LineData, a publisher of leasing software and asset finance platforms, held a debate on Brexit on 22 June, just before the national referendum. It discussed the possibility of a UK exit from the European Union, and its likely consequences. Saad Ahmed analyses the key points
The Linedata debate was chaired by John Rowland, executive director of Cicero.
On the panel were Kenneth Farrugia, chief business development officer at Bank of Valletta, Malta, and Ashley Kovas, senior regulatory intelligence at Thomson Reuters.
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Impact on UK-based funds
The chairs predicted that a Brexit would have a serious effect on the investment fund industry. Kovas based his conclusions on the UK having no agreed special protections with the EU following a UK exit.
“We would become, in technical terms, a third country,” said Kovas.
“Looking at it from that perspective, it becomes relatively simple.”
Kovas delved into the impact that a Brexit would have on the Undertakings for Collective Investment in Transferrable Securities (UCITS), in essence a mutual fund based in the EU.
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By GlobalDataIn the event of Brexit, UCITS based in the UK would no longer be able to continue. “UK-domiciled UCITS would cease to be UCITS,” Kovas continued.
If there are no guarantees post-Brexit, these funds would have to redomicile in order to keep their status. As the UCITS Directive deals with three parties – the fund, the manager and depositories – a lack of guarantees post-Brexit would cause considerable upheaval.
Other UK-domiciled funds may also be affected by Brexit.
The Alternative Investment Fund Managers’ (AIFM) Directive is an EU law covering the financial regulation of hedge funds, private equity, and real estate funds, among others. This was integrated into UK law in July 2013, as The Alternative Investment Managers Regulation Act 2013.
Kovas argues that some AIFMs may benefit from Brexit, because while they are subject to the directive, they do not have the ability to passport.
Passporting refers to the ability of firms to carry out financial activities in other European Economic Area (EEA) states. These states include the entire EU, Iceland, Liechtenstein and Norway.
Small or sub-threshold AIFMs have €100m or less assets under management (AuM), or €500m where each of the alternative investment funds (AIFs) under management has no leverage and there are no redemption rights for the first five years.
“Sub-threshold AIFMs may actually see a benefit in a Brexit. At the moment they have to comply with the Directive, but do not actually gather the ability to passport, the other side, or the ‘quid pro quo’, for regulation.”
Small AIFMs are not recognised in many EEA countries, so it is often difficult for them to be marketed outside of the UK. As small AIFMs are already not easily accepted outside of the UK, the loss of passporting which may result from Brexit will have little effect. In losing the restrictions under the AIFM Directive, smaller alternative investment funds could benefit from Brexit.
However, they concluded that Brexit would have a net negative effect on the funds industry in the UK. The Markets in Financial Instruments Directive (MIFID) would no longer apply to UK firms, and they would therefore lose all passporting rights.
Impact on other European countries
Where the fund industry is concerned, Brexit could benefit other European countries vying to be the major financial centre in Europe.
In the case of UCITS, in order for funds to continue operating, they must be redomiciled. The general uncertainty surrounding the nature of a future relationship between the UK and the EU could be of benefit to competing European economic centres.
“There is an excess of €1trn of European assets being serviced out of London. If the UK exits, some of that will be lost to European managers,” said Kovas.
“The price of commercial property in Frankfurt is going up,” remarked Kenneth Farrugia, chief development officer, Bank of Valetta. Firms were already considering moving to Europe’s second financial centre in the event of Brexit, before the referendum results were known.
UK-based firms, and international firms that operate in Europe and use the UK as a base, may potentially look towards cities such as Dublin and Frankfurt to continue operations post-Brexit.
“[Firms] will make decisions that in order to get a footprint in Europe, and continue to take advantage of European freedoms, they are going to need to move some kind of activity into Europe,” said Kovas.
“They will make it easy as possible for UK entities to redomicile in France.”
Farrugia agreed, adding: “A number of UK operators will start evaluating their business and operational models to see how they can establish a business in a European domicile to target European business.”
However, redomiciling funds, such as UCITS, is not straightforward.
Farrugia said: “Clearly they will have to change drastically their business and operational model.”
Farrugia argued that both options open to UCITS managers post-Brexit to continue operation are fraught with difficulty.
Moving funds to an EU domicile would be expensive and time-consuming, and the costs would be borne by shareholders.
The second option, of establishing a management function in a European jurisdiction with sub-delegation to the existing UK operation, is itself extremely complicated.
“There is a layering of course, because you have to comply with regulations in the UK. But also you will have to adopt, apply, and adhere to the regulations in a European Union seat,” Farrugia explained.
Migration of structures would prove costly, and the regulatory aftermath would also lead to mounting costs. Though redomiciling to continue to have access to Europe is a consideration, the process will be far from straightforward.
Brexit could have a secondary, negative effect on other European countries, particularly those which have strong economic ties to the UK.
If Brexit leads to a long-term decline in the UK economy and the value of Sterling, such countries may be affected by declining foreign direct investment (FDI) and tourism.
The potential end to free movement would also increase barriers to UK outbound tourism, as visa requirements may be brought back into force. Malta is one example of an EU country which may be directly affected financially through the implications of Brexit.
“Seven percent of our FDI comes from the UK,” said Farrugia.
“Clearly an impact on the economy of the UK will have an impact on FDIs in Malta.”
Malta is still linked financially to the UK, and Brexit would affect this economic relationship.
“The links with the UK are still very significant,” continued Farrugia.
“Over 30% of tourists are British tourists; you can imagine the impact of the UK leaving the EU. This would impact the currency, and the ability for tourists to travel to Malta, which will impact our economy.”
Future UK-EU relationship
Much of the discussion surrounding the impact of Brexit rests on certain assumptions about the nature of a post-Brexit UK, and its relationship with the EU.
As an exit from the EU is unprecedented, discussants Farrugia and Kovas based their evaluations on a strict in-out basis. Brexit meant a complete EU exit, and the discussion focused on an absence of special terms or treaties.
The shape of the relationship between the UK and the EU will not be decided, in full, for at least two years after Article 50 of the Lisbon Treaty has been triggered by the UK government. At present, it has not, and so negotiations cannot yet begin.
The consensus at the LineData debate was that it was far from clear what shape it would take.
A much-discussed option was the ‘Norwegian model’, membership of the European Economic Area (EEA). Kovas denounced this option as “the worst of all worlds”.
“We would end up having to comply with all the rules, and yet we would have no seat at the table in terms of negotiating them,” Kovas said.
The states in the EEA but not the EU are members of the European Free Trade Association (EFTA). EEA states must incorporate EU law, but as non-members without representation in the EU’s institutions, are unable to directly influence these regulations beyond standing committees.
On the other end of the spectrum of engagement with the EU is the Canadian option. The Comprehensive Economic and Trade Agreement would give Canada access to the European single market, and, if implemented, would eliminate 98% of trade tariffs. However, this agreement also rests on adopting regulations.
“The Canadian model gives them some access to the market, in exchange for compliance with some aspects of regulation,” Kovas added.
As with the EEA case, if the UK were to find itself in a similar deal, the terms would not be debated on equal footing: the EU would retain the upper hand.
All possible options for the UK’s future relationship with the EU will result in more favourable terms for the EU.
“It is logical that a person who is not a member of the club will not get the same terms of membership as the people who are. Where we will end up on that spectrum, who knows,” Kovas said.
The possibility of the UK rejoining the EU was also discussed; however, Farrugia and Kovas agreed this would only be a possibility if Brexit posed a significant threat to the structural integrity of the Union.
“It could precipitate that domino effect of other member states leaving and a collapse of the EU,” said Kovas.
Kovas argued that for many EU nations, particularly the founding members, the EU transcended economic interests.
“It is political, and it is to do with security and safety, and any threat to the integrity of the EU will be seen in that way,” he added.
An implication of this, he argued, is that the EU may want to make an example of the UK to deter any other states from following the same path, which would put the country in an unpleasant situation, said Kovas.
Post-Brexit, if the UK sought to return to the EU, it would likely only occur if it was in the wider interests of the Union.
“If it is in the interests of the other member states, they will let us back in. But it has to be in their interests to do so,” said Kovas.
“It will be a painful process back in, however,” warned Farrugia.
Benefits and opportunities for the UK
To conclude the debate, the panel took questions from the audience as well as the chair, John Rowland of Cicero, on the possible positive effects for the UK of Brexit.
The ability to create trade deals outside of the UK may be a benefit; however, these must at least financially make up for the loss of access to the European single market.
Furthermore, as larger trading blocs such as the US, and the EU itself, are involved in trade negotiations with the same target countries, the UK is likely to find itself on the back foot.
“The EU is in a much better position to do it effectively because they have a much larger bargaining power than we have,” Kovas said.
“It is a trade-off between what we lose by ceasing to be a EU member, economically, and what we gain by our bilateral arrangements.”
The final point discussed was the idea that the UK could become a form of tax haven, drastically reducing corporation tax in an attempt to lure business.Before the referendum, now-ousted Chancellor of the Exchequer George Osborne announced plans to reduce corporation tax to below 15% by 2020. The panel were sceptical about the UK becoming a bloated version of Luxembourg.
“Tax havens and jurisdictions that get into that sphere are small countries, and I think there’s a reason for that,” said Kovas.
“The idea of a large country being a tax haven is something that would strike fear and terror, I should imagine, across the world.
“Personally I would not see that as a very realistic proposition.”<
