In a recent 'lockdown webinar' hosted by the City law firm of Bryan Cave Leighton Paisner, the panel looked at the probable consequences of the UK's departure from the European Union for asset managers in 2021. The discussion covered reverse solicitation, the UK's temporary permissions regime, 'outcomes-based equivalence' and the cross-border distribution of funds.
Partner Matthew Baker observed that it had been three years since the advent of the European Union's second Markets in Financial Instruments Directive (MiFID II) and that he was expecting to see some long-awaited enforcement on the subject.
"It's three years since MiFID II came in and I'm old enough to remember when MiFID I came along and it was about three years after that when we started seeing lots of investigations from the FCA into telephone recording, into market abuse processes, and also they started looking into people's execution policies and conflict-of-interest policies. It became embarrassingly obvious to some clients that they had just cut and pasted the rules at that point, meant to go back to it and never quite did it. So I think it is important to look back as well as looking forwards to make sure that you are remaining compliant."
Associate Nileena Premchand then embarked on an examination of the regulatory implications of Brexit to date, refuting Prime Minister Boris Johnson's assertion last year that the UK and the EU already had an 'oven ready' agreement that merely required activating.
"We wish! As you know, the UK transition period ended on 31 Dec 2020. The UK is now a third [non-EU] country. Some up-to-the-wire talks eventually concluded with the EU/UK trade and co-operation agreement. However, a no-deal Brexit has notionally been avoided but the deal has pretty much amounted to a hard Brexit for many UK firms. There is no detail for the financial services sector. For asset managers, the details remain to be seen. Brexit is on the agenda for the rest of this year, so you'll have to keep watching for updates.”
She then looked at the areas of most interest for asset managers in the next 12 months.
The situation for EU fund firms going into the UK
EU fund and asset-management firms can no 'passport into' the UK and market their funds in the UK, unless they opted into the UK's temporary permissions regime or the temporary marketing permissions regime before a deadline that passed in December. Firms, she said, ought now to turn their attention to the next step – preparing their applications for authorisation in the UK, their 'Passport A permissions.' She went on: "Firms should be receiving a landing slot to permit their applications and we need to start working towards that."
In addition to applying for authorisation in the UK, incoming firms will have to comply with three main categories of rules. The first two are ones that would have applied anyway to incoming firms that were able to 'passport' into the UK but the third category (and probably the most significant, according to Nileena Premchand) are additional rules that the FCA has decided to apply but which ordinarily only really apply to UK-authorised firms. They include rules that the FCA considers necessary to protect customers from sharp practice. Some of these are the famous 'Principles for Business' to be found in the PRIN 2.1 part of the FCA's rulebook – with especial emphasis on Principle 11, which says that a firm must deal with its regulators in an open and co-operative way and must tell the FCA anything relating to it of which that regulator would reasonably expect notice. Others are the rules that pertain to the safeguarding of clients' money and also (for firms with branches in the UK) the Senior Managers and Certification Regime (SM&CR) as it applies to EEA (European Economic Area) branches.
The Overseas Funds Regime
A Financial Services Bill introduced into Parliament late last year is designed to introduce the UK's overseas funds regime. Earlier in that year, HM Government promised to introduce a more streamlined regime to govern the way in which overseas investment funds can market their wares to investors in the UK. Before that, only overseas schemes that were recognised under section 272 Financial Services and Markets Act were allowed to be marketed to retail investors in the UK. The Bill now seeks to expand the range of non-UK retail products that firms can offer to investors in the UK. Broadly speaking, this is to be done by the introduction of two new 'equivalence' regimes which rest on the principle of "outcomes-based equivalence." ['Equivalence' is that which exists when the European Union – and now HM Government – pronounces a country's regulatory regime to be deserving of free-trade arrangements in respect of a piece of legislation such as MiFID II.] One will be for retail investment funds and the other for money-market funds.
The general principle of an outcomes-based equivalence recognises that different approaches to regulation can achieve the same regulatory objective and therefore it does not require overseas funds to be subject to exactly the same regulations as funds in the UK. Instead, the Government hopes to base its pronouncements on the Treasury's overall view of the other country's regulatory regime. This ought to create a competitive market for overseas funds in the UK while providing investors with a great deal of choice. The UK's regime is likely to diverge from the EU's in due course.
Nileena Premchand went on: "In particular to the asset management regime is its approach to UCITS [Undertakings for Collective Investments in Transferable Securities] funds. Before Brexit, more than 8,000 EU UCITS were being marketed into the UK using the passport regime. The temporary marketing permissions regime is available to those funds that opted into the regime to ensure that they could continue to access the UK market temporarily while they applied for individual recognition in accordance with the Financial Services and Markets Act.
"But, given the sheer number of UCITS involved, the [Government is worried that the FCA cannot process] applications for them in time. This would result in a cliff-edge situation for those EEA UCITS that had opted into the TMPL. To address these concerns, the Bill will extend the temporary marketing permissions regime from three years to five years to allow enough time for the Government to complete any equivalence assessments and for the funds in the regime to apply for recognition. That will be either through the overseas fund regime or the more technical section 272 as appropriate."
Nileena Premchand moved on to the overseas framework, which exists already but which the Government wants to reform. The areas that drew most of her interest included the overseas person exlusion, the financial promotion order and the investment services equivalence under the Markets in Financial Instruments Regulation or MIFIR. These are the areas in which there are overlaps between activities and in which there may be some room in which to make the framework more transparent, consistent and easier to work with.
The effect of Brexit on British firms that want to access European markets
As part of Brexit contingency planning, a number of fund managers have moved their operations to Ireland or Luxembourg to benefit from the management and marketing passports. Countries such as Luxembourg have imposed additional substance requirements in relation to the number of indiviudals on the ground in the jurisdiction and the time that such individuals are expected to devote to the business of their companies. Fully functioning operational businesses are now required, rather than shell companies.
Nileena Premchand thought it likely that this trend would continue, with EU states also trying to tighten up rules to do with delegation. Again, in UK managers' Brexit contingency planning, the delegation model is one that Bryan Cave Leighton Paisner sees frequently.
Premchand also noted that the EU was overhauling the Alternative Investments Fund Managers' Directive or AIFMD and she thought it likely that the rules to do with delegation would be considered and narrowed in scope. This, she said, was "one to keep an eye on."
In terms of product distribution, practitioner in the UK no longer have the benefit of the AIFMD marketing passport. This will not result in a change to the status quo for managers who were previously operating by means of the small AIFA regime. This is now something with which many more managers in the UK will have to contend.
Premchand added: "The extent to which this is likely to be onerous depends on the number of jurisdictions that are being targeted but also on the national laws that each state is implementing."
An EU package of measures to do with the cross-border distribution of funds is also due to be implemented later this year. This legislation is aimed at reducing regulatory barriers to marketing and the cross-border distribution of funds. It ought to even out the playing field between member-states and in doing so simplify the process of marketing.
The UK and other countries are eagerly awaiting the long-promised AIFMD third-country marketing passport, towards which (at the time of the seminar) there had been no progress.
Firms ought to be aware that Brexit is unlikely to represent a complete shift away from having to comply with EU distribution rules. Unfortunately, Premchand thought, it is more likely that British firms will be subject to dual compliance. She explained: "To the extent that a European placement agent is pinpointed, they will still be subject to their own requirements under European legislation, which in turn will mean that these European regulatory requirements are likely to apply to UK managers or UK firms through the back door."
Reverse solicitation under MiFID, according to literature published by the law firm, occurs when a client established in the EU initiates “at its own exclusive initiative" the provision by a non-EU firm of investment services or activities. It allows a firm to service EU clients without becoming enmeshed in national licensing requirements.
This is a regime with which British fund firms are familiar. It is one of the methods that firms outside Europe may consider using when deciding how best to provide services in Europe. The rules of reverse solicitation are used throughout the EU but firms ought to exercise them with caution. This was evident when ESMA issued a reminder to firms in January about the MiFID II rules of reverse solicitation. In particular, it said that after Brexit it had noticed some questionable practices on the part of firms. It mentioned firms including general clauses in their terms of business or using online pop-ups or “I agree” boxes, whereby clients state that any transaction is executed on their own exclusive initiative.
In the notice that ESMA issued, it reminded the market of three main principles.
- Every means of communication to be used, such as press releases, advertising on the internet, brochures, phone calls or face-to-face meetings, "should be considered to determine if the client or potential client has been subject to any solicitation...regardless of the person through whom it is issued."
- The provision of investment services in the EU without proper authorisation in accordance with the EU and the national law applicable in member states exposes service providers to the risk of administrative or criminal proceedings, for the application of relevant sanctions.
- When using the services of investment service providers which are not properly authorised in accordance with the laws of the EU and of member states, investors may lose any protection that they might have against various things that the relevant rules of the EU grant to them, including coverage under the investor compensation schemes in accordance with Directive 97/9/EC.
Matthew Baker rounded off the Brexit session with an observation: "There is a subtle...difference between the MiFID reverse solicitation and the AIFMD one. A lot of jurisdictions are going to land up aligning but it gets back to that point that as managers, as distributors, you really do need to think quite carefully about what it is you're doing and how you're doing it.
"It reminds me when the AIFMD first came along five or six years ago and US managers said that their marketing strategy for Europe was reverse solicitation, which does set up that distinction between proactively marketing and sitting there waiting for people to come back and it can just reveal the disconnected thinking. It is one of those ones where you all need to be actively thinking about making sure that you are watching things."
Nileena Premchand noted another thing regarding AIFMD reverse solicitation: "When the cross-border distribution rules are implemented and the rules around pre-marketing come into play, the extent to which reverse solicitation can be relied on, I think, narrows even further."
* Matthew Baker can be reached on +44 (0) 20 3400 4902 or at email@example.com; Nileena Premchand can be reached on +44 (0) 20 3400 3575 or at firstname.lastname@example.org