London spared Brexit pain over EU fund delegation

The European Union is set to tighten rules on how funds can be managed from outside its borders, while skirting more drastic changes that the fund-management industry warned would disrupt long-standing business models.

Proposals from the European Commission include a new requirement for at least two full-time senior managers to be present in the bloc, according to draft documents obtained by Bloomberg. Funds will also need to notify regulators when the majority of their assets are managed outside the EU.

Still, the suggested changes aren’t the root-and-branch overhaul that some in the industry feared might emerge from the review of the Alternative Investment Fund Managers Directive and would have undermined one of the pillars of the City of London.

The EU has been considering rule changes in a bid to strengthen the European asset-management industry. At the end of 2020, firms in the U.K. handled about £2.3 trillion (€2.7 trillion) for hedge and mutual funds overseas, chiefly in the EU’s main hubs of Ireland and Luxembourg -- over half of all fund money managed in Britain, according to the Investment Association. 

Luxembourg is the second-largest fund administration centre in the world after the US, with around €4.6 trillion under administration.

The UK's strategy to stimulate London's funds industry as outlined in a British government report earlier this year was for the country to focus on less regulated so-called alternative investment funds - such as hedge funds or real estate funds - because its clients are mainly institutional investors such as pension funds or insurance companies and are easier to service from Britain than retail clients requiring a local presence.

The EU proposal means EU-based funds can still be managed from external financial centers, at a time when some EU officials are pushing for more financial infrastructure to move inside the bloc after Brexit. The proposal to retain much of this practice comes at a strained period in the EU’s relationship with the U.K., which could risk trade reprisals by suspending part of its divorce agreement.

Delegation “allows for the efficient management of investment portfolios and for sourcing the necessary expertise in a particular geographic market or asset class,” the proposals say. Still, the documents also lay out changes to clamp down on so-called letterbox firms, which outsource so much business they can’t control their own operations. 

The proposed changes will preserve the “valuable features” of delegation while ensuring there are enough EU staff to guarantee “the delegate and core functions are retained” by alternative investment fund managers. In practice, that means “at least two senior managers should be employed or conduct the business of the AIFM on a full-time basis and be resident in the Union,” said the draft text, which could be still subject to changes.

The European Commission declined to comment.

Hedge funds, as well as U.S. fund giants like BlackRock Inc. and European firms such as Schroders Plc and Allianz SE, have lobbied against changes to the practice, saying delegation is crucial, allowing them to concentrate portfolio managers in London as well as other financial centers like New York and Tokyo. They say this helps hold down costs, keeps managers close to their markets and supports recruitment.

“The delegation rules are sensible step in the right direction and strike a good balance between allowing for sufficient flexibility and preventing third-country hedge funds from operating via letterbox companies in the EU,” Markus Ferber, a German member of the European Parliament, said by email.

The proposals come after European Commissioner for Financial Services Mairead McGuinness said in November that she would extend a temporary waiver that allows EU banks and money managers to clear trades in the U.K. That was seen as a post-Brexit victory for the City of London, which is fighting off attempts by the bloc to strip business from it.

©2021 Bloomberg L.P.