Photographer: Simon Dawson/Bloomberg

U.K. Hedge Funds Look to European Watchdog to Ease Brexit Fears

  • Decision due on whether non-EU funds can access single market
  • About 85% of Europe’s hedge-fund assets are managed in London

The future of London as the hedge-fund capital of Europe, along with the 700 billion pounds ($906 billion) of assets money managers control, may be determined by a market watchdog this month.

The Paris-based European Securities and Markets Authority will recommend this month whether hedge funds, private equity and real-estate funds based in some countries outside of the European Union should be able to continue selling products within the 28-nation bloc. The opinion will be closely scrutinized by London-based fund managers because it could become a template for when Britain exits the EU.

“This decision is an important test and will set a precedent for U.K. alternative funds and their access to a marketing passport for European investors post Brexit,” said Lisa Cawley, a partner at law firm Kirkland & Ellis in London. “If other third countries are allowed access by ESMA, then it will be easier for London funds to get approval.”

The so-called Alternative Investment Fund Managers Directive passport for non-EU funds may become mandatory from 2018. Only investment firms based in the bloc will be able to sell their products to European clients once the new rules kick in. ESMA will recommend this month whether those based in countries with “equivalent” rules will also get a passport to do business.

For a quick guide on passporting, click here.

About 85 percent of Europe’s hedge-fund assets are managed out of London, making it the second-largest center after New York. Hedge funds and other alternative funds manage about 10 percent of all assets in the country, according to estimates from industry group TheCityUK.

“In theory, extending third-country AIFMD passporting to the U.K. after Brexit should be straight-forward,” said Matt Huggett, a partner at law firm Allen & Overy in London. “In practice, it will be a political decision with an uncertain outcome. Many managers would like to safeguard themselves beforehand and set up offices in places like Luxembourg and Dublin.”

ESMA will make a recommendation to the European Commission this month on whether to extend passporting to funds in countries with similar rules to the EU, according to an ESMA spokesman in Paris. Countries being considered are: Australia, Bermuda, Canada, Cayman Islands, Hong Kong, Isle of Man, Japan, Singapore and the U.S.

ESMA’s Advice

“The Commission is awaiting ESMA’s advice and hasn’t yet taken a decision yet,” according to a spokeswoman for financial services at the EC. “Third-country provisions vary for each piece of EU legislation and are tailored to each specific sector and activity.”

The watchdog recommended last year that islands of Jersey and Guernsey be admitted to the EU passporting regime, while Switzerland should gain access after adopting new rules. The final decision is up to the EC.

If the U.K. opts to follow the Norwegian example for its relationship with the EU, the industry may continue to have access to the single market without a passport.

Norway is part of the European Economic Area. While it has no say in drafting EU rules, its financial services can operate in the single market in exchange for the country’s contributions to the common budget and for allowing free movement of European citizens.

“More than for other sectors, following the Norwegian model may not be particularly desirable for our industry,” said Jiri Krol, deputy Chief Executive Officer of global industry group Alternative Investment Management Association. “U.K. hedge fund industry would be in the awkward position of following rules decided by countries that don’t really have well-developed industry or experience regulating it.”

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