Two major financial services organisations responded to the news in October that the UK intends to trigger Article 50 negotiations by March of next year with warnings of the potentially challenging path this will likely mean for investors.
Prime minister Theresa May ended the speculation as to when the Article 50 process would be set in motion in an appearance on a Sunday morning TV news show on 2nd October.
DeVere Group chief executive Nigel Green predicted that investors would “dump” UK assets between now and the start of the negotiations, because, he said, despite the commitment to start negotiations, a vacuum of detail remains that leaves “no clear answers to the important questions about the UK’s future relationship with the EU or the rest of the world”.
“This uncertainty suggests a higher risk for investors, and it can be expected that as a direct response, many will dump UK assets as a precautionary measure,” Green, whose company is said to be the world’s largest independent, expat-focused advisory group, added.
Green also predicted continued weakness in the UK’s currency, although he said he thought UK property would remain largely unaffected, as the weak pound attracted investors to what he noted was an asset class with “ongoing fundamental strengths”.
UK investors, he said, should consequently be looking to increase their geographic diversification.
The currency volatility is being cited as one reason why the key FTSE 100 index saw new highs by early October, as investors bet that the biggest multinational companies listed in London will see their earnings made in other countries rise when repatriated back into sterling.
But in contrast, share prices have lagged on the FTSE 250 index, which has a much higher ratio of constituents that do the majority of their business in the UK.
Also weighing in after May’s announcement was the Association of Investment Companies, the UK trade association which represents closed-ended listed investment funds.
In addition to predicting that UK asset values would be hit by Brexit uncertainty, the AIC warned that the collective investments sector would face a significant regulatory hurdle if the UK fails in its negotiations to retain access to Europe’s investment markets.
It said it was recommending that HM Treasury, the ministry responsible for the country’s finances, should apply a “layered approach to funds regulation when the UK withdraws from the EU”.
“Under such an approach, the UK would create a tailored UK regime for funds not actively marketed to European investors. European rules would only be imposed if, and to the extent, that funds are marketed within the EU.”
Ian Sayers, chief executive of the AIC, said: “It makes sense to maximise the opportunity provided by Brexit to create a tailored UK regime for funds which are not actively marketed to EU investors.
“Currently around 95% of investment company investors are from the UK. A ‘layered’ approach would provide an opportunity to simplify the current unhelpful patchwork of EU regulation.
“It would maintain strong regulatory standards for investors but also reduce unnecessary compliance burdens. It would maximise the UK’s ability to reduce costs, enhance competition and support investment in the UK economy. Where funds actively seek EU investors, EU rules would be overlaid.”
“We are cautious about seeking a full passport for EU-wide access ‘at all costs’. The rules allowing investment companies to market into individual EU countries work well and can be used to target additional demand effectively. It is unlikely that the additional compliance costs that come with a full passport would outweigh the benefits of any extra marginal demand. Even UCITS, which have had a full EU passport for many years, have limited cross border distribution in practice.”
That said, UK investment companies have a significant stake in the outcome of rules for selling or distributing funds across borders into the single market.
Mifid II legislation
Just recently the UK’s Financial Conduct Authority confirmed its opinion that investment company shares are not considered “automatically complex” for purposes of MiFID II legislation.
Products that are considered “complex” put added onus on the provider firm to ensure retail investors have a full understanding of what they are buying before they are allowed to trade.
What is uncertain now is how the FCA will adapt its own confirmation once the UK is outside the EU, and where, presumably, MiFID II rules are not as applicable as per the heavy weighting of the local UK market in terms of this part of the UK funds industry.
ESMA, the European Securities and Markets Authority, has so far not provided a detailed response to the Brexit challenge, particularly around technical standards work for which it is responsible, but should the AIC’s call for a multi-layered approach be adopted by the UK government for both closed and open ended funds, then ESMA would likely be drafted in to check what, if any, particular implications there would be for product providers attempting to provide funds on a passport basis across the single market.
The use of funds based in the UK is also likely to be scrutinised by EIOPA, the European Insurance and Occupational Pensions Authority, which has already had an impact on the use of funds in the insurance sector through its responsibilities in relation to the Solvency II Regulation.
If the objective is to initiate a ‘hard’ Brexit – as suggested by UK prime minister Theresa May in her speech to the annual Conservative Party conference on 2 October, when she suggested that what was important was “freedom… from how we label our food to the way in which we choose to control immigration” – then UK insurance regulation is also likely to detach from the EU, with implications for funds targeting institutional investors.
EFAMA, the European Fund and Asset Management Association, which includes member associations from both EU and non EU markets in the region – such as Norway, Switzerland and Turkey – noted in early September that sales of Ucits equity funds were hit in June by uncertainties trigged by the Brexit vote, although net sales of alternative investment funds over the period reported were up, according to a statement from Bernard Delbacque, senior director for Economics and Research at the Association.
Layered approach to funds regulation – AIC proposal
The layered approach to funds regulation would involve setting different rules for:
These funds would only have to apply UK rules. European investors would still be able to purchase investment company shares, as at present, when this is on their own initiative.
These funds would apply both the UK rules and some additional obligations currently required by the AIFM Directive. Currently these involve making certain regulatory disclosures and adhering to the ‘private equity’ provisions. The EU country concerned could also set additional requirements.
Funds opting for a full passport would have access to all EU countries, but would also be subject to all EU funds regulation on top of the UK rules. Investment companies currently do not have access to a full EU passport, unlike Ucits funds. Whilst the UK may seek a full passport for other funds, the AIC recommends that this is not pursued if it means ending access on a country-by-country basis as under the current regime.