In mid-July, ESMA, the EU securities regulator, published an opinion paper suggesting national competent authorities (NCAs) should take a tougher line on policing the asset management sector, adding to the increasingly negative Brexit predictions about the UK’s financial services industry. Within its dedicated guidance, ESMA outlined the approach it wants regulators to take regarding delegation - where a fund outsources key functions such as portfolio or risk management to an entity located in another country.
ESMA’s comments have sparked concerns that NCAs could be forced to impose new restrictions on EU-domiciled funds, which rely heavily on portfolio management staff based in the UK and other locations globally to make key investment decisions, suggesting that NCAs should apply more scrutiny to those fund managers seeking authorisation to relocate to an EU member state if they do not have “at least three locally based, full-time” equivalent staff covering core functions. ESMA’s opinion suggests extra scrutiny should be applied by regulators when activities are delegated to a “third country”, which would include the UK once it leaves the EU in 2019.
Any changes to existing delegation arrangements are likely to have a significant impact on funds established under the EU’s UCITS and AIFMD frameworks, which frequently use third-party management companies (ManCos) or alternative investment fund managers (AIFMs) based in the country of the fund’s domicile, with Luxembourg and Ireland being the most popular destinations for European fund registration. Portfolio management is often delegated back to an investment manager, which can be based outside the EU.
According to EFAMA, the European fund management association, assets under management related to European funds reached €22.8tn in 2016, equivalent to almost a third of the global total. Furthermore, European asset managers are directly responsible for employing more than 100,000 people, 40% of these based in the UK, with a further 500,000 jobs in the wider financial services industry.
Given all the evidence supporting the long and successful history of the delegation model, ESMA’s opinion is unlikely to cause permanent changes to the current system. More likely is that the pressure being applied to NCAs will lead to an increase in regulatory scrutiny to ensure adequate levels of human capital (“substance”) are maintained - something which is in
fact most easily achieved by using a third-party ManCo or AIFM. These entities in turn will be forced to employ a greater number of highly skilled staff, possibly including portfolio managers, and invest heavily in IT infrastructure to support growth.
So, far from the death of delegation, we are likely to see its continued rise in a more sophisticated and stronger form.
Greg Kok is head of ManCo services at Maitland
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