3 June 2021 Investment Funds

AIFMD in the UK after Brexit

 

Overview

The UK ceased to be a member state of the European Union on 31 January 2020. On 31 December 2020, the Transition Period with respect to the United Kingdom’s departure from the European Union ended, with the UK ceasing to be treated as a Member State of the European Union. Amongst other consequences, the UK is no longer directly subject to EU law, including AIFMD. This has a profound impact on the provision of services by AIFMs from the EU into the UK and from the UK into EU Member States.

Overview of UK’s general approach to AIFMD post-Brexit

While AIFMD no longer binds the UK in its implementation, the UK has put in place a domestic regime regulating the management and marketing of AIFs in the UK, which generally maintains the rules set out in AIFMD as implemented at the end of the Transition Period. It is possible that the UK will diverge in its approach from that of the EU over time, whether as a result of changes to the existing rules, or not following future changes to AIFMD.

Marketing and Management / Temporary Permissions

With the end of the Transition Period, the pan-European passports enabling EU AIFMs to manage and market EU AIFs in any EU Member State no longer apply in relation to the UK. As the third-country passport regime envisaged by AIFMD has not been implemented to date, cross-border management and marketing of AIFs between the EU and the UK will instead be subject to varying national rules in the UK and in EU Member States (including under various NPPR regimes). The UK and several Member States made provision for AIFMs (and AIFs) using their passports during the Transition Period to continue doing so on a temporary basis.

UK regime for UK AIFMs

Implementation of the UK AIFMD regime

The UK AIFMD regime is now predominantly set out in a combination of:

The UK Regulations and relevant retained EU law were amended by the Alternative Investment Fund Managers (Amendment etc.) (EU Exit) Regulations 2019 (SI 2019/328) to address gaps and deficiencies arising from the withdrawal of the UK from the EU.

The FCA’s detailed perimeter guidance (PERG) on its implementation of AIFMD remains applicable to the UK AIFMD regime. This guidance was never applicable to the interpretation of AIFMD by other EU regulators.

Modifications to the UK AIFMD regime as a result of withdrawal from the EU

The UK AIFMD regime generally maintains the rules set out in AIFMD as implemented at the end of the Transition Period. At the time of writing, modifications to the regime have generally been limited to those required to ensure its effective operation now that the UK is not an EU Member State. These include changes to:

  • transfer the functions of the European Commission and ESMA to HM Treasury and the FCA respectively;
  • remove information sharing and cooperation obligations in respect of EU authorities;
  • reflect that EU cross-border management and marketing passports no longer apply in relation to the UK, and implement passporting arrangements in respect of Gibraltar AIFMs;
  • implement the Temporary Permissions Regime in respect of AIFs (please see below); and
  • limit the scope of reporting on portfolio companies and the asset stripping provisions to UK companies only (please see the Asset Stripping and Portfolio Company Disclosure pages for more detail).

It is possible that the UK AIFMD regime will diverge in its approach from that of the EU over time, whether as a result of changes to the UK’s existing rules, or not following future changes to AIFMD made by the EU. For example, the UK has indicated that it will not implement the EU’s legislative package in relation to the cross-border distribution of investment funds (please see below).

Marketing of AIFs on a cross-border basis

The pan-European marketing passport under AIFMD no longer applies to the UK from the end of the Transition Period. Accordingly, UK AIFMs may no longer use the passport to market EU AIFs and UK AIFs they manage in the EU, and EU AIFMs may no longer use the passport to market their EU AIFs and UK AIFs in the UK (subject to the Temporary Permissions Regime, mentioned below).

Marketing of AIFs by UK AIFMs in the EU

UK AIFMs must generally rely on NPPR

With the expiration of the Transition Period, UK AIFMs are now considered non-EU AIFMs under AIFMD, and therefore may no longer avail themselves of the pan-European marketing passport in order to market EU AIFs to professional investors in the EU. UK AIFMs may only conduct their marketing activities in EU Member States in relation to AIFs they manage on the basis of a notification and/or approval under the relevant EU Member State’s NPPR regime(s) implementing Article 42 of AIFMD, where provided for. Please see the Marketing page for more information.

Transitional arrangements

Local regulations in certain EU Member States provide for transitional regimes for UK AIFMs which marketed AIFs in their jurisdiction prior to the end of the Transition Period, including with respect to any “black out period”. We can assist clients with identifying jurisdictions in which relevant transitional arrangements may apply.

Third Country Passport

AIFMD contemplates the extension of the pan-European marketing passport to non-EU AIFMs (and non-EU AIFs) at a later date and sets out the relevant passporting arrangements. Whilst an initial review was conducted by ESMA in 2015 as provided for in AIFMD, the third country passport has not been implemented to date. If this third country passport is implemented in the future, it would provide UK AIFMs with another avenue for marketing AIFs in the EU. Please see the Marketing page for more information.

Marketing of AIFs by EU AIFMs in the UK

EU AIFMs must generally rely on the UK NPPR

Subject to the Temporary Permissions Regime mentioned below, EU AIFMs may no longer use the marketing passport under AIFMD to market EU AIFs or UK AIFs to professional investors in the UK. EU AIFMs seeking to market EU, UK or other third country AIFs in the UK are required to make the relevant notification to the FCA under the UK’s NPPR pursuant to Regulation 59 of the UK Regulations (or Regulation 58, in the case of small AIFMs). Please see the Marketing page for more information.

Position of EU UCITS marketed in the UK

EU UCITS are now considered third country AIFs from a UK perspective. As a general matter, NPPR filings referred to above must be made in order to market EU UCITS in the UK, and they may not be marketed generally to retail investors in the UK (subject to a Temporary Permissions Regime that was available to EU UCITS that were already being marketed in the UK under the UCITS Directive passport during the Transition Period).

However, the FCA has power to individually recognise non-UK funds as suitable for sale to retail investors under section 272 of the Financial Services and Markets Act 2000 – an individually recognised scheme would not need to make an NPPR filing as described above.

The UK government has also enacted a more streamlined Overseas Fund Regime enabling non-UK funds to be recognised for marketing to retail investors in the UK based on a determination that the relevant type of overseas fund provides equivalent protection to the UK’s authorised fund regime. Again, a UK NPPR filing would not be required in order to market in the UK an EU UCITS recognised under the Overseas Fund Regime. Please click here for more information in relation to the Overseas Fund Regime.

Temporary Permissions Regime for marketing AIFs in the UK

The UK Regulations provide for a Temporary Permissions Regime (the “TPR”), lasting for three years from the end of the Transition Period. An EU AIFM that was marketing (or could have marketed) a UK AIF or EU AIF in the UK on the basis of the AIFMD marketing passport during the Transition Period was able to request temporary permission to continue marketing that AIF in the UK after the end of the Transition Period on the same terms and conditions, subject to the landing slot described below.

The TPR filing window is now closed, so AIFs not already within the TPR cannot now access it.

With respect to umbrella AIFs that accessed the TPR prior to the end of the Transition Period, the FCA has indicated that new sub-funds established after the end of the Transition Period may not utilise the TPR. Accordingly, in order to be marketed in the UK, new sub-funds must be notified to the FCA under the UK’s NPPR.

Generally, an AIFM utilising the TPR is subject to the same rules which currently apply to it in its home state. However, the FCA has some additional responsibilities and may require additional information from the AIFM. Whilst relying on the TPR, the EU AIFM must:

  • continue to comply with the FCA rules that currently apply to it; and
  • notify the FCA of any changes to the documentation for a passporting AIF, and changes to the passporting AIFM’s programme of operations (as it provides such information to its home state regulator).

Whilst the TPR applies, the FCA will have the power to take certain measures against the EU AIFM in relation to revoking or suspending its ability to market in the UK, e.g. in the event of non-compliance.

The FCA will issue a “landing-slot” for each AIF utilising the TPR, during which the relevant EU AIFM should make the necessary filings to market the AIF in the UK on the basis of the UK NPPR.

Marketing of EU AIFs by UK AIFMs in the UK

UK AIFMs seeking to market an EU AIF in the UK for the first time must make the requisite notification to the FCA pursuant to Regulation 57 of the UK Regulations. Please see the Marketing page for more information.

However, a standstill direction applies to UK AIFMs that marketed EU AIFs in the UK during the Transition Period, so that the AIFM can continue to market the AIF in the UK under the existing rules, without the need to make a new notification under Regulation 57 of the UK Regulations. Upon the standstill direction ceasing (currently anticipated to occur on 31 March 2022), the AIFM will need to have made such notification.

Marketing of UK AIFs by EU AIFMs in the EU

Subject to the availability of any national transitional regime, EU AIFMs marketing UK AIFs in the EU will need to comply with relevant NPPR regime(s) implementing Article 36 of AIFMD. Please see the Marketing page for more information.

Cross Border Distribution of Funds (“CBDF”)

The UK has decided not to implement the EU’s package of measures relating to the cross-border distribution of funds (which include, amongst other things, a harmonised regime for pre-marketing AIFs and rules relating to the contents of marketing communications in relation to AIFs). Please see the Marketing page for more information.

Although the rules explicitly only apply to marketing AIFs under a passport, a recital in the CBDF Directive notes that national rules cannot in any way disadvantage EU AIFMs vis-à-vis non-EU AIFMs. Therefore, some EU Member States may apply similar pre-marketing rules under NPPR, which could therefore affect UK AIFMs seeking to market AIFs into EU Member States.

PRIIPs Regulation

The disclosure requirements under Regulation 1286/2014 on key information documents for packaged retail and insurance-based investment products (the “PRIIPs Regulation”) continue to apply in the UK to AIFs made available to retail investors in the UK, with only minor amendments at the time of writing. The UK government has signalled its intention to make further alterations to the regime in the future, including to allow greater scope to the FCA to clarify the scope of the PRIIPs Regulation.

Management of AIFs on a cross-border basis

Under AIFMD, EU AIFMs may avail themselves of a pan-European management passport, enabling them to manage AIFs based in other EU Member States. After the end of the Transition Period, UK AIFMs no longer have passporting rights to manage EU AIFs and EU AIFMs may no longer exercise passporting rights to manage UK AIFs.

  • EU AIFMs are still able to manage unauthorised UK AIFs on a cross-border basis if they do not carry on regulated activities in the UK, subject to the same rules which apply to other third country AIFMs. Authorised UK AIFs (e.g. non-UCITS retail schemes) will require an authorised UK AIFM.
  • UK AIFMs: in the absence of the third country management passport, whether a UK AIFM is permitted to manage EU AIFs based in the relevant jurisdiction on a cross-border basis must be assessed on a country by country basis. EuVECA, EuSEF and ELTIF as such need to be managed by EU AIFMs. Also, Luxembourg RAIFs (reserved alternative investment funds) may no longer have a UK AIFM, but a UK AIFM can still manage an unregulated Luxembourg SCSp. EU AIFs managed by UK AIFMs are now treated as having a third country AIFM under AIFMD, impacting their marketing arrangements as set out above.

The Trade and Cooperation Agreement agreed between the EU and the UK that came into effect (on a provisional basis at first) following the end of the Transition Period contains very limited provisions in relation to financial services, including in connection with investment funds. However, the EU expressly reserves the right to implement or maintain requirements that (i) only legal persons having their registered office in the European Union can act as depositories of the assets of investment funds; and (ii) fund management activities must be performed by a specialised management company, having its head office and registered office in the same Member State. The UK also reserves its rights in similar terms.

Delegation by EU AIFMs to UK entity

AIFMD delegation rules

EU AIFMs are able to delegate functions to third parties, including portfolio management, subject to their compliance with obligations imposed by AIFMD and the Level 2 Regulations. Please see the Delegation page for more information.

EU AIFMs may still delegate portfolio management to UK based portfolio managers following the end of the Transition Period, provided they comply with the AIFMD delegation requirements. As the UK delegate is now considered a third country entity, additional requirements apply to such delegation, notably the requirement for the AIFM’s and the delegate’s supervisory authorities to have in place an adequate cooperation agreement. In satisfaction of this requirement, ESMA and the EU national securities regulators have agreed a multilateral MoU with the FCA, which came into effect at the end of the Transition Period.

Regulatory scrutiny of delegation arrangements

Delegation arrangements of AIFMs have been subject to increased attention by European regulators in the recent years. Brexit has further focused attention on this area, as many UK-based fund sponsors have secured continued access to the EU marketing passport by establishing new EU AIFs which they manage as the UK delegate of an EU AIFM. In some cases the EU AIFM is a third party service provider or a newly-established EU firm.

Several local EU regulators have reminded domestic AIFMs of their obligations regarding delegation under AIFMD, including with a view to ensuring that these AIFMs do not risk being deemed to be “letter box” entities. By way of example, the CSSF has, amongst other things, clarified expectations regarding minimum staffing and substance of the AIFM, the initial and ongoing due diligence it expects Luxembourg based AIFMs to exercise vis-à-vis its delegates, and how it expects this to be documented.

At the EU level, ESMA has set out certain concerns regarding delegation arrangements, notably in the context of Brexit, in its Opinion of July 2017. In that Opinion, it examined the adequacy of delegation arrangements and, notably, set out its expectations as to ensuring sufficient structure, expertise, substance, and technical as well as human resources that must be retained by the delegating entity, and examined the level of due diligence and monitoring that would need to be conducted by the delegating AIFM. It also set out how it expects local regulators to assess requests for approval of delegation arrangements, in the interest of greater supervisory convergence. ESMA reiterated these matters in its letter to the European Commission of August 2020 in the context of its review of AIFMD.

Further EU legislative developments in this area are likely to be of particular relevance to UK delegates of EU AIFMs.

Other regulatory considerations for UK-based delegates of EU AIFMs

  • In addition to the rules relating to delegation under AIFMD, EU Member States have differing approaches as to whether the provision of portfolio management (or other services) to local entities may constitute a regulated activity in that jurisdiction. Whilst, prior to the end of the Transition Period, UK portfolio managers may have been able to rely on a MiFID passport in order to provide such services to EU entities, this is no longer possible. UK portfolio managers intending to act as delegate of an EU AIFM may therefore wish to seek detailed advice in this regard.
  • Based on ESMA guidance, AIFMs delegating portfolio management or risk management activities are generally required to ensure that their delegates are subject to equally effective regulatory requirements on remuneration as those applicable to the AIFM, or, if that is not the case (e.g. in the event of regulatory divergence by the UK) that they either put in place contractual arrangements to ensure that the remuneration requirements applicable to the AIFM will be adequately implemented and not circumvented. Please see the Remuneration page for more information.
  • From the perspective of a UK delegate of an EU AIFM, providing portfolio management or risk management services for an AIF (including an EU AIF) constitutes the regulated activity of “managing an AIF” under the UK Financial Services and Markets Act 2000, requiring specific regulatory permission. An exemption applies if the functions have been delegated by the AIFM, so long as the AIFM is not a letter-box entity.

Other related activities by UK based entities

The UK becoming a third country impacts other rights and permissions on which UK-based entities relied when providing services related to the marketing or management of AIFs within the EU, beyond AIFMD itself:

  • Distribution: In some EU jurisdictions, activities connected with fund marketing may be treated as regulated activities requiring a financial services licence. Prior to the end of the Transition Period, UK FCA-authorised distributors were able to market AIFs into such jurisdictions on the basis of a passport. This ability has now fallen away with the end of the Transition Period, reducing the scope of fund marketing activity that UK-based staff may conduct within certain EU countries.
  • Advisory arrangement: The end of the Transition Period does not, in principle, impact the ability of EU AIFMs to appoint UK investment advisers. However, the provision of investment advice to an EU AIFM may, depending on the local regulatory interpretation and the relevant fact pattern, constitute the conduct of a regulated activity in the Member State in which that AIFM is based under MiFID II. UK based advisers may no longer rely on any MiFID II passport in order to perform such activities. ESMA (in its Opinion of July 2017) and local regulators have also set out expectations regarding EU AIFMs putting in place advisory arrangements.
  • Other: Any ability to passport MiFID Top-Up permissions under AIFMD falls away with the end of the Transition Period. Regulated activities previously provided under the relevant MiFID Top-Up permissions will be subject to local rules.

Various Member States and the UK have put in place transitional arrangements regarding the above.