The effect on UK real estate fund managers
What UK real estate fund managers need to know about the United Kingdom’s vote to leave the European Union
The United Kingdom has voted to leave the European Union. Assuming this proceeds, and depending on what arrangements might be negotiated, there are likely to be consequences for UK real estate fund managers and for the financial services industry as a whole. We expect that whilst the departure process will take several years, fund managers will already be assessing the risks and opportunities that the UK’s exit may bring.
In this blog, we identify some of the key areas that UK real estate fund managers will be considering and monitoring closely over the coming weeks and months.
What access will UK managers continue to have to the single market post Brexit?
The shape of regulation that will apply to UK real estate fund managers after Brexit will depend on the nature of the UK’s relationship with the EU including the key issues of access to EU markets and the continued ability to distribute products to European investors. Whilst it is thought that the clearest way in which this could be achieved would be to adopt the “Norwegian model” through the UK acceding to the European Economic Area (EEA) Agreement (which would retain single market access), whether this would be acceptable from a political perspective is not yet fully clear, since this model is generally understood to require free movement of people and significant financial contributions to the EU’s budget, opposition to which were features of the pro-Brexit campaign.
Short of EEA membership, the model could be some sort of bespoke arrangement for the UK accessing the single market, whether through a series of sector-specific treaties (the so-called “Swiss model”), a more extensive free trade agreement (the so-called “Canadian model”) or some sort of special affiliate status negotiated for the UK adapted from the current EEA arrangements. If, however, the UK is treated as a third country under EU financial services legislation and if UK investment firms wanted to continue to provide investment services or products to clients in the EU, UK rules will need to be deemed equivalent by the European Commission. The paragraphs that follow consider the position if the UK does not conclude any such arrangement and is considered a “third country” under EU financial services legislation.
What is the impact on distribution under the AIFM Directive?
Assuming the UK does not accede to the EEA Agreement or negotiate an arrangement with equivalent access, the UK will become a “third country” for the purposes of the AIFMD. As such, UK based AIFMs will lose their right to manage funds based in other EEA domiciles and their right to market UK domiciled AIFs to investors in other EEA signatory states using the AIFMD marketing passport. UK managers and funds would be able to take advantage of private placement regimes in electing EEA signatory states on the same basis as US or Channel Island based funds and/or managers, for example, although such private placement regimes may be abolished after 2018. Should the European Commission decide to introduce a passport regime for third country AIFMs or AIFs, then it is likely that the UK should be in a position to demonstrate that it has a suitably equivalent regulatory regime and be able to access this arrangement. However, the introduction of such a regime is uncertain and possibly less likely following Brexit (not least as the UK was one of, it not, its main proponent in negotiations under AIFMD).
A more likely post Brexit scenario for UK real estate fund managers is that those managers who wish to distribute more widely to EU investors than can be readily accessed through private placement regimes will need to set up a fund domicile and distribution platform in a suitable EU member state, for example in Ireland or Luxembourg, with an AIFM established in such jurisdiction, in some cases, delegating portfolio management back to operations in the UK.
Of course, setting up a fund domicile and distribution platform in another EU member state could raise a number of UK tax issues, particularly where business functions, and/or people, are transferred out of the UK. In addition, to the extent that certain services are delegated back to the UK, this will raise transfer pricing and VAT issues, which will need to be explored.
Given the likely need for UK fund management firms to rely on delegated arrangements from EU distribution hubs and platforms as discussed above, a further concern will be potential changes to the delegation rules that currently enable AIFMs to delegate to a UK based investment manager. This will depend on whether the post-Brexit UK regime would be deemed to be sufficiently equivalent to enable delegation by EU firms to UK investment managers, which we consider on balance to be the more likely scenario, although changes to those rules could be made that are less favourable than at present. For example, the EU might pass more stringent rules in relation to the remuneration regime that must apply to the delegated third country manager, including bonus caps, which is something the UK has resisted strongly to date but which it may be unable to influence so strongly in future. However, the delegation model could also be adversely affected by changes in the tax regimes of different EU member states. There may be changes to delegation rules enabling AIFMs to delegate to a UK based investment manager.
When considering the restructuring of EU management companies, to the extent there is delegation of portfolio management by an EU entity to, say, a UK management company, the substance of the EU management company will be an important focus of the EU and national Member State regulators. There is already a supervisory focus on whether some EU management companies are simply “letter box entities” and this is likely to intensify in a post-Brexit world.
The overall impact of Brexit (as far as can be seen as this stage) is likely to depend upon on the nature of the fund manager and the scope and scale of its activities. It is quite possible that smaller managers not requiring significant access to EU distribution (for example, those for whom access to the EU market through third country private placement regimes is sufficient) will be able to flourish in the future UK regulatory regime and that it may become significantly more cost-effective for start-up managers to launch than at present. However, the burden is likely to increase for those managers that do need to establish a hub in Dublin or Luxembourg, for example, even if using a third party provider or platform, as they will be subject to two different regimes.
It may be that larger fund managers with existing European operations (in jurisdictions such as Luxembourg and Ireland) will see little impact upon their ability to distribute products throughout the EU, since they are for the most part probably distributing AIFs from non-UK jurisdictions already. However, the position for fund managers which are subsidiaries or divisions of banks (or other financial institutions such as insurance companies) may become more complicated by reason of developments outside the fund management area, in particular if they are considering a reactive restructuring of their operations, including potential relocation of parts of their business.