UK/EU Investment Management Update

The UK’s access to EU financial markets will not form part of the upcoming trade talks. As for equivalence for financial services (e.g., under MiFID II), on February 25, 2020, the commission updated its Q&A on the Future EU-UK Partnership; the Q&A states, bluntly:

The granting (or not granting) of equivalence is a unilateral measure by the EU. Equivalence can be withdrawn at any time. Decisions should be reciprocal.

By contrast, the UK is seeking a legally binding equivalence framework.

The commission aims to complete the equivalence assessment for the UK by June 2020, as set out in the UK/EU Withdrawal Agreement. In the meantime, the EU and UK will continue to discuss areas that are covered by the trade talks such as goods, security, movement of citizens and fisheries.

UK FCA – considerations for UK firms

On February 18, 2020, the FCA updated its web page Considerations for UK firms after the transition period, which sets out questions for firms to assess the impact that the end of the transition period (December 31, 2020) may have on their business. The FCA, however, provided additional commentary on the following considerations:

• Engaging with non-UK regulators: Firms should be prepared to discuss their plans with European regulators to ensure that they are ready and able to continue servicing European Economic Area (EEA) customers after the transition period ends. In turn, firms should also be prepared for European regulators making direct contact with them about their intentions. Firms should act lawfully and respond appropriately and in a timely manner with European regulators as they would with the FCA.
• Servicing EEA customers: Firms should be prepared for the possibility that not all of their activities may be covered by the arrangements agreed between the UK and the EU on January 1, 2020. The FCA reminds that decision-making should be guided by achieving the right outcome for customers, which involves treating them fairly irrespective of where they are located. In particular, choosing to stop servicing the consumer may cause significant consumer harm.
• Outsourcing: Firms will need a clear understanding of their dependencies on outsourcing or third-party service providers in order to assess whether the firm will be able to continue accessing such services after the transition period.

ECB’s Brexit preparation warning

On February 12, 2020, the European Central Bank (ECB) published a supervisory review, which noted that some UK banks still needed to take “substantial action” to implement their post-Brexit operating models. While the review is targeted at banks, the ECB’s message presents similar considerations to investment firms.

The ECB set out a few concerns for banks looking to revise their business models, which may also be relevant for investment funds by analogy:

• Branches in countries outside of the EU (e.g., the UK post-Brexit) should be used to meet local needs and not to perform critical functions or provide services to EU-based customers.
• Undue complexities in cross-border business models should be avoided (e.g., splitting a trading desk across multiple legal entities according to specific product characteristic would not be an acceptable practice).
• A qualitative approach to compliance should be taken (e.g., a firm should not merely transfer a certain number of staff but also employees with appropriate levels of seniority and skills).

The above, along with the European Securities and Markets Authority’s (ESMA) previous Opinions on firms’ relocations post-Brexit, makes clear that, for example, an Irish or Luxembourg MiFID firm or alternative investment fund manager (AIFM) will generally not be able to establish a small entity in Ireland/Luxembourg and then have people working in a branch in the UK, from which UK staff will deal with EU27 clients/investors.

There is no immediate effect of the Cayman Islands’ being placed on the Non-Cooperative List, and it is entirely possible that the Cayman Islands will be removed from the list when it is next updated around October 2020. The Cayman Islands has adopted various pieces of legislation to address the EU’s concerns, the latest being the Private Funds Law and the Mutual Funds (Amendment) Law, enacted on February 7, 2020, both of which address the EU’s concerns for collective investment vehicles.

As a technical matter, being placed on the Non-Cooperative List means that three types of EU “defensive measures” become applicable:

• Non-tax defensive measures: Broadly, these preclude access to EU funding from the European Fund for Sustainable Development or the European Fund for Strategic Investments. These measures are not expected to be relevant to investment managers.
• Administrative tax defensive measures: EU member states have agreed to implement at least one of these measures that, broadly, amount to increased monitoring and audit risk of structures involving a jurisdiction on the Non-Cooperative List.
• Legislative tax defensive measures: The potential measures consist of (i) denying tax deductions for payments made to entities in jurisdictions on the Non-Cooperative List, (ii) amendments to controlled foreign company (CFC) rules (an anti-avoidance regime that all EU member states are now required to have in place) to ensure that such rules better catch CFCs in listed jurisdictions or impose a higher rate of tax if so caught, (iii) either applying higher withholding tax rates or imposing a new specific withholding tax on payments made to entities in listed jurisdictions and (iv) denying participation exemptions on distributions on profits from entities in listed jurisdictions. Importantly, no member state has yet adopted such measures, but the EU has encouraged member states to implement at least one of them by January 1, 2021.

The inclusion of the Cayman Islands on the Non-Cooperative List should not cause any particular issues for Cayman funds under the AIFMD from a marketing perspective, as the AIFMD refers to managers/funds not being on the Financial Action Task Force on Money Laundering (FATF) list (which relates to money laundering and financial crime) rather than the Non-Cooperative List. However, managers will need to check whether they have side letters that refer to the Non-Cooperative List or whether any EU member state into which they market their funds somehow prohibits the marketing of funds that are domiciled in a country on the Non-Cooperative List. It is also possible that certain EU investors may decide against investing in Cayman funds on the basis of internal controls and policies. Finally, managers of Cayman funds will also need to consider whether it would be appropriate to draft risk factors for their disclosure documents to address the Non-Cooperative List.