Exploring Brexit: Could US-style parallel fund structures be an answer for UK funds worried about passporting?
UK Fund managers are facing years of uncertainty regarding distribution across the European Union (EU) following the result of the referendum. Richard Street explores a possibility based on a US industry precedent
The vote by the UK electorate to end its 43-year membership of the EU surprised many in the asset management industry. Less than two months prior to the referendum a survey undertaken by RBC Investor & Treasury Services indicated that only 5 per cent of 80 asset managers predicted a victory for the ‘leave’ campaign (Brexit: Asset Managers will Cope, 2016). Yet today market participants are confronted by the prospect of complex divorce proceedings taking several years of negotiations before an amicable settlement is reached.
Richard Street
Richard Street

The uncertainty over the shape and form of the post-Brexit framework has raised concerns across the financial services spectrum; whether through volatility in the capital markets or the potential vulnerability of UK-based employees. The list of questions continues to grow and is primarily based upon continued access to the single market.

In the UK, a significant majority of unit trusts and Open-Ended Investment Companies (OEICs) are defined as UCITS funds, meaning they can be distributed under the EU’s passporting rules. It is conceivable that following ‘Brexit’, however, a UK fund could lose its UCITS status and be prevented from distributing to the EU. Though a good proportion of asset managers already adopt an approach of establishing domestic funds, and leverage locations such as Dublin for distribution cross-border, it is not unheard of for a UK fund to do so. It is those asset managers who are exploring options, one of which could be parallel fund structures.

This is a similar model to one initiated by the US alternative fund management industry that may offer a viable option for their cousins across the Atlantic. As US managers do not have access to an EU passport to market their funds some have opted to establish these in a way in which an authorised third party management company manages the EU component. This approach removes the costs associated with establishing an EU investment management platform.

Depending on the requirements, the model has two variations.

In one, the authorised third party management company is designated with the portfolio management of the fund management platform based in the US. In doing so, the platform falls under EU regulation, without contamination to the non-EU structures.

In the other, the authorized third party management company is designated to provide risk and portfolio management and in turn appoints the US fund manager to act as advisor to the fund. The third party management company also oversees the investment committee and appoints other relevant third parties to administer the fund as necessary, such as a depositary.

For example, a US real estate investment manager who relies on domestic investment, but wants to attract additional investors away from home can adopt this method and meet their investment objectives. The parallel structure is domiciled in jurisdictions such as Delaware or the Cayman Islands for domestic purposes, while Dublin among others is used when attracting investment from the EU and Asia.

Theoretically, there is no tactical reason why this approach could not work. The model currently runs on the basis of leveraging the regulatory framework implemented under the Alternative Investment Fund Managers Directive (AIFMD). While there may be nuances between the two structures that require attention, the spirit of parallel structures persists in both regimes.

The Irish Collective Asset-management Vehicle (ICAV) introduced last year was an initiative to minimise the administrative complexity and cost of establishing and maintaining collective investment schemes in Ireland. It complements other legal forms of Irish regulated funds and can be used in conjunction with master-feeders or parallel fund structures.

Once the UK government invokes Article 50 of the Lisbon Treaty, the official mechanism for withdrawing from the EU, the interests of competing financial centres such as Frankfurt and Paris will be brought into focus. Emotions inevitably might run high during divorce proceedings and some EU proponents may argue that parallel structures, as a back door to the prized single market, ought to be shut. However, given that they are commonly used by the US alternative investment industry, Brussels might need to tread carefully to avoid the risk of any pyrrhic victory.

Currently, the UK’s financial services framework post-Brexit remains unknown but this approach may be worthy of consideration as an alternative method to access EU fund distribution channels. Many market observers believe that some type of EU passporting agreement will ultimately be struck and parallel fund structures under the US model will not be required. Then again, many of them also predicted with the same high degree confidence that the ‘leave’ vote would not prevail.
Richard Street is head of global client coverage for Europe and Middle East at RBC Investor & Treasury Services.
This article appeared in the October 2016 edition.