Authors: Patricia Volhard, Partner and Simon Witney, Special Counsel, Debevoise & Plimpton LLP
The decision of the UK to leave the EU – with the expectation that it will also leave the EU’s single market – obviously has important implications for US private fund sponsors with investors or fund management businesses in Europe. But unfortunately, as things stand, it is not possible to say precisely what those implications are, and businesses therefore have to plan for various possible outcomes. Any contingency plan may have to be engaged at relatively short notice, so advance planning is certainly wise.
For most US private fund sponsors, the EU does not offer anything that could accurately be described as a “single market” anyway, since the European institutions have primarily focussed on removing trade barriers between members of the bloc, rather than for the benefit of outsiders. That means that, under existing “third country” marketing rules, it is open to each of the EU’s member states to apply their own rules to non-EU fund managers who are seeking to raise money from European investors (subject to certain EU-wide minimum requirements – including detailed reporting requirements and restrictions on certain distributions from controlled EU portfolio companies). Navigating those national rules has been something of a headache for US sponsors, although it is one that they have learned to live with.
The centrepiece of EU regulation in this area is, of course, the 2011 Alternative Investment Fund Managers Directive (AIFMD). At the time those rules were being discussed, a number of US fund sponsors were concerned about the lack of market access for third countries, and in response to those concerns a specific procedure was written into the 2011 Directive that was supposed to trigger a pan-EU “passport” for qualifying third country fund managers starting as early as 2015. In fact, it is an open question whether the passport that is foreseen in the Directive will be of significant value to a third country manager, given that it requires full compliance with the AIFMD and regulatory supervision by an EU regulator. This would be a real challenge given that a US manager would then have to comply in full with both US and EU rules, and would be subject to the supervision of both the SEC and an EU regulatory authority (which could not be the UK’s FCA once the UK leaves the EU). It is therefore very important to many US managers that national private placement regimes continue for as long as possible even if and when the passport option is extended to US managers. The national private placement regimes are not perfect, but for many US managers, particularly mid-sized ones, they are so much better and easier to use than an AIFMD passport would likely be.
In any case, the launch of this non-EU passport has no doubt been significantly delayed by Brexit. It will be politically hard to introduce it – and therefore make it available in future to UK-based managers – while discussions about the UK’s relationship with the EU are ongoing. Depending upon the way in which UK/EU negotiations proceed, there may actually be reasons why it would suit the EU to offer the third country passport to UK (and, therefore, other third country) managers, instead of the more attractive bespoke deal that the UK will seek, but what is clear is that the question of whether and when US sponsors can access a passport is now inevitably wrapped up with the Brexit negotiation.
Some US sponsors with an important and diverse EU investor base had already decided to access the EU passport in a different way: by setting up a stand-alone fund manager in the EU, and using its AIFMD licence to market the fund on a pan-EU basis. Building substance in the EU, and obtaining an AIFM authorisation there, has the advantage of keeping supervision and compliance with EU AIFMD rules separate from SEC requirements, while some of the work of that manager, in particular its portfolio management, can be delegated back to the US, if desired. But many US sponsors chose London for their EU presence, and they may now have to re-think that structure.
Whether a re-structure makes sense will depend on the final Brexit deal. Many hope that transitional arrangements will allow the existing system to continue beyond the UK’s expected departure in 2019, and it does seem that both sides are willing to at least consider a bespoke deal for the UK longer-term, which could facilitate privileged market access for the UK. If that turns out to be the case, it might well make sense for existing US sponsors that have established an EU manager in the UK to stay for now, unless there is a demand among their EU investors to make a change before the details of any future deal are known. This could be the case, for example, for EU insurance companies, which in certain circumstances benefit from a better capital treatment under their EU capital regime if they invest in funds established in the EU. But absent specific investor requirements, now is most likely to be a time for significant contingency planning, rather than a wholesale change of structure. The time for change may come, and may come soon, but for a number of funds, it has not yet arrived.
Debevoise and Plimpton LLP is an AIC Tier 1 Associate Member.