8234hermann.beythan@linklaters.com

Silke BernardPartnerTel: +352 2608 8223 silke.bernard@linklaters.com

Luxembourg

Paloma FierroPartnerTel: +34 913 996 054paloma.fierro@linklaters.com

Samuele PioAssociateTel: +39 02 88393 5372samuele.pio@linklaters.com

Italy

Dario LongoPartner Tel: +39 02 88393 5219dario.longo@linklaters.com

Anna FerraressoManaging Associate Tel: +39 02 88393 5257anna.ferraresso@linklaters.com

Raoul HeinenManaging Associate Tel: +352 2608 8331raoul.heinen@linklaters.com

Netherlands

Bas JennenPartner Tel: +31 20 799 6287 bas.jennen@linklaters.com

Leonard van den EndeManaging Associate Tel: +31 20 799 6236 leonard.van_den_ende@linklaters.com

Julia DixonPartnerTel: +44 20 7456 4406julia.dixon@linklaters.com

Sebastian BarlingPartnerTel: +44 20 7456 5352sebastian.barling@linklaters.com

Raza NaeemManaging AssociateTel: +44 20 7456 5272raza.naeem@linklaters.com

Benjamin MaconickAssociateTel: +44 20 7456 4940benjamin.maconick@linklaters.com

Ireland (Arthur Cox)

Robert CainPartner Tel: +353 1 920 1050 robert.cain@arthurcox.com

Tara O‘ReillyPartnerTel: +353 1 920 1787 tara.oreilly@arthurcox.com

Kevin MurphyPartnerTel: +353 1 920 1177kevin.murphy@arthurcox.com

Barbara GonzalezManaging AssociateTel: +34 913 996 028barbara.gonzalez@linklaters.com

Laura PalomoManaging AssociateTel: +34 913 996 131laura.palomo@linklaters.com

8522

_Stg

04/0

2.19

linklaters.com

© Linklaters LLP. All Rights reserved 2019

Linklaters LLP is a limited liability partnership registered in England and Wales with registered number OC326345. It is a law firm authorised and regulated by the Solicitors Regulation Authority. The term partner in relation to Linklaters LLP is used to refer to a member of Linklaters LLP or an employee or consultant of Linklaters LLP or any of its affiliated firms or entities with equivalent standing and qualifications. A list of the names of the members of Linklaters LLP and of the non-members who are designated as partners and their professional qualifications is open to inspection at its registered office, One Silk Street, London EC2Y 8HQ, England or on www.linklaters.com and such persons are either solicitors, registered foreign lawyers or European lawyers.

Please refer to www.linklaters.com/regulation for important information on our regulatory position.