‘Wait and see’ has been a rational strategy for many private equity and venture capital firms thinking about their post-Brexit structure. With very little detail on the shape of the final deal between the UK and the rest of the EU, firms have had little to go on. And – although it has been possible to anticipate the impact of a cliff-edge, ‘no-deal’ Brexit in March 2019 – that worst-case outcome has always seemed unlikely, and planning for it would be costly and disruptive. Add to that the fact that many firms have recently completed a fundraising, and don’t expect to be in the market again for a few years, and the best answer was generally to sit tight and monitor developments.
Unfortunately, publication of the UK Government’s White Paper on July 24, setting out the principles of the deal that the UK will seek from the EU, has not (yet) taken matters much further forward. While the White Paper, a summary of which is available here, has intensified the debate in the UK about what (if any) Brexit will command the support of the legislature, it has not delivered any certainty to businesses – and a disorderly Brexit in March remains a possible (if still unlikely) outcome.
Of course, UK-based firms that know that they need to be in the market in April 2019 or shortly afterwards – and know that they will want an EU marketing passport then, or an EU structure to suit the preferences of some of their continental European investors – have been busy getting ready to make their application to another EU regulator (usually the Commission de Surveillance du Secteur Financier in Luxembourg, or the Central Bank in Ireland) so that they have an EU Alternative Investment Fund Manager authorized in time for the UK’s scheduled departure on March 29. Many have held off pressing the button on those applications until now – hoping that political agreement on a transitional period would be embedded in a substantially agreed Withdrawal Agreement, effectively deferring the need for an EU AIFM until January 2021. That hoped-for certainty did not arrive in time for the June EU summit. As a result, the European Commission has warned member states and private businesses to step-up their preparations for Brexit, and last week the European regulator, the European Securities and Markets Authority, issued a notice advising firms to make their applications now because a transitional period is not guaranteed.
ESMA’s instruction will affect a minority of firms. But, for others, now is certainly the time to make sure that all the consequences of a ‘hard Brexit’ in March 2019 have been fully anticipated. While portfolio company trading issues are critical, the firm’s own structure may also give rise to more immediate concerns. Advisory firms (including those advising non-EU funds) have to understand what consequences there may be if they lose their passport to distribute funds and arrange deals across the continent; while any contracts that have references to the European Union or the European Economic Area need to be checked to make sure they will still work when the UK is no longer a member of either bloc. UK-based fund managers who are likely to launch a fundraising in 2019 or 2020 should consider whether the existing private placement rules will work for them, or whether they want to set up an EU structure to access European investors (in particular, those who prefer such a structure for regulatory reasons). Service-provider AIFMs may be part of the answer: they offer some optionality in case the UK ultimately secures a third country passport. But any structure that relies on delegation of portfolio management back to a UK manager is also vulnerable to a disorderly Brexit, because co-operation agreements must be concluded between relevant regulators.
Meanwhile, the current debates among UK politicians about what type of Brexit the UK will seek in its negotiations with the EU are a depressing sideshow. Even if it is still likely that a transitional period will be agreed, and the headline terms of a deal (at least on goods) will be included in it, time is running out for those who cannot afford to trust the politicians to reach a sensible compromise.
Simon Witney is special counsel at Debevoise & Plimpton.
This is part of a series, European Funds Comment, by Debevoise & Plimpton.