Carte blanche

“A Luxembourg perspective on Brexit-proof solutions”

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Since the notification in March 2017 by the UK government of its intention to part ways with the EU following the Brexit referendum of June 2016, the European commission and the UK government are stepping up efforts to come to an agreement on withdrawal terms.

Negotiations are still ongoing and there is no certainty but rather reasonable hopes that a ratified withdrawal agreement will be struck ahead of the March 29, 2019 deadline.

Absent any deal by then, the UK faces the risk of a “hard Brexit” which would involve unprecedented consequences for the alternative investment funds industry, mostly and just to name a few, the loss of the AIFMD passport for UK Alternative Investment Fund Managers (AIFMs) and Alternative Investment Funds (AIFs), and doubts about whether portfolio management of AIFs could still be delegated back to UK regulated entities. With the Brexit deadline fast approaching, any fund promoter with a UK nexus has contingency planning on top of the agenda. 

From a Luxembourg perspective, we have observed the following trends since the Brexit vote. The immediate reaction post referendum was to rather establish non-UK AIFs (such as Luxembourg AIFs) to safeguard the benefit of the EU passport. Awaiting the extension of the AIFMD passport to third countries, the benefit of the passport is at present subject to a full EU setting (both the AIF and the AIFM are required to be EU-based).

By setting up Luxembourg AIFs, UK managers were securing the EU status of the fund.

Jérôme MullmaierJérôme Mullmaier, Counsel (Loyens & Loeff)

By setting up Luxembourg AIFs, UK managers were securing the EU status of the fund and they could still use their UK AIFMs until Brexit. The hope was also that the AIFMD third country passport would be introduced before Brexit and that the UK would be among the first to benefit from the third country passport with its EU equivalent regulatory framework.

It however turned out that Brexit has pretty much stalled the extension of the AIFMD passport to third countries. With the looming March 2019 deadline and related anxiety around whether the withdrawal agreement (if any) would contain some transitional period, UK fund promoters had to reconsider the AIFM location itself.

The size of the manager and existing Luxembourg footprint then plays a key role when considering available solutions. A fair bit of big asset managers with already some personnel in Luxembourg have filed an application with the CSSF to get their own “in house” AIFM.

The third party AIFM model is now familiar to managers and investors.

Jérôme MullmaierJérôme Mullmaier, Counsel (Loyens & Loeff)

Mid-market players tend to rather appoint third party AIFMs either as a long term or interim solution until they get their own licence. The third party AIFM model is now familiar to managers and investors alike and is probably meant to keep up its momentum.

For many fund promoters, handing over some governance control to the third party AIFM is often preferred over going down the costs and substance implications of filing an AIFM application. Substance expectations have recently been toughened up by the CSSF and meeting them comes with a real effort and investment for any applicant.

The success of the third party AIFM model is often reliant on the delegation of portfolio management back to a sponsor entity (often an FCA regulated firm). This governance structure has recently come under threat as a result of multiple regulatory initiatives.

First, Esma has released an opinion on Brexit relocation making it clear that a relocation in the EU of UK AIFMs should not end up with most of the groundwork being actually carried out from the UK through delegation schemes. A proposed EU regulation also got released last year which purpose was notably to hand over to Esma the review of delegation arrangements involving material delegation back to third countries.

Luxembourg is then well placed [...] to attract the AIFM as well.

Jérôme MullmaierJérôme Mullmaier, Counsel (Loyens & Loeff)

This draft regulation has come under fire and the latest expectation is that Esma’s involvement will ultimately be toned down. Another immediate concern facing UK managers is the absence of any cooperation agreement between the CSSF and the FCA which is in principle required under AIFMD for any delegation of portfolio management by a Luxembourg AIFM to a third country firm.

There have been comforting statements by high up individuals confirming that entering into such an agreement will be high up on the agenda of both regulators in case of hard Brexit. Fund managers however have to get prepared for the worse and some are already considering some alternative delegation arrangements involving group entities regulated in other non EU jurisdictions (such as SEC regulated firms).

Overall, the immediate concern for UK managers is to secure distribution channels in the EU post Brexit but some other regulatory and tax implications also come into play when opting for any relocating EU jurisdiction, such as the Beps action plan which incentivises managers to establish both the fund and the manager in the same jurisdiction. Luxembourg is then well placed to leverage on its prominent position as a fund domicile to attract the AIFM as well.