Delegation refers to asset managers registering a fund in one country, such as Luxembourg, but keeping their portfolio management staff in another country, such as the UK.
It is commonly used by Luxembourg-domiciled funds to outsource functions such as investment and risk management back to a home country such as the UK.
Currently, 17% of Luxembourg assets equating to €672.7bn, are managed by British-based asset managers, according to Alfi figures.
Any attempt to rein in the practice would have big implications for Luxembourg, where delegation forms the backbone of the second largest fund centre in the world after the US, overseeing €3.9trn (£3.4trn, $4.6trn) net assets under management at the close of July 2017.
“There shouldn’t be an issue around delegation because it works,” Alfi chairwoman Denise Voss told International Adviser at the association’s conference in Luxembourg this week.
According to Voss, the practice has attracted increased scrutiny for “political” reasons.
“This model is tried and true, there have been no problems with it, it had no issues, no sanctions. The only explanation I can come up with is that it’s political because there aren’t any non-political reasons for having this discussion.
“Some member states see Brexit as a once-in-a-lifetime opportunity to get business. And some say that even to the potential detriment of the Ucits brand,” she said.
France is regarded as being the main proponent of more stringent conditions on delegation in Europe.
Luxembourg industry representatives have also noted that ever since the Brexit vote, the French Government has been pushing for the wholesale relocation of financial firms from London, rather than the bulking-up-of-operations approach favoured by Luxembourg.
Earlier in the week, the Reuters news agency reported that the European Commission proposed extending the powers of the European Union’s markets watchdog, the Paris-based European Securities and Markets Authority (Esma) to oversee the financial sector in a move to extend the EU’s grip on the industry as the bloc prepares for Brexit.
The proposal is part of a broader long-term plan that could lead to the common supervision of the European financial sector and widely expand EU regulators’ clout over foreign firms that operate in the union.
Esma will also be granted powers to directly monitor transaction data in markets.
“Eventually we could arrive at a single European capital markets supervisor,” the commission’s vice president Valdis Dombrovskis was quoted as saying.
Risk of “fragmentation”
Industry experts had previously warned that differences in regulatory interpretation by local regulators at the national level could result in a fragmented European single market.
Also speaking to International Adviser at the Alfi conference, Julie Patterson, head of investment management regulatory change at KPMG, observed how each member state was likely to implement its own slightly different version of the revised Markets in Financial Instruments Directive, or MiFID II.
The European Commission’s proposals are aimed at addressing exactly such concerns, but will still need the backing of EU states and European Parliament lawmakers.
Detrimental to asset management
“This is basically giving Esma some sort of powers when there are instances of delegation or outsourcing for Ucits funds and alternative investment funds, which are currently under the supervision of the national competent authorities,” Voss said.
“Yes, we are going more towards a single market, but no one has agreed [this move] and there might even be EU treaty issues with going in that direction. It’s not me saying that, but lawyers.”
This course of action could be detrimental to the asset management industry, Voss warned.
“It potentially will result in double layers of approval, it will take more time, more money, more cost, for something that works perfectly fine and it’s supervised well [by Luxembourg’s regulator, the Commission de Surveillance du Secteur Financier (CSSF)] and we haven’t had issues with.
“The important point is that this is all about giving investors around the world access to global portfolio management expertise. This is why Ucits has been so successful around the world.
“But again, we support the [Capital Markets Union], we support the European Union, but let’s be sensible about it. We’re supposed to be in a better regulation mode and it doesn’t seem to be assisting with the CMU to be putting unnecessary tethers on an industry that you want to be part of a successful markets union,” Voss added.
European regulators usually require asset managers to have some staff on the ground in the EU when granting licences and approving funds.
Earlier in March, Esma said it had started examining issues around delegation to limit “regulatory arbitrage”, whereby asset managers use EU bases to conduct business across Europe but keep most senior staff in London.
In July, Esma then issued guidance on investment fund relocations from the UK, warning national regulators from preventing investment firms from setting up ‘letterbox’ entities across the continent in the wake of the Brexit vote.
In doing so, Esma conferred “strict conditions” saying extra scrutiny should be applied by regulators when activities are outsourced to third countries located outside the EU, which would include the UK once it leaves in 2019.
According to some regulatory experts, if asset managers want to set up a Mifid-compliant company in the EU this would need to be staffed by at least 20-50 specialists to prove that it isn’t a ‘brass plate’ entity.
This has intensified fears of the European fund industry facing dispersal after Brexit, as asset managers might have to move investment staff to EU countries in order to satisfy local regulators concerned about a “race to the bottom” on standards, as countries compete to attract UK-based financial firms after Brexit.
“This work is aimed at avoiding competition on regulatory and supervisory practices between member states, and a possible race to the bottom, which might be detrimental to the Capital Markets Union,” Esma chairman Steven Maijoor said.