Many UK firms currently carry on cross-border services in Luxembourg in reliance on an EU financial services passport (e.g. under the Alternative Investment Fund Managers Directive ("AIFM Directive") or the Markets in Financial Instruments Directive ("MIFID")).
The purpose of this note is to determine the potential implications a no-deal Brexit may have, in particular on UK Alternative Investment Fund Managers (“AIFMs”) of Luxembourg Alternative Investment Funds (“AIFs”).
In a nutshell
UK AIFMs will lose their management and marketing passporting rights under the AIFM Directive at the end of 2020 (failing any new deal);
2 options for UK AIFMs:
- establish and be authorised in the EEA to be allowed to manage and market Luxembourg AIFs to professional investors across the EEA;
- becoming third-country managers and be able to manage most Luxembourg AIFs under certain conditions and subject to CSSF’s notification.
The delegation of functions from Luxembourg AIFMs to UK firms in the context of the AIFM Directive should remain permitted.
On 23 June 2016, the EU referendum took place and the people of the UK voted to leave the EU (“Brexit”).
On 10 April 2019, further to multiple rejections by the UK Parliament of the withdrawal agreement endorsed by the European Council on 25 November 2018, the European Council agreed to extend the withdrawal period for the UK to leave the EU.
On 30 October 2019, the day named as "exit day" in UK legislation was changed to 31 January 2020 at 11 pm UK time.
On 29 January 2020, the European Parliament approved the Brexit divorce deal.
On 31 January 2020, the UK officially left the EU at midnight CET (11 pm UK time).
On 1 February 2020, an 11-month transition phase began, running to 31 December 2020.
Luxembourg Brexit Laws
On 8 April 2019 Luxembourg adopted two laws regarding measures to be taken in relation to the financial sector in the event of a withdrawal of the United Kingdom of Great Britain and Northern Ireland from the European Union (the “Brexit Laws”). The purpose of the Brexit Laws was in particular to anticipate the loss of passporting rights for financial services providers established in the UK which would result from a hard Brexit, since these entities will then be considered to be “third-country firms”. The Brexit Laws granted the ability for competent authorities to set out a grandfathering period for services provided to existing Luxembourg clients such as investment funds, AIFMs and management companies.
As the Brexit Laws were issued on the assumption of a hard Brexit scenario, following the ratification of the UK withdrawal agreement (the “Withdrawal Agreement”) by the Council of the European Union on 30 January 2020, on 31 January 2020, the Commission de Surveillance du Secteur Financier (the “CSSF”) published a Press Release clarifying its position. Since a hard Brexit scenario is -at the time of the publication- no longer relevant, (i) the CSSF’s individual decisions granting the 12-month transitional regime to UK entities in accordance with the Brexit Laws; and (ii) all notifications made in this context through the CSSF dedicated e-Desk portals have lapsed.
Moreover, the CSSF Brexit dedicated e-Desk portals were closed with immediate effect.
The CSSF had further called for UK impacted entities to prepare and anticipate beyond the end of the transition period, i.e. 31 December 2020.
End of transition period: Get ready for changes as from 1 January 2021
Since 1 February 2020, the UK is no longer a member of the EU and its institutions. However, according to the terms of the Withdrawal Agreement, a time-limited transition period has been agreed and will last until 31 December 2020 (the “Transition Period”).
During the Transition Period, (i) EU laws and regulations will continue to apply in the UK as if it were a Member State; and (ii) UK entities (including, investment firms, credit institutions and investment fund managers) can continue to provide services in Luxembourg on a cross-border basis and will hence not lose their current passporting rights.
On 12 June 2020, the UK government notified the EU that it did not intend to request an extension to the Transitional Period under the Withdrawal Agreement, reducing the amount of time left for the EU and UK to agree a post-Brexit deal to six months, making a no-deal Brexit more likely.
In case of departure of the UK from the EU without a deal, which seems likely to happen, the UK would be considered a third country, like any other non-EU country. (i.e., a country which is not a member of the European Economic Area ("EEA")). Consequently, UK firms would no longer be able to provide services in other EEA Member States under the financial services passports. For example, a UK AIFM would no longer be able to market its EEA alternative investment fund AIF in other EEA Member States under the AIFM marketing passport.
Potential implications of “no-deal” Brexit for UK AIFMs
On 7 July 2020, the European Commission published a Notice to stakeholders – withdrawal of the UK and EU rules in the field of asset management, where it urges asset managers to "assess the consequences of the end of the transition period" and "take appropriate action".
After the end of the Transition Period, the EU rules in the field of asset management, in particular the AIFM Directive, no longer apply to the United Kingdom. This will have in particular the following consequences:
- AIFMs need to be established and authorised in the EEA to be allowed to manage and market AIFs to professional investors across the EEA.
- Member States may allow AIFMs who are not established and authorised in the EEA to market AIFs exclusively within their own territory under so-called National Private Placement regimes (hereafter "NPPR"). The AIFM Directive provides Member States with discretion as to whether to activate NPPR and allows for stricter rules in addition to the minimum requirements in the AIFM Directive. Some Member States do not have NPPR, while other Member States only allow marketing to professional investors. In Luxembourg, the marketing of AIFs by non-EU AIFMs to professional investors in Luxembourg without passport is permitted under the conditions set out in article 45 of the Luxembourg act of 12 July 2013 on AIFMs, as amended (the “AIFM Act”).
- AIFMs must take a number of steps to inform investors of the consequences of the withdrawal of the United Kingdom from the EU and the end of the transition period, in particular AIFMs must disclose to investors any material change to the information that is required to be disclosed in accordance with Article 23 of AIFM Directive, which includes, but is not limited to, the legal implications of the contractual relationship entered into for the purpose of investment. In Luxembourg, the CSSF published back in October 2019 a press release in the context of a no-deal Brexit scenario pursuant to which UK AIFMs which will be considered as third-country managers in case of a no-deal must obtain the consent of their Luxembourg AIFs’ investors and notify the CSSF in order to validly act as third-country managers of Luxembourg AIFs. For this purpose, the CSSF indicated that such Luxembourg AIFs must be exclusively available to professional investors or well-informed investors. It should be noted that the RAIF regime would be hardly compatible with this third-country management regime and that a conversion of the RAIF should be contemplated or, alternatively, the appointment of a fully authorised third-party AIFM with a delegation to the UK third-party manager should be organised. We expect to see new guidance to be issued by the CSSF in light of the upcoming end-date of the Transition Period in relation to the application of the above requirements.
- The delegation of certain functions to providers established in the UK may be undertaken provided that the relevant requirements in the AIFM Directive are complied with. In particular, where the delegation concerns portfolio management or risk management and is conferred on an undertaking established in a third country, a cooperation agreement between the competent authority of the home Member State of the AIFM and the supervisory authority of the undertaking carrying out the delegated function in the third country must be in place. In this context, ESMA and EU securities regulators have agreed in February 2019 no-deal Brexit Memoranda of Understanding (“MoUs”) with the Financial Conduct Authority which will come into effect at the end of the Transition Period, which is of particular importance for EU/EEA based AIFMs who, on the basis of Article 20 of the AIFM Directive have delegated or sub-delegated (part of) their asset management activities to UK firms. On 17 July 2020, ESMA, EU national securities regulators, and the FCA confirmed that these MoUs, agreed in 2019, “remain relevant and appropriate to ensure continued good co-operation and exchange of information after the UK leaves the EU and will come into effect at the end of the Transition Period”.
UK AIFMS with a top-up “MiFID” authorisation and UK “MiFID” firms providing services to Lux AIFMS
It is also worth noting that the CSSF has recently clarified its position on third country firms providing investment services or performing investment activities.
The CSSF circular 20/743 ("Circular") amends Circular 19/716 and clarifies, in particular, when an investment service provided by a third-country firm is deemed provided in Luxembourg. The CSSF considers this is deemed to be the case if one of the following conditions is met: the third-country firm has a branch in Luxembourg, the investment service is provided to a retail client established or situated in Luxembourg, or the place of the "characteristic performance" of the service, i.e. the essential service for which payment is due, is deemed to be in Luxembourg.
This clarification has consequences for UK AIFMs which carry out in addition investment activities to professional clients in Luxembourg and UK MiFID firms which provide advice to, or carry out portfolio management as delegates of, Luxembourg AIFMs. Indeed, where the activities would be carried out on a mere cross-border basis (where the characteristic performance of the service would not be in Luxembourg), the relevant UK AIFMs, advisers and portfolio managers would be able to continue their cross border activities after 31 December 2020 without triggering Luxembourg notification/authorisation requirements.
In light of the above, UK AIFMs will lose their management and marketing passporting rights under the AIFM Directive at the end of the Transition Period in case of a no-deal. Generally speaking, UK AIFMs must therefore be authorised in the EEA to be allowed to manage and market Luxembourg AIFs to professional investors across the EEA.
In the absence of such authorisation, UK AIFMs would become third-country managers, but we expect that they would in principle be able to continue to manage most existing Luxembourg AIFs under certain conditions (e.g. obtaining consent of the investors and accomplishment of the relevant notification to the CSSF), to the extent that such AIFs are available only to professional investors / well-informed investors. We expect that the CSSF will issue further guidance in this context in the coming months.
Finally, the delegation of functions from Luxembourg AIFMs to UK firms in the context of the AIFM Directive should be permitted to the extent the conditions for the delegation to third-country firms are complied with. As indicated above, a cooperation agreement in this context should in principle be in place in case of no-deal.
Reopening of the FCA Temporary Permissions Regime (« TPR ») for inbound passporting EEA firms and investment funds in the UK.
It should be noted that the UK Financial Conduct Authority (“FCA”) has announced the reopening of the TPR as from 30 September 2020.
This reopening of the TPR is relevant for Luxembourg AIFMs who manage UK AIFs or market AIFs in the UK and would like to continue new and existing regulated business within the scope of their current permissions in the UK after a no deal Brexit for a limited period of time while seeking full UK authorisation or, if only marketing funds in the UK, making a National Private Placement Regime (“NPPR”) application. It should be noted that Luxembourg AIFMs who have previously submitted a notification under the TPR can update their notifications to the extent applicable to reflect the accuracy of the current services provided or the list of marketed funds/sub-funds.
The FCA will issue additional information in the context of the reopening of the TPR in September
Aurélien Hollard, Partner | Avocat à la Cour
Benjamin Bada, Partner | Avocat à la Cour
Aurélia Viémont, Counsel | Avocat à la Cour