Preserving the right to passport funds to the European Union is a vital aim of Brexit negotiations for UK fund managers. Kit Klarenberg assesses the likelihood the UK will retain this cherished ability.
In a foreshadowing of the eventual hair’s breadth result, British citizens, politicians, newspapers and businesses seemed about evenly split on the issue of whether the country should stay or go right up until polling day on June 23.
The financial services industry was decidedly less binary. While a few lone voices were fervent in their support of Brexit, the sector was overwhelmingly in favour of remaining. Many of the largest financial institutions in the UK, including Citi, Goldman Sachs, JP Morgan Chase and Morgan Stanley, were among the most generous donors to the official Remain campaign.
The industry’s enthusiasm for the UK remaining within the EU stemmed from a desire to preserve the raft of passporting rights that membership grants to states and the businesses operating therein; with them, services can be cheaply and effectively marketed and offered across the 28-member bloc from a single jurisdiction.
As history would have it, of course, the best efforts of the Remain campaign failed – now, the question of whether Britain will retain its continental visa is very much up in the air. A highly contradictory political picture on both sides of the English Channel exacerbates this lack of clarity.
A month after the vote, new foreign secretary Boris Johnson announced passporting would be maintained, due to the high levels of mutual economic dependency between the UK and the Eurozone. It was “manifestly in the interests” of the EU to maintain this relationship, he said. In response, German member of parliament Michael Fuchs, a key ally of chancellor Angela Merkel, said the UK would definitely lose its access to the single market if the country seceded from the Union.
“If you’re member of a club you have certain benefits, but if you’re out, you don’t have them any more,” he explained.
In early September, vice-president of the European Commission Valdis Dombrovskis took a slightly softer tone, saying the UK could continue to enjoy the free movement of capital, goods and services – as long as the free movement of people was maintained. David Davis, newly appointed UK Secretary of State for Exiting the European Union, retorted that if membership of the single market entailed “giving up control” of the UK’s borders, the country had little interest in retaining its single market access. A spokesperson for prime minister Theresa May hastily clarified that Davis was expressing his own view, not official government policy.
HOW OSLO CAN YOU GO?
Brussels’ evident intransigence on the issue of passporting jars with the rosy picture of a post-Brexit UK propagated by ‘Leave’ campaigners in the lead up to the referendum. Many advocates of departure, including Helena Morrissey, the now-former chief executive of Newton Investment Management, envisaged Britain emulating Norway – joining the European Economic Area, participating in the European Free Trade Agreement and retaining single market access as a result.
The Norwegian model is an obvious one to adopt, but the realities of such an association may not be palatable to ‘Leavers’. As noted by Emmanuel Macron, until recently France’s minister for the economy, Norway’s passporting rights don’t come for free – in fact, it pays as much per capita for its arrangement as the UK does currently.
Norway is also obliged to adopt EU laws and regulations – while playing no role in their drafting. A spokesperson for the International Capital Markets Association notes the UK will be expected to do much the same: “The EU is almost certain to insist UK laws conform with EU law as a condition for future access to the single market – and this might not be politically acceptable in the UK after the vote to leave.”
There is a clear conflict at the core of the passporting debate. The clawing back of legal sovereignty, an ability to restrict immigration and the ending of EU budget contributions were all key issues for the Leave campaign and Leave voters – yet, none of these goals are apparently compatible with the retention of single market access.
Given this quandary, it would be understandable if every asset manager in the UK – whether homegrown, or an overseas operator – were currently feeling apprehensive. In the immediate aftermath of the referendum, it certainly appeared investors were spooked, hurriedly withdrawing £3.5 billion (€4.12 billion) from UK investment funds, more than was withdrawn following the collapse of Lehman Brothers. Publicly listed asset managers based in the UK were also hammered in the days following June 23, with shares in Legal & General falling 30%, Henderson Group 27% and Schroders 24%.
Since then, the FTSE 100 has largely rebounded and money has cautiously but steadily flowed back into investment funds, bringing their assets to pre-referendum levels. There’s also evidence to suggest firms aren’t panicking about passporting – at least for the time being.
In August, a Preqin survey of 140 investment managers suggested a distinct lack of concern. While 7% said they were considering their position, and 17% were uncertain about their operations remaining in the UK, no UK-based respondents stated they positively intend to relocate some or all of their business operations from the UK as a result of Brexit.
The overwhelming majority of respondents, 76%, did not anticipate any changes to their business operations in the future. As a result of these findings, analytics firm Cerulli Associates does not believe passporting rights will be withdrawn outright. Furthermore, Barbara Wall, its European managing director, says any new conditions attached to these rights will be minimal.
“The EU would have little incentive to deprive itself of the expertise of Europe’s biggest financial centre, or to risk restrictions being placed on the export of EU goods and services into the UK,” she says.
“Before long it will be apparent that Brexit’s effect has been exaggerated and that it will require a degree of evolution for some firms, not revolution.”
THE SACKING OF LONDON
Nonetheless, not everyone in the industry is quite so convinced of passporting’s viability. Guy Stephens, managing director of wealth manager Rowan Dartington, is among them.
“UK politicians have repeatedly announced we will preserve passporting rights, but they would say that, wouldn’t they? The Lisbon treaty, effectively the EU constitution, makes clear free movement of people and capital are inextricably linked, and the line emanating from Brussels is consistent: the UK will categorically lose its passporting rights if it doesn’t retain freedom of movement. The line from the UK is also consistent: we won’t retain freedom of movement,” he says.
“Those are obviously irreconcilable positions, meaning one side will have to budge – and that side won’t be the EU. In negotiations, the UK has everything to lose, and the EU everything to gain – it’s fundamentally in the interests of Paris and Frankfurt to take as much from the City of London as possible.”
However, even if the UK doesn’t retain its passporting rights, UK asset managers may be able to retain a degree of access to the single market. As Stephens notes, Ucits IV allows for fund sales on the continent from the UK, and this won’t necessarily be lost – although, it may be subject to renegotiation, and could be amended in the EU’s favour.
For Jorge Morley-Smith, director of business support and promotion at the UK Investment Association (IA), it’s not all doom and gloom either. While he concedes the issue is a concern, none of the IA’s member firms has announced any major relocation plans. Moreover, he points out the vast majority of UK Ucits funds are sold to domestic investors, and many key services – such as the export of portfolio management to funds domiciled in Luxembourg – do not in fact rely on passporting rights.
What of major overseas firms? While passporting is an important right, the UK offers benefits to corporate denizens that no other jurisdiction in Europe presently does. Even if passporting rights are lost, the UK will retain its beneficial timezone, favourable tax regime, large and conducive financial services infrastructure and world-class legal system.
The UK’s lack of bargaining power with the EU may be overblown too. Daniel Mahoney, head of economic research at UK think-tank the Centre for Policy Studies, says London’s status as a financial centre places the country in a good position to negotiate. What’s more, the UK’s commercial relationship with the EU isn’t a one-way street – EU businesses will likely wish to retain access to UK financial services.
“It is too often forgotten that the EU would be severely damaged by an acrimonious divorce with the UK. Morgan Stanley has previously calculated that Eurozone GDP would contract by almost as much as British GDP in a ‘high-stress scenario’,” he says.
“No doubt EU policymakers will have the Greek crisis in the back of their minds, and will be well aware that problems associated with the Italian banking system will be exacerbated if markets lose confidence in the Brexit negotiations.”
It’s surely premature to speak with any degree of certainty on the future of passporting in the UK. Negotiations won’t start until next year at the earliest, and may last a decade – at the end of which, passporting rights might emerge intact, but they might just as easily be diluted, limited, modified, or scrapped outright. In the meantime, and potentially afterwards, the UK will remain a key beachhead for firms that wish to export their services to the continent.
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