Robert Ophele, chairman of the French regulator (AMF), recently predicted that the EU’s fund industry would be ‘profoundly transformed’ by Brexit.
With the UK being one of the major centres for alternative funds, the industry should be prepared for certain changes in fund domiciliation patterns in 2020 and beyond, as the Conservatives push forward with leaving the European Union.
In the past, fund domiciliation decision-making has been predominantly influenced by factors such as the reputation of a jurisdiction, investor sentiment, set-up timelines and processes, regulations, costs and the quality of the service providers.
Now, however, three additional factors are dominating the thinking: the advent of Brexit, base erosion and profit shifting (Beps), and the drive to introduce local economic substance requirements for companies’ tax residency to prevent fund managers setting up ‘letter-box’ entities.
Domicile decision-making for the alternative fund industry has entered a new era of geographic challenges and opportunities.
UK election reinforces passporting concerns
Following the Conservatives’ election victory, Boris Johnson has swiftly acted on his pledge to ‘get Brexit done.’ Which, while alleviating a degree of uncertainty about the post-Brexit fund landscape, has also reinforced concerns over market access and passporting.
These pre-election concerns from the industry have already led to questions over the UK’s status as a major fund domicile for the alternative funds industry. This would be of huge significance for Ireland and Luxembourg.
Luxembourg’s financial regulator (CSSF) has already introduced enhanced substance requirements to prevent the setting up of ‘letter-box’ entities, with just a handful of back office staff, in EU jurisdictions, whilst driving investment processes back in London.
Brexit therefore means more substance in EU jurisdictions where funds are domiciled.
Three options for UK managers after Brexit
Post-Brexit, it remains possible that funds domiciled in the UK could lose their EU passport; although UK asset managers should be able to make use of national private placement regimes (NPPRs) or reverse solicitation as is the case in the Channel Islands.
We have seen over the last two years a growing number of Jersey-registered alternative fund managers opting to future-proof their strategies and market into Europe through NPPRs. It shows that it is a route that works and is a good means of accessing EU capital in the context of Brexit.
Until we have further clarity on the regimes that will be available to alternative fund managers post Brexit, those running a close-ended alternative fund as a UK manager will likely have three choices: they can appoint an AIFM in Europe, relocate the fund, or restrict their customer base by cutting back on European investors and simply marketing their fund to UK investors.
Brexit will also mean EU-UK regulatory divergence over time.
The EU Commission, in its EU State of the Union 2018, proposed significantly increased financial regulation in Europe post-Brexit, and proposed building a functioning capital markets union across the EU. In comparison, the FCA is likely to introduce a less onerous regulatory regime for UK’s alternative fund managers as it will no longer be centrally regulated.
Factors beyond Brexit that will affect fund domiciles
What’s more, once the UK has left the EU, it will not be involved in the decision-making on the second edition of the alternative investment fund managers directive (AIFMD II), the passport extension, or the continuation of private placement and reverse solicitation.
As important as Brexit will likely be for future fund domiciliation patterns, it is conceivable that the longer-term effects from Beps will be even more significant. The measure, designed to end tax avoidance by multinational organisations, recently entered its multi-year implementation period. It includes rules on permanent establishment and transfer pricing that will shake up the alternative fund industry possibly even more than the ramifications of Brexit.
Beps will jettison a lot of the interest tax deductions that the alternative fund industry generally uses in its fund structuring, and it could also lead to lower returns. As the EU intends to be an early adopter of Beps, it will have significant effects on the alternative investment industry.
With alternative fund assets forecast to reach $14trn by 2023, the industry’s alternative investment fund managers are facing complex decisions about their fund domiciliation, and the stakes are high.
Justin Partington is group head of funds at IQ-EQ
