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T
he UK’s title as Europe’s leading hedge fund centre is
unassailable. Eighty-five percent of Europe’s hedge fund
AuM (assets under management) is controlled out of
London, translating into roughly $906 billion. The impact of a
no deal Brexit on banks, insurers and market infrastructures is
potentially very troublesome and painful, but the implications
for hedge funds appears to be far less destabilising.
Collateral damage
Some hedge funds will inevitably be affected by Brexit, namely
those running UCITS or fully compliant AIFMD (Alternative
Investment Fund Managers Directive) products whereby the
AIFM is based in London and the AIF is domiciled in an onshore
EU market such as Luxembourg or Ireland. These fund struc-
tures will have been set up to maximise managers’ European
distribution footprint, giving them unfettered access across all
member states.
As the government confirmed it will withdraw from the Single
Market and has vanquished all hopes of achieving a mutu-
al recognition deal with the EU, AIFMD and UCITS will be
voided at domestic funds post-Brexit. This means hedge funds
using UCITS or AIFMD wrappers to passport will lose their
cross-border distribution rights, which may incentivise some
firms to re-domicile or build up substance in onshore markets to
retain EU access.
“Firms are worried about a soft Brexit where the industry is
forced to comply with EU regulation without having any say
on how it is framed.”
HEDGE FUND COO
Still no clue
One hedge fund COO in London said that while larger managers
with EU investors had built up substance in Luxembourg and
Ireland and registered in a handful of other markets, most firms
were procrastinating because they did not want to accrue large
legal and administrative costs implementing a Brexit contin-
gency plan when the outcome of negotiations is still painfully
unclear. Others are simply waiting for the European Securities
and Markets Authority (ESMA) to issue concrete guidance about
delegation before making any definitive decision on substance.
The debate around delegation continues to mystify and frus-
trate market participants in equal dosage. Neil Robson, partner
at Katten Muchin Rosenman, said the announcement by the Au-
torité des marchés financiers (AMF), the French market regula-
tor, stating it would not challenge the existing delegation model,
was a “win” for the UK, although warned against complacency.
Robson acknowledged the AMF may have simply reined in its
hostility because it was fully aware ESMA is taking a tough line
on the delegation matter already.
The status quo remains unchanged
Not everyone is convinced a mass relocation or ‘Brexodus’ will
happen in large numbers. Firstly, European Commission data
shows just 3% of AIFs are authorised to market in more than
three countries. Most UK managers run non-EU funds and will
market to EU investors through National Private Placement Re-
34
Global Custodian
The Hedge Fund Annual 2018
gimes (NPPR), an arrangement whereby
firms must register and file an Annex IV
with the regulator in each member state
they are selling into.
“The reality is that very few UK hedge
fund managers solely managing non-
EU funds have been focussing on the
introduction of the AIFMD passport, so
the impact of Brexit on this segment of
the industry is not going to be as serious
as it has been in other sectors, such as UK
managers of EU domiciled funds,” says
Bill Prew, founder and CEO at INDOS
Financial, an independent provider of
depositary services.
Prew explains most UK firms will simply
continue using the NPPR arrangement,
assuming EU regulators do not change the
rules post-Brexit. He also said managers
will avoid EU markets where the regulato-
ry regimes are less accommodating, much
as they already do today. However, any
rash or ill-thought out revisions to NPPR
by the EU would be a hammer blow at
hedge funds with European investors.
AIFMD is under review and regulators
are considering whether NPPR should be
allowed to expire, a decision which would
force third-country managers with EU
clients to park themselves firmly inside
the Single Market. While some have
argued the Financial Conduct Authority’s
(FCA) absence in ESMA’s policy discus-
sions may lead to a protectionist approach
being taken, others are confident this
will not happen, arguing it would prompt
managers to exit the EU entirely.
No cutting corners
A well-oiled trick perfected by a number
of non-EU hedge funds determined to
side-step AIFMD compliance has been
to rely on reverse solicitation, a spurious
legal concept that lets managers avoid the
rules providing they do not contact inves-
tors directly. Instead, they must wait for
prospects to call them. It is an approach
that is open to enormous risk and abuse,
at least by a small minority of managers.
Some believe more UK managers may
opt to use the reverse solicitation route
post-Brexit if they are shut out of Europe.
However, this plan is likely to fall flat as
the EU is pushing through prescriptive
rules limiting pre-marketing activities
such as the dissemination of fund doc-
umentation with would-be clients prior
to launch. Pre-marketing is a ploy used
by managers to scope out EU investor
interest without having to register under