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Response to Brexit: the view of the WMA

Chris Hamblin, Editor, London, 27 June 2016

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It seems evident that once the United Kingdom leaves the European Union it will still have to abide by many of that body's directives if it wants to benefit from 'passporting' and the status of 'equivalence.' John Barrass, the deputy chief executive at the UK's Wealth Management Association, gives us his opinion.

Under article 50 of the Treaty of Lisbon, which serves more or less as the EU's constitution, any country that decides to withdraw from the alliance has to tell a special council that it intends to do so. In accordance with that council's guidelines, it will then negotiate its new relationship, if any, with the EU. The operative clause here is article 218(3) of the Treaty 'on' the Functioning of the EU. EU membership will cease at the date of entry into force of the withdrawal agreement or, failing that, two years after the country has handed in its notice to the council. Its membership can go beyond two years if the various organs of the EU, in agreement with the leaving state, so decide.

The UK's bargaining position

Compliance Matters asked John Barrass, the deputy chief executive at the UK's Wealth Management Association, for his opinion about the applicability of various financial EU laws to the UK after its departure from the union. He was confident that plenty of legislation, present and future, would apply: “Article 50 has to be initiated. David Cameron is saying that he will leave office in three months' time and that it will be for his successor to initiate the article 50 negotiations, which therefore won't start until then. It's extremely unlikely that there will be any derogations from the Markets in Financial Instruments Directive, i.e. relaxations of MiFID rules, for us while we're in the EU. It's even said – but not by us at the WMA – that we might not find ourselves out before 2019. The period of our leaving can go on beyond two years if all the EU states allow it. No derogations have been on the cards for anybody.”

PRIIPS

The EU's packaged retail and insurance-based investment products (PRIIPs) regulation is timed to come in to force on 1 January 2017. Barrass said that the WMA had been trying to influence the final shape of the law, with the UK having to obey the law before its departure from the EU because of the timing.

“A very powerful 'association of associations,' the European Fund and Asset Management Association, has identified a number of problems with PRIIPs' 'level two' (detailed implementation) stage. High-net-worth individuals have every right to invest in PRIIPs. It is theoretically possible for such a retail investor to invest in a fund with an insurance wrapper and he'd get his key information document (KID) for that, but he might also invest in it as a UCITS, so he'd get his disclosures in that form. The customer is going to be confused as he is going to receive two statements; there is no single template. The PRIIPs regulation calls for different things to be said about the same funds and different ways of disclosing the same costs. Our firms (as investors in PRIIPS for clients) are the distributors of KIDs, which brings added problems – distributors have to add their own bits to the reports – and so I wrote a note on this to the European Commission.

“The EU has decided not to extend the date of January 2017 to redraft the language, but it has made some kind of concession by staging a workshop in July – I have no idea what the outcome of that will be.”

Apart from the problem of two different disclosure documents being presented to a retail investor who invests into the same fund through different means, EFAMA believes that the PRIIPs RTS will ultimately militate against consumers for the following reasons.

* Past performance (and benchmark) of a PRIIP is no longer disclosed to investors, even though future scenarios are based on them. EFAMA believes that it is contradictory, and gives the wrong message to investors, to acknowledge that the disclosure is not a guide to the future but then to insist that elements of past performance should be extrapolated into an unknown future.

* Costs are shown only by their effect on return averaged over the recommended holding period of a PRIIP, making comparisons between products impossible and not showing investors the actual costs.

* The calculation of transaction costs is based on improper assumptions. The PRIIP KID, unlike the UCITS KID, will include transaction costs in the overall cost disclosure. The EU's PRIIPs draft regulatory technical standards (published two months ago) are meant to provide a common method for the calculation of those transaction costs but that method is to be based on market data that cannot be obtained before MiFID II/R comes into force and, more importantly, the costs being disclosed include not just the actual costs but also market movements. This is because transaction costs are deemed to include changes in the market price from the moment the decision is made to deal (“the observed market price”) and the price at which the transaction actually takes place. EFAMA believes that this incorporates a spurious accuracy and does not provide useful information by which to hold the manager to account since market fluctuations are outside his control. It could also lead in certain circumstances to negative transaction costs - an unreal concept.

* Retail investors are provided with too much prescriptive narrative that inhibits detailed explanation of the actual product.

* The quality of the PRIIP KID will suffer massively as not enough time is given to get the rules right first and then implement them properly. EFAMA is worried that, at best, the final regulatory technical standards – which are essential for the development of the KID – will only be officially published in the third quarter of 2016, leaving only three to four months for product manufacturers and distributors to meet the deadline of 31 December 2016. Many KIDs will therefore not be ready on time.

MLD IV

Barrass could see no effect that Brexit would have on the UK's financial crime laws: “Financial crime – no change there. The fourth Money Laundering Directive will come into force in 2017, before we leave the EU. The EU is, in any case, catching up with the UK in this directive by taking the risk-based approach to AML compliance. We're also leading in the fight against terrorist finance.”

Where British involvement could be crucial

The WMA is also taking part in negotiations over another piece of EU law and, in gaining approval from the European Commission, it might already have secured a powerful enough ally to win the argument. In this case, British lobbying might have already won a victory from which the wealth management industry of the UK can benefit after Brexit, making it a useful example of membership of the EU being of benefit to the British wealth management industry at the negotiating stage, while the same negotiations benefit the industry after departure from the EU. Alternatively, British involvement might still be needed, in which case the fact that the UK is pulling out of the EU might stop other Europeans from listening to its wealth managers and might bar the desired reforms.

Barrass explained: “I've been looking in the Prospectus Directive. This has been about bonds. The retail corporate bond market in Europe is dysfunctional, opaque and illiquid. These bonds receive [i.e. are subjected to] the full panoply of disclosure rules. €100,000 is the demarcation point. Above it, bonds are exempt from the retail prospectus and retail disclosure requirements. This has led to a situation in which all bonds are now issued in the institutional market. In other words, the buyers of the bonds or equities are institutions, i.e. a full Fidelity or Blackrock or retirement fund, or a bank. It is very hard for individuals to invest directly in good quality corporate bonds. In the review of the Prospectus Directive we propose to eliminate the €100,000 limit. [Our lobbying] worked. The commission drafted a new law to get rid of the ceiling, but the member-governments disliked it and the European Parliament wanted to qualify it. We have proposed qualified investors to be brought in as a target market to cut through that.”

Why is there any resistance at all to this apparently incontrovertible argument? Barrass theorised: “The wholesale side likes the status quo. They haven't latched on to the fact that qualified investors (like private banks) won't force them to make extra disclosures. The member-states are wary about the leakage of bonds unsuitable for the private investor through institutions such as private banks into retail hands. That's their opinion. The Parliament likes the idea of attracting more retail investors – if Brexit happens before it implements the [reforms] then I fear that things might grind to a halt without the stimulus of our presence. [The UK has] a much better capital market than anyone else.”

He also thought that the timing of Brexit was essential: “If we leave after the reform, we're in with no problems, but if we leave afterwards, we'll need to decide what the agreed law is. We'll have to worry about 'equivalence.' [EU law on various subjects often guarantees good treatment to firms from countries whose laws are 'equivalent' to the EU's.]

“Equivalence may not equal the ceiling. ESMA [the European Securities and Markets Authority in Paris] has some notes on what it might mean. ESMA, however, does not have a vote in any EU decisions about which non-EU countries are 'equivalent.' The people who really make up their minds about it are in the European Commission.

“There are also deliberations about equivalence in the European Court. Equivalence comes with reciprocity, in the same sense that dual criminality does. Once the UK has left – which it will have done by, say, 2020 – we'll have to be judged equivalent.”

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