One of the biggest challenges for the finance sector and its regulators is the monitoring and mitigation of risks within a global network of overlapping, inter-connected ecosystems that allow capital and investments to flow across national borders.
The evolving nature of this challenge means the priorities and interaction between supervisors have morphed considerably in recent years – and will continue to do so. Although inevitable, such shifts have the power to significantly alter practice, process and business models at regulated firms. In particular, two related regulatory developments could oblige many European asset managers to radically rethink how they structure and locate their operations.
One is uncertainty over the future relationship between the UK and EU regulatory regimes following Brexit; the other is the changing balance of responsibilities between national regulators within the EU-27 and its pan-regional European Supervisory Authorities (ESAs). Combined, forthcoming shifts in regulatory responsibilities could prompt asset managers to re-examine existing operating structures, notably in relation to how tasks are allocated and delegated, including to third-party service providers.
On the one hand, asset managers which market their services on both sides of the English Channel must evaluate whether and how to establish new operations to allow them to deliver services to existing customers after March 2019. On the other, asset managers that continue to be regulated within the EU may need to ensure their delegated operations meet with the approval not only of national competent authorities (NCAs) but also of the European Securities and Markets Authority (ESMA), which may be granted increased oversight powers under a legislative proposal issued by the European Commission last September. As noted recently by the Association of the Luxembourg Fund Industry (ALFI), managers of EU-domiciled funds could need approval from ESMA in order to delegate or outsource activities to non-EU jurisdictions.
In terms of Brexit, UK-registered asset managers that invest money on behalf of European clients – but which currently have no or limited presence on the European mainland – face the need to adapt their operating models. Such firms cannot rely on use of existing passports to market, distribute or service funds in Europe after Brexit, and as such are already entering discussions with regulators and service providers on the kind of EU-27 facilities required to enable them to continue to serve existing clients. Any discussions will have been lent further urgency by the ‘Notice to Stakeholders’ issued to fund managers and investors by the European Commission on 8 February, which reminded UK-based funds that they will lose their UCITS status in March 2019 and outlined strict conditions for delegation.
Although EU-27 UCITS management companies authorised by EU-27 competent authorities which are subsidiaries of UK entities will be permitted to continue to operate in the EU-27 post-Brexit, UK branches will not. Moreover, firms that establish EU-27 operations will need to take into account recent ESMA guidance on the required substance of such entities. In short, a letterbox or brass-plate presence – i.e. the company’s name on a serviced office populated by a skeleton staff, while the bulk of processes and decisions are kept in the UK – will not cut the mustard. Provision of asset management services to European is likely to carry the obligation to locate substantive operations within EU-27 too.
Even if unaffected by Brexit, any European asset manager that relies on delegation as part of its operating model will need to reassess existing arrangements in light of the EC’s ESA review. As per the Commission’s recent notice, EU-27-registered firms may only delegate or outsource to UK entities following a cooperation agreement between EU and UK regulators, having provided ‘objective reasons’ for using services from a non-EU jurisdiction.
Currently, a European asset manager running a fund investing in US equities might locate portfolio managers within the US and / or use US-based teams for part of the fund administration and custodian services, in order to receive optimal servicing. Similarly, that asset manager might establish local distribution support capabilities in Asia, directly or through the appointed transfer agent, to handle relationships with in-country banks and other distribution partners across the region. Such arrangements have been integral to the success of UCITS, EU-registered mutual funds that cost-effectively manage funds and deliver returns to clients on a global basis. The continuation of ‘follow-the-sun’ operating models that allow asset managers to locate or contract operations near to investors and / or investments will be critical to UCITS’ further advancement at a time when GDP and savings growth are stronger in the eastern than western hemisphere.
The extra powers likely to be granted to ESMA could be positive for asset managers that choose to delegate or outsource in terms of harmonising supervisory practice. But if the shift in responsibility limits the ability of firms to delegate – inside or outside the EU – the competitiveness of UCITS could be undermined. Further, as ALFI has flagged, it may be that UK asset managers marketing funds in the EU-27 would be regulated by ESMA post-Brexit, in terms of approval of delegation and outsourcing arrangements, under ESMA’s proposed new powers.
As regulatory responsibilities shift, it is prudent to conduct thorough due diligence to ensure changes can be made swiftly and efficiently. The need to establish a substantive presence in the EU-27 could prove a significant logistical and budgetary challenge for UK firms post-Brexit. Even those firms relatively unaffected by Brexit might well benefit from a reappraisal of where they locate and how they delegate operations and processes, in light of the ESA review.
For UK-registered asset management firms, a number of jurisdictions across Europe are already extremely well-positioned to provide the services and facilities to enable firms to get up and running in a way that satisfies both regulators and clients. As the world’s second largest fund domicile, for example, Luxembourg has long maintained a robust regulatory infrastructure that demands a substantive presence from licence-holding institutions.
At BNY Mellon, our approach is to support the global ambitions of our clients via a ‘follow-the-sun’ model that ensures we can service their needs regardless of where they are headquartered and how their geographic footprint spreads. After all, access to a wide range of skills, services and experience in a variety of locations not only enhances the flexibility and responsiveness of clients’ operating infrastructure – it can also help to identify and limit operational risks.
You can meet the author of this article, David Claus, along with the BNY Mellon team at our stand at the ALFI European Asset Management Conference taking place 6-7 March, 2018 in Luxembourg.