Almost a year after Article 50 was triggered, it remains unclear what Brexit will mean in practice, or even what sort of Brexit the UK government wants to achieve. However, there have been certain tangible developments for investment managers, including opinions issued by the European Securities and Markets Agency (ESMA) which seem to indicate the likely direction of post-Brexit regulatory travel within the EU.
The first signs of changes in investor behavior are also starting to emerge. This article focuses on two areas where Brexit may affect the fundraising environment for European private debt managers: structuring considerations and investor considerations.
Naturally, Brexit has caused particular scrutiny of geographic structuring. While some UK-only private debt funds are structured as English or Scottish limited partnerships, over the past few years Luxembourg has emerged as the leading domicile for pan-European private debt fund structures, with Ireland its principal competition.
One of the current advantages of a Luxembourg-based (or Irish-based) fund is that it is possible to appoint a UK management entity while still benefiting from the pan-European marketing passport introduced by the Alternative Investment Fund Managers Directive (AIFMD).
This may be achieved either by appointing the UK entity directly as alternative investment fund manager (AIFM) or under a delegation arrangement from a locally-domiciled AIFM, which could be a group entity or a third-party ‘host’. Post-Brexit, the marketing passport will no longer be available under the first of these models. Consequently, the delegation model will become critical for UK managers.
ESMA has published a series of opinions on delegation. Most significant for investment managers is its opinion of July 13 2017, which suggested EU regulators would be required to follow a heavy-handed and prescriptive approach to delegation, likely resulting in delays and additional costs to managers.
Controversially, ESMA suggested, among other things, that the geographical spread of a fund’s investments might serve as an argument against delegation outside the EU, which seems an unusual notion in the age of the internet. The opinion was met with concern by many market participants and industry groups. Some queried what problem ESMA was actually seeking to rectify, given that the delegation model is well established and tried-and-tested.
Particular objections were raised as to its broad scope, with not only new UK delegation arrangements affected but also existing and global delegations, including to US managers. There has even been talk of the International Organization of Securities Commissions (IOSCO) reviewing ESMA’s approach.
It seems unlikely that EU lawmakers would want the final delegation rules to impact substantially on global management structures. However, even assuming delegation remains viable globally, there remains the possibility that UK managers could be excluded if UK regulations are deemed to fall short of equivalence with EU standards. Clearly, this would pose serious challenges for the UK funds industry as a whole. At the moment, most industry participants are continuing to wait and monitor developments.
What is certain is that, post-Brexit, an EU-based fund directly appointing a UK-based manager as its AIFM will no longer have access to the marketing passport, so UK managers looking to follow this fundraising strategy, assuming they prefer not to relocate and assuming delegation remains possible, need to consider opening an EU office or appointing a local ‘host’ AIFM which may then delegate portfolio management back to the UK.
That said, national private placement regimes (NPPRs) remain and there is no reason to think they will be ‘switched off’ imminently, so an alternative, in particular for smaller managers or those looking to raise limited capital in the EU, would simply be to follow the example of most non-EU managers and market under the NPPRs.
For most investors, Brexit is likely to be a non-issue when considering manager allocations, compared to the likes of track record, pipeline, operational stability and so on. As always, though, there are exceptions to the rule, particularly investors whose mandate or investment policy requires that they invest in the EU.
Depending on the investor, this may either mean that they will no longer invest in funds with a pure UK investment strategy, a notable example being the European Investment Fund (EIF), or that that they are required to invest in EU-based funds and/or funds with EU-based AIFMs (although, depending on the delegation rules, this may in any event be a viable option for many UK managers). The EIF’s withdrawal from investing into UK-focused funds means that, for smaller UK fund managers especially, similar investors within the UK, such as the British Business Bank (BBB), have now assumed greater strategic importance.
A positive aspect, at least for some types of private debt managers, is that Brexit may result in investment opportunities which may themselves form the basis for future fundraisings. For example, regardless of whether the long-term economic consequences of Brexit are neutral or even positive, short-term dislocation is likely to present opportunities for special opportunities and distressed debt managers. Certain managers are already considering these types of scenarios.
To date, the impact of Brexit on private debt managers has been limited. Depending on the final form of the delegation rules and whether NPPRs remain available, legal and regulatory issues may arise over the next few years which affect fundraisings, but these should be manageable with careful structuring.
Record recent fundraisings by UK managers launching pan-European private debt funds attest to continuing high investor demand and, while certain private debt strategies such as UK direct lending may be impacted by Brexit, corresponding opportunities may arise in other strategies such as special opportunities. As Brexit approaches, there are reasons for well-prepared managers to be optimistic about the fundraising environment.
Samuel Brooks is a senior counsel in the investment management group at law firm Macfarlanes in London. This article appeared previously on Private Debt Investor.