Ireland and Luxembourg, the EU countries that have attracted the biggest influx of Brexit-related fund business, are to probe asset managers’ local entities in a move that reflects the level of scrutiny of the so-called delegation model at the heart of fund management.
Financial regulators from both countries plan to review management companies in their jurisdictions to ensure they have sufficient substance and are not operating as letterbox entities.
Many asset managers run a delegated model, in which they domicile funds in Ireland or Luxembourg but manage them from investment centres such as London or New York. EU rules permit this as long as the management company, the EU legal entity sitting behind the funds, can prove they are not shell companies taking orders from portfolio managers in the UK or US.
For the purposes of the review, substance is defined as being “appropriately accountable” and employing a minimum number of local staff, and it became a key issue in the debate over the City of London’s future post-Brexit.
Fearing that asset managers may seek to circumvent Brexit by having a minimal EU presence and delegating the bulk of activity back to London, EU regulators tightened the rules, notably requiring groups to employ at least three full-time employees in the EU.
The Central Bank of Ireland, which regulates Ireland’s €2.5tn fund industry, said last week that it would issue questionnaires to asset managers to assess compliance and follow up with site inspections.
“The scope of our thematic work will be informed by the knowledge that we have obtained through our engagement at a European level and from the considerable uplift in applications for authorisation we have received due to Brexit,” said Michael Hodson, director of asset management at the regulator.
The Luxembourg watchdog, the Commission de Surveillance du Secteur Financier, also said it would make site checks at asset managers’ local operations, with the threat of sanctions.
CSSF director Marco Zwick said asset managers needed to take the exercise seriously, warning that its outcome could affect future rules governing delegation.
“If we find that some companies delegate without [sufficient substance] and if we have to sanction companies, that would raise a lot of questions at European level about whether the outsourced model is still valid,” said Mr Zwick.
His warning was a reference to a recent EU attempt to change the delegation rules. In 2017, the EU proposed imposing new checks on groups delegating portfolio management outside the bloc, a move that was defeated. The proposals were believed to have been driven by France in a bid to capture a slice of the UK’s £7.7tn asset management market.
“The discussion [around delegation] is going to continue but that’s also where the private sector has a role to play,” Mr Zwick told the Financial Times.
“If we were to do checks and find out that half of the market is not compliant, the result could be that someone at European level will say ‘You can’t do delegation’”. Asset managers can stave off such a clampdown if they “provide assurance that they can effectively supervise outsourced activities”, said Mr Zwick.
The CSSF issued new guidance on delegation and substance last year, which applies to both newly authorised and existing management companies. Mr Zwick said the regulator had been “pragmatic” by allowing managers more than a year to adapt their businesses. However, the CSSF expects groups to fill any gaps in compliance by early next year.
Ireland also warned it would take a hard line on so-called dual hatting arrangements, where UK-based fund salespeople carry out business in the EU by flying in and out. Mr Hodson said that temporary secondments of UK staff to EU entities could work provided that the arrangement is not “structured simply as a device to circumvent the EU rules”.
Large numbers of UK and US investment managers have set up entities in Ireland and Luxembourg in preparation for Brexit. M&G Investments and Columbia Threadneedle are two of the biggest names to set up in Luxembourg, collectively transferring client assets of €46bn to funds in the country.
Meanwhile, Ireland authorised a record number of funds in 2018 and welcomed groups such as Legal & General Investment Management, Standard Life Aberdeen and Morgan Stanley Investment Management.
