UK funds in a post-Brexit world: into the unknown?

MA:

Good day everyone, and welcome to our podcast series ‘Thinking Aloud with BNP Paribas’. Today’s podcast is ‘UK funds in a post-Brexit world: into the unknown?’. I’m Matt Adams, head of Asset Manager and Owner Client Lines in the UK and Middle East and I’m delighted to be joined today by Daniel Gonzalez Fuster. Daniel is Head of Institutional Investors Client line UK and Middle East. Daniel, perhaps if we could start with you introducing your background and your current role.

DGF:

Thank you Matt. I have been working for the last 23 years at BNP Paribas Securities Services, in a number of locations. Today my main responsibility is to drive our strategy and value proposition for our institutional investor clients in the UK and Middle East, which covers mainly asset managers and asset owners such as insurance companies, pension funds and official institutions, as well as private capital and hedge fund clients. This means that I lead and coordinate our go-to-market strategy, the design of our products and solutions as well as our product management framework, ensuring that our product capabilities are aligned with our internal policies, market practices and regulation.

MA:

That’s great, thank you Daniel. You clearly have direct experience of many different fund regimes, having worked in many different markets across the Americas and Europe – no doubt your language skills have come in handy there. Of course, we’re at a very crucial juncture right now for the UK funds market this year, and there’s much talk of what needs to be improved. But before we look at that, what do you see that’s working very well for the UK already vis-à-vis your broad experience elsewhere?

DGF:

So, when I compare the UK market with others, the first thing that strikes me is its dimension. ­The UK is still the second largest asset management centre in the world, second only to the US, and still manages 37% of the assets in Europe, which is really significant. Despite Brexit and the difficulties of Covid-19, UK-managed assets have still increased healthily year-on-year. So that is quite important.

Then, what I think is important is that the UK is not only a major producer / originator of funds, but it’s also a very relevant consumer of foreign funds, being a leading cross-border destination. For instance, the UK is the number one destination for Irish funds and the number five destination for Luxembourg funds, which is also very relevant.

Besides these quantitative elements, I think the UK is a very mature and well developed market that has a very wide range and variety of well-established fund structures. For instance, structures range from European structures like UCITs, to very local and domestic structures related retail schemes, which brings a large choice of vehicles to the investment strategies of asset managers. It’s quite interesting because we have seen that, during this pandemic context, a very domestic product such as the investment trust has been a very resilient product, in terms of liquidity, having even more liquidity than open-ended funds, which I think is quite interesting.

So, indeed, as in many other fields, the UK is a very relevant player and even, I would say, a true reference in the asset management space for its size, maturity and innovation.

MA:

Yes, absolutely. So, with this in mind there’s quite a lot at stake at the moment. Financial services was largely left out of the Brexit trade deal back in December, and although we have a Memorandum of Understanding that was announced in March, we still don’t have much tangible detail on what it means for setting up and distributing funds into and importantly, out of the UK.  Are you optimistic about the UK as a fund domicile? Or are you more nervous about the challenges that the UK will face?

DGF:

I think it’s a very good question. Definitely, I think there are quite a lot of challenges.For instance,how to maintain and increase overseas sales of UK funds – we need to acknowledge that on the whole, UK funds are mainly bought by UK investors. Since 2012 the share of UK funds held by overseas investors has been decreasing in a consistent manner and now I think it represents only 4% of total UK fund sales^[1]. So definitely, this is an important point that hopefully will be addressed in the future.

And indeed, I think we are at a crucial point. Many are concerned about what is the real competitive edge of the UK fund in industry. As we were saying, we don’t have yet very clear solutions. Some players believe that the UK asset management space is still a bit disadvantaged in comparison to their European peers, especially the retail funds space, as the proposed Overseas Fund Regime does not really have a reciprocal offer yet from the European Union. And indeed in this context, we see that Luxembourg and Dublin are still being considered as much more attractive locations to sell cross-border products.

MA:

Indeed, if I interject there, I know there was some push back from UK industry professionals – we’ve seen that in the media – certainly around the Overseas Funds Regime and indeed whether it should be scrapped, in order to ensure a more level playing field going into new arrangements and of course, the opportunities as well.

DGF:

Yes, indeed, it’s part of this challenging situation but the good news is that maybe, for the first time in a long time, the local industry will have more control over its own destiny. Definitely, we could be at a real turning point, and the catalyst that we have long needed to channel more fund flows into the UK.

For instance, just to give you an example, there have been several suggestions for improving the UK fund structures. We have seen the proposal from the Investment Association to put in place the Long-term Asset Fund (LTAF), which is now being backed by the UK government. This could be a new structure that would allow wider access to assets such as infrastructure and private companies which are not listed or regularly traded, that will help to have more adapted redemption mechanisms for these funds which are investing in illiquid assets. So, we need still to see how this could complement products such as the investment trust, but definitely this is a very interesting and promising opportunity. If we look to what has been done in Ireland, Managers are looking more and more at the new Partnership Structure to avail of private capital opportunities. So as in Ireland, the UK has an excellent reputation for providing fund administration and other asset services, so I think definitely we have the right ingredients to make something positive. 

Another growing trend and opportunity that the UK needs to capture is ESG. As you know, flows into ESG funds have been increasing by over 60% in 2020^[2], and definitely it will be important that we are able locally to capture this opportunity and from what I see, local authorities are already having the right focus on this topic. For instance the FCA has already issued a consultation paper seeking views on proposals to enhance climate-related disclosures from asset managers like insurance and regulated pension schemes. This was done in 2021, and we expect the technical screening criteria of a UK green taxonomy to be completed by the end of 2022. So definitely, we can see that we’re really putting the right focus on this important topic which I think is quite positive news.

MA:

Yes absolutely, and obviously a lot of interest, quite rightly so, in the climate-related initiatives and more broadly ESG. And it’s perhaps worth mentioning, at a broader level, that the UK is positioning itself globally as a leader in the transition to net zero.

So the eyes of the world will be on the UK this year, and we also host COP-26 in Glasgow in November. I think, it’s important to ensure that the financial services and investment industry really reflect this drive and get on board with it, and that we can capture the demand for ESG in the very best way possible.

So, it does feel to a certain extent that we’ve been talking about the ‘opportunities and challenges’ for UK funds in a post-Brexit environment ever since the end of the Brexit transition period. It’s obviously been half a year since then. A lot of interest leading up to it. Can you tell us a little bit about what interest and concerns we’ve seen from clients, and how BNP Paribas has been helping with this?

DGF:

Yes, I think that as in any activity, ambiguity does not help to make business, and hopefully we will have soon more clarity on the Fund equivalence regime, which for me, is key.

And indeed, as we were mentioning before, when speaking with market players, the expectation is local UK regulation will diverge, which can create interesting new investment vehicles. As we were saying before, this is currently being analysed.

However, we should not underestimate the cost of this divergence, as having to cope with two different sets of regulation can be expensive for local players. Just to give you an example, the five-year exemption granted by the UK to produce the PRIIPS reporting, which in principle is good news for the domestic players, is also raising some concerns as the UK entities might need to comply with two different set of reporting during the extension of this period.

So, this type of divergence might force some players to choose between focusing on UK products or cross-border products, which is not ideal. What we see, to answer your question about clients, is that asset managers definitely are reassessing their operational and distribution strategies and trying to really better understand which is going to be the future market trend.

MA:

Yes, I think it’s notable that we’ve seen a handful of managers ourselves enquire, or in some cases, move their funds to a UK domicile post-Brexit, but would you say this has been few and far between?

DGF:

Yes, I think interestingly enough, I would say that we have seen both movements, foreign asset managers setting up UK funds but also UK asset managers willing to secure their European distribution capabilities and in some cases relocating part of their business, staff, or legal entities to the EU.

And I believe that this is what good asset managers do – diversify in order to reduce their risk exposure.

Indeed, as part of this reassessment, we have seen some of our clients asking us for input and assistance with new requirements around documentation, regulatory approval and what needs to be done, and this for both sides of the Channel, both in the UK and the European Union.

I think this is something important – this is being done also in context of further diversification of investment strategies and asset classes. Indeed, we see many traditional asset managers looking at alternative asset classes like real estate and infrastructure, or private debt.

But in spite of these challenges and complexity, maybe to finish on a positive note, I would say that there is no major expectation that the UK market might contract. It’s true that the absence of an equivalence regime agreed between the UK and the EU means that divergence is a reality and this is only going to increase. But again this divergence might potentially create some costs will be also an incentive for asset managers maybe to simplify their regulatory obligations by relocating some of their global fund ranges to the UK. So that, definitely, might create some opportunities.

What is clear, is that we will assist our clients in this challenging, but I am sure very fruitful, journey that we will face together.

MA:

Very much so, and exciting times ahead. Well thank you very much Daniel, for your insights and of course to all of our listeners. We hope you found this podcast to be interesting and useful, and we look forward to welcoming you to the next one. Thank you.

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[1] Source: Investment Management in the UK 2019-20, The Investment Association https://www.theia.org/sites/default/files/2020-09/20200924-imsfullreport.pdf

[2] The Financial Times, https://www.ft.com/content/27025f35-283f-4956-b6a0-0adbfd4c7a0e