Hermes Investment Management warned that a vote for the UK to leave the European Union could mean that some UK-based asset managers relocate parts of their business elsewhere.
The firm was originally founded in 1983 as the primary manager of the BT Pension Scheme but is now one of the largest institutional fund managers in the UK, with £24.1bn ($34.6bn) of assets under management and £169.8 bn in assets under advice. The UK will hold a referendum on June 23 on whether to remain in or leave the EU.
Eoin Murray, head of Hermes’ Investment Office, and Neil Williams, group chief economist at Hermes, said in a report that the UK is the largest single market for fund management in Europe, accounting for as much as half of total EU turnover. The report said: “Yet, this dominance is contingent on its continuing ability to do business across the continent. A Brexit may impede the ability to distribute funds into the EU from the UK.”
Both Ucits and the Alternative Investment Fund Managers Directive would impact UK fund managers if there is a leave vote. Ucits allows authorised funds to be marketed across the European Economic Area if both the fund and management company are registered in an EEA country, although portfolio management can take place elsewhere. AIFMD covers asset managers managing non-Ucits funds or marketing them to professional investors within the EEA. The EEA is the single market that includes the 28 EU member states and Iceland, Liechtenstein, and Norway.
“Depending on what the ‘out’ looks like, marketing to, and the servicing of clients in, the EEA may need to occur within the EEA,” added Hermes. “It’s thus possible that UK-based firms wishing to continue distributing EEA domiciled funds into the EEA, may need to consider locating some parts of their business to the EEA, in the event of a Brexit.”
However if UK-based funds move to an EEA jurisdiction, it is likely that this would be a taxable event for investors. In addition both Ucits and AIFMD are recognised globally, particularly in Asia and Latin America, so global distribution could also be affected.
Hermes said the financial services sector in the UK has a trade surplus of over £16bn, equivalent to about 1% of GDP. UK financial services firms can currently operate in other EU member states without setting up a local branch under a passport scheme. In the event of Brexit there would be significant additional costs in establishing local branches in European centres, maintaining local capital, and seeking approval from multiple local regulators.
In addition, if the UK votes to leave, the UK government would either need to pass EU regulation as new UK law or if not, negotiate equivalence each time the EU updated its legislation.
For example, the UK could decide not to implement MiFID II, the regulations covering EU financial markets from January 2018. “Suppose that the UK regulatory regime for trading venues was not deemed equivalent to MiFID – this could force EU investors accessing global markets through the UK having to take their business elsewhere. Dublin, Paris and Frankfurt would be the obvious local beneficiaries,” added Hermes.
As a result, European business could shrink to the gain of financial centres in the US and Asia.
Murray said in the report: “London’s status as a global financial centre and gateway to the EU would be threatened if it’s no longer the dominant force in clearing European financial markets. London enjoys ‘king status’ as the centre for clearing foreign exchange trades (over three-quarters of EU trading) and bond futures.”
This could also be at risk if the European Central Bank requires clearing houses of euro-denominated business between European banks to be based in the eurozone. “Overall then, financial services has more than most other sectors to lose from a Brexit,” added Murray. “Given the City’s strong starting point, Brexit may not short-term be a complete ‘disaster’, as the City maintains, at least initially, much of its comparative advantage. But, is it all worth risking?”
Williams warned that if Brexit occurs, the UK renegotiation to gain access to trade could take several years and other countries could also decide to hold referendums.
“This questions the EU as a relative haven should Brexit occur,” he added. “In which case – given the second-round effects and the ECB’s ongoing QE – Brexit would probably benefit the US dollar and Japanese yen.”
He also predicted that the pound and UK equities would probably fall and the Bank of England would defer interest rate increases as the economy slows. Ratings agencies have said they could downgrade the UK in the event of a Brexit so the Bank of England could also become a sponsor of gilts, UK sovereign debt, via quantitative easing potentially intensifying the pressure from ‘lower for longer’ yields on pension schemes.
“Short-term conventional gilts may benefit initially, especially on a hard exit,” said Williams. “But this could be short-lived, given about one-third of the £1.3 trillion gilts outstanding is backed by international investors sensitive to currency and ratings risk, particularly if Brexit reignites the risk of Scotland breaking from the Union.”
A survey from the Chartered Institute for Securities & Investment found that 70% of members said their clients would be worse off if the UK votes to leave the European Union. The CISI’s online survey ran for six weeks and attracted more than over 1,300 respondents. Simon Culhane, chief executive of CISI, said in a statement: “This survey reflects the nervousness amongst our membership about the effect on their clients’ investments, as opposed to their own personal opinion, if and when the UK leaves the EU.”
Philipp Hildebrand, vice chairman at BlackRock, said financial services in the UK would be undermined in the event of a Brexit vote at the International Financial Services Forum yesterday according to Reuters.
Reuters reported that he said Switzerland spent 10 years negotiating 120 trade pacts with the EU, that do not include financial services, and in return must accept the free movement of EU citizens.
George Osborne, the UK Chancellor of the Exchequer, tweeted yesterday: “New @hmtreasury analysis shows 285k UK jobs linked to EU financial services exports. Leave vote would put 10s of thousands at risk #FT125.”
Non-partisan UK blog Number Cruncher Politics, said the latest probabilities for the referendum results were 77.7 % for vote remain and 22.3% for vote leave using data up to May 8.
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