By Clare Francis, Global Head of Investors and Insurers, and Regional Head of Global Banking, Europe, Standard Chartered
As confusion reigns over the shape of Brexit, some of our Asian and Middle Eastern asset management clients are having second thoughts about planned UCITS fund launches. One of the questions being asked is whether this is the best time to launch a UCITS? As before doing so, they want to see the final exit agreement and get a sense of the future EU trade relationship.
For asset managers in the UK, Europe and further afield, much remains unclear. Most immediately, hurried measures are under way to make sure that business can continue as normal – from trading through to operations – whenever Brexit happens.
Managers are also thinking ahead to the longer term, once the dust settles and relative normality resumes, and trying to anticipate unintended consequences. For Asian and Middle Eastern managers, for example, without the UK the UCITS vehicle will not be able to cover such a large market.
For UK and European asset managers, former pan-European fund registrations must be reassigned, for the jurisdictions where no post Brexit arrangements have been agreed bilatrally. Fortunately, most fund administration activities were offshored to specialist centres several years ago, so the back end operational activity is not likely to be affected, for most of the institutions.
Fragmented trading liquidity will certainly be an unintended consequence, however. UK and European asset managers are seeking to anticipate where they will be able to find sufficient liquidity. With financial market liquidity fragmenting between the UK and the EU, as well as bank capital, where can they execute large, regular transactions?
“Best execution” meets fragmented liquidity
Under the EU’s Mifid II directive, asset managers must achieve the best possible result for customers when executing trades. Although UK asset managers will not be subject to Mifid on leaving, the UK’s rules are likely to be equivalent. But with Europe’s multiple trading venues spread across the UK and the 27 remaining member states, the best source of liquidity for trading in a specific security or financial instrument might be hard to access post Brexit. UK-based asset managers might have difficulties accessing EU venues and vice versa.
Furthermore, Brexit will split trading liquidity across venues. Asset managers will want to be sure they can continue to trade in the venues that have the deepest liquidity for the securities they hold. Again, Mifid obliges them to.
To gain access to the deepest liquidity, firms that have not established entities in both London and the EU may consider doing so. Others may consider the provisional “national no deal arrangements” hastily established between the UK and some EU states. They may want to make use of these arrangements for now and then restructure operations over the longer term as the future UK / EU relationship becomes clearer.
Or they can trade through their banks. Like other banks, Standard Chartered has replicated its London operations within the EU, in our case in Frankfurt. Unlike many other banks, we are also helping clients to set up tailored solutions to Brexit’s undoubted challenges.
Distribution and the Brexit border
As per the prevailing conditions, from a distribution perspective, UK registered funds will cease to have the passports to EU member states, enjoyed for about 20 years. Unless a multilateral arrangement is agreed or multiple bi-lateral agreements put in place, asset managers will not be able to distribute a single fund across both the UK and the EU states.
In the short-term, the UK has set up a “temporary permission regime” relating to Luxembourg, one of the two main centres for UCITS fund registration. This allows funds registered in Luxembourg to register under the regime and continue activities in the UK. But this is a bilateral approach taken by the UK and currently no similar arrangements exist with other jurisdictions. Importantly, Luxembourg has not yet reciprocated the arrangement, although there is a proposal in the pipeline.
Consequently, UK and European asset managers must review where to register a fund, depending on where most of their investors are. There may be some duplication, with separate funds registered in both the UK and an EU state. Management companies must be established where the fund is registered.
Beyond the immediate practicalities there may be longer term consequences. For example, fast-growing Asian fund managers have used UCITS funds as a vehicle for selling not just into Europe but also into Asia, taking advantage of the EU’s reciprocal agreements. If UCITS cannot be sold in the UK in future, these managers may decide to opt for the passporting regimes within their regions i.e. the likes of ASEAN fund passport or the Asia Regional Funds Passport (ARFP) instead.
Avoiding unintended consequences
As Brexit appears to draw nearer, asset managers face immediate operational challenges, which appear manageable with the help of a bank that is willing to discuss the full range of issues from execution through to fund distribution.
New markets such as alternatives, sustainability, and emerging markets are very important. As West goes East and the Middle East and China opens access to new markets collective industry thought is crucial, if the industry is to capitalise on fast changing investor cycles as and when they emerge. The expert financial concepts that an institutional market like London, Europe and New York have built have much to offer. We need to ensure as markets emerge quickly the West doesn’t collectively loose its momentum and its way.
The full implications of Brexit for trading and distribution may well prove to be bigger issues. After all, best execution is a regulatory issue that also impacts investment performance, while suitable distribution is equally key.
While the destination of Brexit will not be clear for some time, it’s evident that asset managers must anticipate the future and look digital and global if they are to avoid unfortunate unintended consequences.