Some impacts for fund managers of Brexit November 2015-1 -
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1 Some impacts for fund managers of Brexit The Conservative government is committed to having a referendum on the UK s membership of the European Union (EU) within two years of its election in 2015, with the options being to Leave the EU or to Remain on new terms to be negotiated by David Cameron. 1 At the time of writing opinion polls suggest that the result is too close to call. In this note we shall explain some of the implications and issues for fund managers were the UK to leave the European Union a scenario commonly referred to as Brexit (British exit). 1.1 Departure from the European Union is likely to imply departure from the Single Market Until recently, much commentary on the implications of Brexit has been predicated on the idea that, after departure, the UK would stay inside the European Single Market. The thought was that the UK would, despite leaving the EU, remain in what is called the European Economic Area (EEA) an economic area that includes not the European Union itself but also a set of countries (Norway, Iceland and Liechtenstein) that agree to abide by the rules of the Single Market even though as non-eu members they have no direct role in setting the rules. In our view the UK would be unlikely to remain in the EEA post-brexit, for at least two reasons. First, the issue of immigration has been central to the Brexit debate in the UK. There is free movement of persons within the European Union, which means that any EU citizen is entitled to travel anywhere within the EU to work, to seek work, to retire, to study or simply to reside. This freedom of movement is one of the four key freedoms of the Single Market (alongside free movement of goods, services and capital). It is an entirely non-negotiable feature of EU membership. Many of those seeking to renegotiate Britain s membership of the EU have urged that the UK must be able to impose restrictions upon the free movement of persons. Others argue that since doing that is impossible, the UK must leave the EU. A vote for Brexit would be likely to be interpreted by UK policymakers as meaning that UK voters were no longer willing to tolerate free movement of persons. But free movement of persons is not only a feature of the EU. It is a feature of the EEA, also. So if the UK were to leave the EU in order to restrict free movement of persons, it would also need to leave the EEA. 1 On 10 November 2015 Cameron set out his four demands for renegotiation in a letter to Donald Tusk, President of the European Council (http://issuu.com/spectator1828/docs/donald_tusk_letter_001_d5d09dcc167f11?e=5505998/31263273) The four areas for demands were: Economic governance : including specifically that the Treaties should be modified to recognise that the European Union has more than one currency and that EU businesses based outside the euro area should not be discriminated against. Competitiveness. Sovereignty : including specifically that the Treaties be modified to remove the UK s obligation to pursue ever closer union and that groups of national parliaments should be able to block unwanted EU legislation even in areas where the EU has competence to legislate. Immigration : including specifically that EU citizens coming to live in the UK should have to wait four years before receiving benefits. - 1 -
The second reason EEA membership is unlikely to be considered acceptable post-brexit is that non-eu members of the EEA have no direct influence over the rules of the Single Market (e.g. they have no voting power). Aside from free movement, the other major issue in the Brexit referendum debate has been whether, as a non-euro member of the EU, the UK is soon likely to find itself systematically outvoted in setting Single Market rules as Eurozone members (who would if voting collectively have sufficient voting weight always to carry the day) started voting together. It would seem to make little sense for the UK to leave the EU on the grounds it feared it would be forced to abide by Single Market rules set by the Eurozone that it could not prevent, only to agree to be a member of the EEA and thus subject to Single Market rules it had no voting influence over at all. 1.2 Being outside the Single Market would mean a changed status for UKbased funds when dealing with the EU A UK-based fund currently gains both obligations and rights because of the UK s membership of the Single Market. There are a series of important EU regulations that create such obligations and rights for funds. Five of the most important such regulations for the funds sector include: Markets in Financial Instruments Directive (MiFID). The various market abuse directions and regulations (AMLD). The Transparency Directive. The Undertakings for Collective Investments in Transferable Securities (UCITS) Directive. The Alternative Investment Fund Managers Directive (AIFMD). Collectively these provide a passport entitling funds to operate their services across the EU on a common level playing field basis and protect funds located in one member state being discriminated against by authorities elsewhere. At the same time, they create a series of regulatory obligations and compliance requirements. After departure from the EU (and hence the Single Market), funds based in the UK would cease to have this automatic market access, except insofar as such access obligations were created by international agreements such as the International Organization of Securities Commissions (IOSCO), unless and until some specific arrangements were made for UK-based funds under between the UK and the EU. In our view it is very likely that, unless the UK sought or entered into other agreements that restricted its ability to do deals with the EU (e.g. if it applied for NAFTA membership, which is not implausible), it would make an agreement with the EU that included significant entitlements for UK-based fund managers to offer services to the EU. The UK and the City in particular are simply too large a component of the EU financial services and finance sectors to be replaced by such services elsewhere within the timescales required (under the Lisbon Treaty there is a two-year timetable from the notification of an intention to leave the EU to the event itself implying a 2017 Brexit vote would be followed by Brexit in 2019). That means that in the short to medium term, unless the UK took the opportunity of departure from the EU to seek a radically different international alignment (which is possible), fund managers probably would continue to have access to the EU on fairly similar terms to at present. Over the medium to longer term, however, that would be likely to change. In particular, with a UK departure from the EU the EU s rule-making procedures would become less influenced by the UK s global outlook and more focused upon devising a finance sector that serves the financing needs of the EU itself. Furthermore, with the UK gone the non-eurozone EU might fairly quickly be wound up, and Single Market rules would become ever-more focused upon the euro area. That might mean that funds operating in euros would fund they faced formal or de facto restrictions on their ability to operate from outside the euro area, as the European Central Bank and the general thrust of regulation sought to bring activities that affect euro flows mainly within their direct jurisdiction and control. - 2 -
1.3 The period of departure would create opportunities for fund managers The finance sector manages and mitigates risks. The process of Brexit would involve a period of considerable uncertainty. Funds that anticipated and dealt with that uncertainty could be well-placed to serve various clients. Such clients might include: Firms within the rest of the EU that supply into the UK market. Firms within the UK supplying into the rest of the EU. Firms based outside the EU that use the UK as an access point into the rest of the EU. Firms based outside the EU that supply into the UK. Firms or wealthy individuals exposed to UK-euro currency fluctuations. Firms or wealth individuals exposed to movements in the value of UK assets. Firms based in or dealing with countries with which the UK might enter into new favourable trade agreements, shifting the balance of trade and creating new opportunities (e.g. perhaps Canada, Australia or the US). Firms operating in other parts of the non-eurozone EU that might fear the sustainability of those countries EU membership as non-euro members could lessen, potentially implying either joining the euro or departing from the EU. Dimensions of uncertainty could include issues such as: What would happen to UK GDP? What would happen to the value of sterling? What would happen to the integrity of the rest of the non-eurozone EU? Would the path of UK interest rates change (e.g. might interest rate rise be delayed in the event of Brexit)? Could there be implications for the value of UK real estate (either falling as capital was withdrawn from the UK or rising as interest rates continued to be low despite continuing economic recovery and rising inflation)? Could Brexit have an impact on the likelihood of Scotland leaving the UK, potentially having implications for UK sovereign debt or the creditworthiness of Scottish assets? How would internal UK policymaking respond to a Brexit vote? Would it go down an archly deregulatory route, throwing off the shackles of Brussels, or would it seek much more regulation in areas Brussels imposes restrictions (e.g. could the UK introduce more protectionist rules relating to international takeovers, as has been floated repeatedly in recent years)? We shall not seek to address all of these questions in this one note. Instead, we shall address a number of them in a series of notes to follow. - 3 -