European Union: Brexit – Impact On UK Fund Managers Active In Germany

On June 23, 2016, the UK electorate voted in a referendum by 51.9% to 48.1% to leave the EU. The actual departure from the EU will be preceded by complex negotiations. Although the UK Government has not yet notified the European Council of its intention to withdraw under Art. 50 of the Treaty on the European Union, it seems that there is no doubt that such notice will be given. In such case, the UK would cease to be a member of the EU no later than two years after notice.

The following summarizes some relevant aspects for UK AIFMs active in Germany following a departure by the UK.

1. Impact on Debt and Loan Originating Funds investing in Germany

Germany just recently amended its German Banking Act (Kreditwesengesetz) and Investment Act (KAGB) as a result of which an exemption applies for AIFMs and AIFs lending to German borrowers which is no longer deemed a regulated banking activity. Following a departure, UK AIFMs will be non-EU AIFMs. For non-EU AIFMs the same exemption is available. However, an additional requirement applies in such case: non-EU AIFMs only qualify if the AIFM has obtained permission by the German regulator (BaFin) to market the AIF in Germany to semi-professional investors. This means in practice that the non-EU AIFM must be fully AIFMD compliant as this is a requirement for marketing to semi-professionals.

Such additional requirement should not cause too many concerns for UK AIFMs if these AIFMs continue to be fully authorized and in compliance with AIFMD.

The change is more drastic for sub-threshold UK AIFMs which currently benefit from the same exemption without having to comply with AIFMD.

2. Marketing into Germany

Following the UK departure, UK AIFMs would become subject to the marketing regime for non-EU AIFMs. The AIFMD provides for the introduction of a marketing passport for non-EU AIFMs which is expected to be implemented some time in 2017 but could also be postponed to a later stage. Whenever the passport will be implemented, it will be limited to countries  only which have been considered eligible for the passport treatment by ESMA (see our client information dated August 4, 2015). We would expect the UK to be a non-EU country eligible for the passport if they continue to follow AIFMD.

a. If the departure occurs prior to the introduction of the passport for non-EU AIFMs (seems rather unlikely):

UK AIFMs, irrespective of their size (i.e. AIFMs which are fully authorized under the current AIFMD regime as well as the currently exempt sub-threshold AIFMs) have to comply with the German implementation rules of Art.42 of the AIFMD. This means:

• Regarding marketing to professional investors, they have to comply with AIFMD disclosure, anti-asset stripping requirements and in addition they have to appoint a depositary (which is of course no issue for those AIFMs which already are subject to AIFMD but it would be new to sub-threshold AIFMs).
• Regarding marketing to semi-professional investors they have to be fully AIFMD compliant (which should be no issue for those AIFMs which already were subject to AIFMD but it would be new to sub-threshold AIFMs).
• The above assumes of course that a cooperation agreement for the purpose of systemic risk oversight and ensuring effective exchange of information is also entered into between the UK and Germany.

b. If the departure occurs after the introduction of the passport (which seems the more likely scenario):

3. Impact on Crossborder Advisory Services

Often a local German group entity is acting as advisor to the UK based AIFM. Many of such local entities rely on the group privilege where the advisor is a subsidiary of the AIFM or where the advisor is only rendering sub-advisory services. The regulatory situation should remain unaffected. However, where there is no group relationship and the group exemption is not available, German advisors appropriately licensed in Germany can provide such services to the UK AIFM based upon the MiFID passport regime. Such passport will again no longer be available and it remains to be seen (and would be essential) whether the UK will implement equivalent rules permitting also EU services providers to provide such crossborder activities in the UK.

UK advisors which provide, on a crossborder basis or by having a branch in Germany, advisory or placement services in Germany based upon the EU passport under MiFID will also be affected by the new non-EU status. The passport will no longer be available. Under MiFID II passport regimes for non-EU service providers are foreseen but the implementation is subject to ESMA's equivalence decision. The Commission has just recently further postponed the implementation date for MiFID II until January 2018. If the UK were to continue to apply MiFID rules and if the UK implemented MiFID II rules (fully and including also a right for EU service providers to provide services into the UK) then such UK advisors should be able to rely on a passport. Failing this, those structures would need to be re-considered.

4. Impact on German Investors investing in UK AIFs

German investors which are subject to the German Insurance Ordinance (e.g. pension funds) will have to consider the following as a result of the departure:

For investments in private equity funds the departure should not have much impact because the allocation under the so called private equity quota under the Insurance Ordinance only requires that AIF and AIFM have their seat in an OECD country (which is and continues to be the case for the UK) and that the AIFM is subject to supervision which is equivalent to the one which EU AIFMs which are fully authorized under AIFMD or subject to a sub-threshold regime are subject to. In case the UK does not substantially change its regulatory regime for AIFMs, we would expect at this stage that these requirements could be met.

With respect to investments in AIFs investing in real estate, debt and other asset classes, the Insurance Ordinance provides that such an AIF would only qualify under the specific asset class quota (i.e. "real estate funds quota", "alternative investment funds quota") if the AIF and the AIFM have their seat in the EEA. If the rules of the Insurance ordinance remain unchanged until the departure of the UK, going forward UK AIFs / UK AIFMs would become less attractive for those investors (unless the UK opts to be an EEA country following departure which many consider as an unlikely scenario because it would require the UK to comply with all obligations of an EU member without having the same rights).

With respect to existing investments it remains to be seen whether the German regulator will make appropriate amendments to provide for grandfathering provisions. This is certainly advisable and should be pushed for by the industry and investors.

Investors subject to Solvency II may be faced with higher capital requirements: Under Art.168 (6) (c) of the Commission Delegated Regulation (EU) 2015/35 AIFs established in the EU which are closed ended and not using leverage benefit from a preferential capital treatment (i.e. consideration as type1 equity). Such preferential treatment is also available for non-EU AIFMs if they have opted for the passport under the regime for non-EU AIFMs. As set out above, this passport regime has not yet been introduced. Once it is introduced and assuming the UK would be an eligible country for the passport (i.e. the equivalence test is positive), then investments in UK AIFs could also fall under the benefits for Art.168 (6) (c) of the Commission Delegated Regulation (EU) 2015/35 if the respective AIFM of such UK AIF makes use of its passport right.

5. Conclusion

Much is still uncertain at this stage. This includes the likelihood of the departure (which a few still hope not to happen), the timeframe of a departure and of course also the new arrangements which will follow a departure. A new legal framework has to be implemented based upon which business can continue. The non-EU passport regime which is already foreseen in MiFID II and AIFMD today will become of substantial importance in that respect and hopefully the Commission, ESMA and the German legislator, with all that is on the agenda to date, will also be able to focus on a fast and reasonable implementation of such passport regimes. This being said, the passport regimes will only be available if the UK keeps in place equivalent EU legislation in order to fulfill the equivalence standard. Given that the UK (like other non-EU countries) has, going forward, no right to participate and influence the EU legislation, the UK may possibly put in place several regimes: e.g. a domestic one and an EU equivalent regime which UK service providers have to follow in case they would like to benefit from a passport regime in the EU. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.