Brexit - the potential effects on licence requirements

If the United Kingdom becomes a third country in terms of UCITS, AIFMD, MiFID II and other European provisions, UK entities will have to deal with several issues in Germany – two of them are (i) licence requirements and (ii) the impact on German institutional investors wishing to invest into UK funds.

 

What you need to know

• If the UK becomes a third country, financially regulated UK firms must deal with different regulatory licensing regimes.
• Post Brexit the EU-Passport may no longer be available and depending on the service provided and product offered, the UK firm may be required to establish a branch or comply with individual market access rules of the different member states.
• Future investments by German pension funds and other investors subject to the German Investment Ordinance into a UK AIF may require some more structuring (e.g. a wrapper) to be attractive.

Market access and licence requirements

If the UK decides not to become an EEA member in the context of Brexit, depending on the “way out”, UK firms might have to deal with the consequences of becoming third-country firms in terms of the above Directives. Various EU Directives – for the purpose of this article UCITSD, AIFMD, MiFID and MiFID II/MiFIR as well as CRD IV are taken into consideration – have different protection mechanisms and regulation principles including licence requirements for third-country firms.

Licence requirement topics

UCITS Directive

The question of third-country regulations is not a focus of the UCITS Directive. This is because a fund that is not domiciled within the EEA, cannot be (or become) a UCITS-fund. Rather, investment funds domiciled outside the EEA are AIFs even if operated/managed like a UCITS.

Since no requirements exist at EU level, each member state may define its own ways of accessing its market.

In Germany, the access is, in accordance with the Directive itself, focused on German and EU UCITS (as set out in section 294 of the German Capital Investment Code (Kapitalanlagegesetzbuch – “KAGB”)).

Only section 296 KAGB deals with third-country providers of “UCITS”: BaFin, the German Financial Supervisory Authority, may agree with the competent bodies of third countries that the provisions of sections 310 and 311 of the German Capital Investment Code (inbound) and sections 312 and 313 of the German Capital Investment Code (outbound) apply for the marketing of comparable investment funds, i.e. essentially the same regulations as for EU UCITS and/or the notification of German UCITS for marketing in the EU. Since these third-country investment funds are, from a legal perspective, not UCITS due to being located in a third country, these investment funds are referred to as foreign AIFs, with the special feature, that, in order to provide for comparability, the product-related rules of the Directive as well as the marketing rules have to be met (section 296, para. 3 KAGB).

For example, Germany has entered into an agreement with Switzerland stipulating that Swiss securities funds may (similar to UCITS) be marketed in Germany by means of a simple notification process. Conversely, a corresponding notification process for Switzerland is implemented for German UCITS. Such an agreement might be used as an example for a potentially similar agreement between the UK and Germany – which in our view should be even easier to achieve as long as the UK adheres to the UCITS provisions.

AIFM Directive (the AIFMO)

Unlike the UCITS Directive, the AIFMD provides for a differentiated and more harmonised third-country access right: however, it is subject to a staggered implementation over time.

As far as it concerns EU-based management companies of AIFs (EU AIFMs), it is intended that upon compliance with the access requirements in a member state, they may market AIFs, which are managed by them and have their registered seat in the EU (EU-AIF), in any other member state to professional clients following implementation of the notification procedure. Currently, this AIFM passport only applies to EU AIFMs managing and marketing an EU AIF.

Third-country AIFMs may only market their foreign AIFs in a member state if this member state allows the possibility of doing so within the framework of a private placement regime or another access procedure. A third-country AIFM is obliged to obtain such approval for each member state and/or review exemptions.

In the future, a non-EU AIFM may be allowed to market AIFs managed by it by applying the AIFM passport, article 67, section 1 AIFMD. A prerequisite for this is, among others, a positive opinion from ESMA on the respective third country, the compliance with the regulations provided for by the AIFMD as well as the adoption of a delegated act by the Commission. Assuming the UK will go on adhering to AIFMD- like provisions, in our view UK AIFMs and their AIFs will most likely be able to benefit from the AIFMD-third-country passport regime once implemented.

The regulation, article 67, section 1 AIFMD, and access regime is reflected in the KAGB. Marketing to professional (and semi-professional) investors is also based on the procedure following advice and delegated acts from ESMA (section 295, para. 2 and 3 of the German Capital Investment Code). Special German regulations apply to marketing to private clients, i.e. similar rules must be applied by the foreign AIF as German AIFM/AIF have to comply with.

MiFID and MiFID II (including MiFIR)

Under the current MiFID, the possibility for third-country companies to gain access to the EU market is not harmonised. Each member state may adopt its own rules.

A third-country company establishing a branch in one EU member state and obtaining authorisation to provide investment services there, may not adopt the MiFID passport to provide its services in other EU member states. The only possibility for the companies to overcome this access barrier is (i) to establish branches in the respective member state and separately obtain authorisation for providing investment services or (ii) to establish fully MiFID licensed subsidiaries which may use the EU passport. Other possibilities are (iii) the application of reverse solicitation or (iv) any national exemption possibilities.

The status quo outlined above will be amended by MiFID II: while a registration procedure in accordance with article 46 MiFIR will be required for third-country companies to provide services cross-border to at least per se professional clients (subject to staggered implementation and grandfathering provisions), the member states may, as far as it concerns other categories of clients, i.e. opt-up clients and retail clients, require that the third-country company establishes a branch (article 39 of MiFID II). In more detail:

• In accordance with article 46 MiFIR, a third-country company wanting to provide cross-border investment services to eligible counterparties and per se professional clients must be registered with ESMA. In this context, the member states may not impose further requirements on the registered third-country companies. In this way, the MiFIR procedure establishes a European harmonised set of rules and regulations for addressing at least per se professional clients. Separately, the possibility of reverse solicitation remains unaffected.
  
  However, a so-called equivalence decision regarding the third country from which the company originates is required (structurally similar to that under AIFMD) – (voluntary) compliance with the MiFID II/MiFIR regulations only by the company itself without respective national regimes in the third country does not suffice.
  
  Pursuant to article 47 MiFIR, third-country companies may, in compliance with the national regulations, continue providing investment services in the member states for up to three years following adoption of a decision in connection with the respective third country.
  
  It must be taken into account that this procedure refers only to investment services. Credit or deposit business as well as other banking services which are not investment services may not be carried out or provided in the EEA through this procedure. To this end, national law continues to apply which effectively prevents a harmonised overall approach.
• If the third-country company wishes to address retail clients or opt-up professional clients, articles 39 et seqq. MiFID II will apply. Pursuant to these articles, it is at the discretion of the respective member state to specify whether establishing a branch in the member state is required or not. Alternatively, the previous national regime may be maintained (or, if applicable, a further developed regime). MiFID II does not provide for a harmonised system in this regard.
  
  The possibilities of reverse solicitation remain unaffected in this context.

Currently, the Germany Securities Trading Act deals only marginally with the obligations of third-country companies regarding the cross-border provision of investment services to clients in Germany. The core standard is section 31 para. 10 of the German Securities Trading Act, defining the applicable conduct of business rules in a cross-border context.

The authorisation for providing investment services is, however, governed by the licence requirements of the German Banking Act (Kreditwesengesetz – “KWG”) allowing for exemptions in accordance with section 2 KWG.

With regard to such an exemption, BaFin differentiates between certain categories of clients, whereby differentiation is not made between professional clients and retail clients in accordance with MiFID, but between institutional and private clients. It should be noted that not each professional client within the meaning of MiFID/MiFID II is at the same time “an institutional client”.

The German legislator will probably opt not to apply the requirement of a branch under MiFID II (at least according to the draft bill). Other EU member states also seem reluctant to opt for this requirement. In Spain, the Netherlands and France on the other hand there seem to be tendencies towards endorsing an obligation for establishing a branch.

CRD IV

CRD IV does not contain many direct rules for access to the EU market by third-country market participants. In this respect, the licence requirement topic for banking services remains with the individual member state.

The German authorisation requirement for banking services is subject to KWG rules, cf. above.

Alternatives for accessing the market

Reverse solicitation

In principle, every EU–Directive provides for the possibility of reverse solicitation. Reverse solicitation occurs if a European client contacts a third-country firm on its own initiative and requests service. In practice, this possibility of accessing the market is still sometimes strongly used, even though past experience has repeatedly shown that a substantial business model should not be based on this principle.

Wrappers for investment structures

Wrappers are frequently applied, especially in the area of fund investments, e.g. in the form of a fund-linked note. This has the advantage that instead of complex marketing in accordance with AIFMD or the national marketing regime for investment funds, which is even more extensive for private clients, the Prospectus Directive with its generous exemptions and its private placement regime typically applies to the note.

Parallel vehicles for investment structures

The launching of European vehicles parallel to the original foreign investment structure is becoming increasingly noticeable. Both European investment vehicles and foreign investment structures make investments in accordance with the same investment rules, typically even in the same asset. European investment vehicles (and/or their EU management companies) may make comprehensive use of the advantages for EU providers, e.g. they may apply the European marketing passport. Such parallel structures, however, are expensive and only worthwhile in case of investments with greater volumes.

Possibilities for exemption

Most national supervisory regimes provide for possibilities for exemption for the provision of services in the EU. Especially when providing a service to (per se) professional clients, the need for supervision is often not emphasised strongly enough and an exemption is, to the extent required by law, granted.

German investor considerations

Besides these licence-related topics, one should also bear in mind the applicable restrictions on the investors’ side, in particular insurance companies (Solvency II) and investors which are subject to the German Investment Ordinance (Anlageverordnung – “AnlV”) such as pension funds, when investing into UK AIF and other UK investment structures.

Solvency II

German and other EU investors subject to Solvency II may be faced with a higher capital stressing pursuant to article 168 para. 6 lit. c) of the Commission Delegated Regulation (EU) 2015/35 in case they invest into non-EU-AIF. Whereas AIFs established in the EU which are closed ended and not using leverage benefit from a preferential capital treatment, such preferential treatment is only available for non-EU AIFMs if they have opted (and are able to opt subject to the staggered implementation set out above) for the passport under the regime for non-EU AIFMs.

Investment Ordinance

For investments in private equity funds, becoming a third-country firm should not have much effect as the allocation under the so-called private equity quota of the AnlV only requires that AIF and AIFM have their seat in an OECD country (which is and will continue to be the case for the UK); the further criteria that the AIFM is subject to supervision which is equivalent to the one which EU AIFMs have to comply with should be achievable.

With respect to indirect investments into real estate, debt and other asset classes, the AnlV provides that any such AIF would only qualify under the specific asset class quota (i.e. “real estate quota”, “alternative investment quota”) if the AIF and the AIFM have their seat in the EEA. If the rules of the AnlV remain unchanged until the departure of the UK, it will be difficult (subject to some structuring or wrappers) or impossible for German investors, which have to comply with the AnlV, to invest into UK AIFs.

In the past , BaFin and the AnlV very often provided some relief by grandfathering provisions, i.e. investments correctly made under a former version of the AnlV can remain unchanged and the new AnIV only applies for new investments. It remains to be seen whether such a grandfathering can also be implemented in the event of the invested asset, e.g. the UK AIF, changing its status into that of a third-country AIF.