Pan-European regulator ESMA has recommended a raft of changes to the regulation of investment funds, which could result in significant restrictions on the capacity for UK-based asset managers to continue to operate EU-based funds after the UK leaves the bloc at the end of this year.
Writing to the European Commission ahead of the EU executive's review of the AIFMD regulation, ESMA chair Steven Maijoor highlighted concerns on delegation, substance requirements, secondments and white label providers arising as a result of Brexit.
At the end of the Brexit transition period in December, the UK will become a third-party country with respect to European fund regulation. UK-based asset management firms have thereby been actively putting in place measures to meet "substance" requirements to allow for the delegation of fund management and other key functions for Europe-based funds back to London.
However, Maijoor, who also said the issues should be considered with regard to UCITS funds, warned that the UK's exit from the EU may "increase operational and supervisory risks and raise questions as to whether those AIFs and UCITS can still be effectively managed by the licensed AIFM or UCITS management companies."
He explained: "In light of the withdrawal of the UK from the EU, delegation of portfolio management functions to non-EU entities is likely going to further increase.
"Such extensive delegation arrangements may result in a situation where the majority of human and technical resources (e.g. IT systems) needed for the day-to-day operations are maintained."
Maijoor therefore recommended "further legal clarifications on the maximum extent of delegation" to ensure "authorised AIFMs and UCITS management companies maintain sufficient substance in the EU", and went as far to suggest the formation of a list of "core or critical functions that must always be performed internally" within the EU.
He said that while "extensive use of delegation arrangements may increase efficiencies and ensure access to external expertise taking into account the global nature of financial markets, they may also increase operational and supervisory risks".
Commenting on the letter, financial regulatory partner at law firm Ashurst Jake Green said: "This is a significant letter in terms of what it is covering and what it is trying to do and should not be underestimated. Put simply, it is an attack on London.
"The sections on delegation, secondments and white label providers are stark and could lead to serious repercussions because it may materially impact current structures and flexibility in using UK based portfolio managers and expertise.
"It is also doubtful that Luxembourg and Ireland will be happy with this as it could materially impact their fund offerings."