Brexit won’t lift the compliance burden

Regulations, and the increasing resources devoted to complying with them, are an everyday feature of a fund manager’s operations.

The European Union’s Alternative Investment Fund Managers Directive, which supervises how funds are managed, administrated and marketed in Europe, is just one of several complex and far-reaching regulatory developments that managers have had to navigate post-financial crisis.

Better Capital founder John Moulton has characterized the AIFMD as unnecessary and having little benefit. “I hate bureaucracy and complexity, and the EU is a master of producing it,” he told Private Equity International in March. Moulton is, unsurprisingly, in favor of the UK leaving the EU after the membership referendum on June 23.

However, fund managers voting “leave” on the premise that quitting would lift the compliance burden would be making a mistake.

Speaking at King & Wood Mallesons’ annual private equity investment funds seminar at its London offices last week – which started by highlighting the increasingly complex regulatory landscape – partner Tamasin Little said of a possible “Brexit”: “I don’t think the level of regulation would decrease.”

This is for three key reasons. First, “the UK has never been short of financial sector regulation,” Little said, adding that much of EU financial sector regulation stemmed from the UK.

Second, leaving the EU would not mean the end of AIFMD for UK funds. Post-Brexit, the UK government could seek to maintain its current status within the AIFMD, meaning little would change. Or, the UK might seek to be treated as a third country under the regime, in which case UK funds wanting to market in Europe would be required to apply country by country to different National Private Placement Regimes. Either way, firms will still have to interact with the directive – due to be revised next year ahead of AIFMD II – if they wish to market in Europe.

Third, increasing regulation is a global, not just European, phenomenon. It spans from an increasingly active SEC to China, where the government is tightening listing rules for private equity firms.

“The whole world is increasing regulation,” Little said.

The UK is not immune. In line with the OECD’s anti-tax avoidance initiative laid out in its Base Erosion Profit Shifting (BEPS) recommendations, the UK government is introducing a new method for calculating the level of tax relief managers can claim against financing costs. The changes to UK rules governing interest deductibility appear in the Finance Bill and will apply from April 2017.

The UK government is also targeting the taxation of fund manager remuneration off its own back. Following in the footsteps of the disguised investment management fee rules included in the Finance Act 2015, the Finance Bill also includes intricate rules on the taxation of carried interest. These include a sliding scale that accounts for how long an investment was held to determine whether money made on investments is treated as income or is eligible for lighter capital gains tax treatment.

“It’s a very complicated new piece of law,” said KWM partner Laura Charkin. “You have to do a lot of compliance work to prove CGT treatment.”

The message from the KWM seminar is clear. The UK regulatory environment is increasingly complex thanks to “a number of wide-ranging regulatory projects,” KWM’s Simon Witney said.

This is unlikely to change whether the UK is in or out of Europe.