20 January 2020
The General Election and the future of Brexit - what it means for Guernsey funds
The general election on 12 December was a momentous fork-in-the-road moment for British politics, delivering Boris Johnson's Conservative government a majority of 82 - the largest since Margaret Thatcher’s 102 in 1987. It also brings the prospect of more stable British politics after a decade of coalitions, slim majorities and minority governments.
Most significantly, it means that the Brexit debate (at least, whether or not we leave) is over: on 9 January the third reading of the European Union (Withdrawal Agreement) Bill 2019–20 (the "Withdrawal Bill") passed by 330 votes to 231, leaving UK on course to leave EU by the end of January 2020, with Boris Johnson promising that the ongoing deal with the EU will be in place by the end of 2020, failing which the UK’s ongoing relationship with the EU will be on World Trade Organization terms.
So what does this mean for Guernsey? Guernsey is not subject to the laws of the UK, and is not (and never has been) a part of the European Union (the "EU"). As a Crown Dependency, Guernsey's constitutional relationship with Britain is with the legal institution of the British Crown, not the UK Parliament or HM Government. Guernsey only benefits from the UK's membership of the EU in a limited fashion, via Protocol 3 of the United Kingdom Treaty of Accession to the European Community of 1973, which brings Guernsey within the EU Single Market for the purposes of trade in goods (but not, significantly, services). Protocol 3 will cease to have any effect once the UK's membership of the EU ceases.
Brexit will therefore have no direct impact on the Channel Islands' financial services industries. Guernsey will continue to be treated as it is now: as a 'third country' (i.e. non-EU member) for the purpose of financial services. Indirectly, however, we expect Brexit to result in positive impacts for Guernsey.
Access to EU Markets under the AIFMD
The Alternative Investment Fund Managers Directive ("AIFMD") provides third-country firms two possible means of accessing EU markets:
- via national private placement regimes ("NPPR"); and
- (theoretically) an extension of the (pan-EU/EEA) passport regime granted by the AIFMD (the "Passport Regime") and the subsequent phasing out of the NPPR.
Currently the only means by which Guernsey funds may be marketed in the EU is via the NPPR mechanism. Guernsey was given an 'unqualified and positive assessment' in July 2015 in connection with the Passport Regime, subsequently reconfirmed in July 2016, putting Guernsey first in line to be granted access to EU markets by such means. The UK’s vote to leave the EU in June 2016 put this process into stasis; the Conservative's election victory and the passing of the Withdrawal Bill may have ended it. Granting a country the size of the UK (the second largest in the EU, behind Germany, representing c15% of the EU's total GDP, and with a significant imbalance in trade in financial services) access via the Passport Regime was probably never contemplated. Given the UK's full regulatory alignment at the time of its departure from the EU, it would seem impossible for the UK not to satisfy the regulatory requirements to be given such access (at least initially; at the time of writing it is unclear whether and to what extent the UK will in the future diverge, following chancellor Sajid Javid's comments in a recent interview with the FT that 'there will not be alignment, we will not be a ruletaker'). We therefore expect that – initially at least – the Passport Regime will not be extended to any countries.
Not that this is a bad thing; indeed, quite the opposite. The NPPR continues to offer non-EU funds access to almost all of the EU’s largest capital markets, whilst avoiding many of the most burdensome AIFMD obligations which the Passport Regime would entail. Whilst the Passport Regime would allow full pan-EU distribution, in practice 97% of all funds marketed in the EU are registered for sale in three or fewer Member States. So the reality is that the extent of access given by the Passport Regime simply isn’t required.
The UK is often considered to have had a liberalising and internationalist influence on EU policy, arguing consistently for more open trade policies. The loss of this influence following Brexit may see the EU becoming more protective of its own markets, potentially meaning tariffs or non-tariff (i.e. standards based) barriers being introduced. However, this is more likely to be in industries most heavily impacted by the competitive pressures of globalisation (typically labour intensive ones), rather than the investment funds industry.
We therefore expect the net result of Brexit – in the short term at least, until the UK's direction of travel becomes clearer – to be the retention of the NPPR as the means by which Guernsey funds are marketed into the EU, which we consider to be a quicker, less expensive and more flexible solution than the Passport.
And what of access to the UK? Guernsey has signed a memorandum of understanding with the UK to retain NPPR equivalent access after the UK leaves the EU, leaving the overall position effectively unchanged by Brexit. Furthermore, December's Queen's speech referred to financial services legislation being brought forward and 'simplifying the process which allows overseas investment funds to be sold in the UK', suggesting that enhanced UK access might be made available for Guernsey funds.
Given the current arguments about regulatory alignment of the UK post-Brexit, it’s probably safe to assume that Brexit will result in greater regulatory scrutiny of the UK and, by extension, Guernsey, given its strength as an offshore funds domicile (in 2015, KPMG estimated that Guernsey investments funds facilitated approximately £51 billion of overseas investment to the EU from global investors, and Guernsey acted as a conduit for £53 billion of overseas investment by European investors). Our view is that Guernsey is well placed to withstand any such scrutiny.
Guernsey has consistently demonstrated its commitment to adhering to the highest regulatory benchmarks; its standards of regulation, tax transparency, anti-money laundering (AML) and combating the financing of terrorism (CFT) have been evaluated and endorsed by the EU, OECD and other international bodies.
Most recently, and a fine case in point, is Guernsey's adoption of economic substance legislation in response to the EU's inter-governmental Code of Conduct Group (COCG), which in 2017 expressed concern that Guernsey's tax system could facilitate offshore structures aimed at attracting profits that do not reflect real economic substance. Guernsey was initially included on a 'grey list' of jurisdictions that had committed to address certain concerns. Following close work with the COCG, EU Member States and the other Crown Dependencies, Guernsey adopted legislation and high-level guidance in December 2018 and on 12 March 2019 the EU Council confirmed that Guernsey had met its commitment to implement sufficient substance requirements and therefore removed Guernsey from the 'grey list'.
One immediate positive of this for Guernsey investment funds was that the European Investment Fund is once more able to invest in Guernsey domiciled funds, reopening significant potential asset raising opportunities.
The general election clarifies the immediate future in that the UK's departure from the EU is now no longer in doubt. The long term relationship remains to be seen (you should probably brace yourself for more 11th hour, cliff edge chatter in December 2020).
Having never been a member of the EU, Guernsey starts from a position of strength with respect to Brexit. Challenges will nonetheless arise. However, with its close political, economic and cultural relationship with the UK (still by certain measures the 5th largest economy in world) and, in particular, London, its continuing international engagement and its ability to adapt, Guernsey is in a strong position to deal with those challenges and take advantage of the opportunities any Brexit outcome might bring.