London is a hub for many pan-European funds, but Brexit could disperse that power.
“Brexit means Brexit” said Theresa May, now U.K. prime minister, in the early days after the U.K.’s vote to leave the European Union. There would, she said, be no attempt to remain inside the Union.
Unfortunately, for anyone trying to plan ahead for a post-Brexit world, any attempt to interpret the phrase more deeply is doomed to fail. Nobody knows what Brexit will really mean. Britain has yet to formulate a negotiating position. The EU has yet to respond. Neither side knows how much it wants to change.
For buyout firms hoping to continue making investments in both the U.K. and continental Europe, the expectation must be that there will at least be some. They can also expect what Suneel Kaji of private equity-focused consultancy Accordion Partners calls the “increased friction costs” of doing business from outside the bloc.
These could include taxation, talent acquisition, additional travel burdens and the duplication of regulatory effort, among other worries.
There will, Kaji adds, most likely have to be a greater show of cultural involvement and commitment to Europe than in recent years, when firms tended to have their senior continental European colleagues work out of London, even those with the best contacts and networks in their home countries.
So while London won’t be “eviscerated as a financial center,” Kaji believes private equity firms—whether global or merely pan-European—will likely have to open more offices across Europe and step up the functions and activity of those they already have. “Rather than the current hub-and-spoke model, with London as the hub,” he says, “private equity will revert back to the model that existed in the 1980s in Europe, where markets were fragmented, with origination and execution teams on the ground in local markets.”
Kaji doesn’t see Frankfurt or Paris, for example, as alternative or parallel hubs to London, but thinks instead that firms will entrust more responsibility to local teams in regional offices, hosting teams that speak the local language, understand the culture and have a good network of local contacts.
That doesn’t mean investment committees will move out of head office or that the functions of the current hub will disappear. But there will likely be fewer executives jumping on planes from London to outlying offices than has been the case until now. Instead, they will be based permanently in their home markets.
Not everyone is convinced. Laura Dixon, head of marketing and communications at London private equity firm HgCapital LLP points out that the firm already has a Munich office and sees it as a very important part of the business. The firm’s industrials team is based in Germany, because that is where so many successful, family-owned businesses have their home. HgCapital’s investment committee is based in London, and the Munich team does come to London for meetings. But sometimes the investment committee also meets in Munich from time to time. There have always been different investment rules for different countries in Europe and that is unlikely to change, she says.
And one big U.S. private equity shop, which declined to be identified although it has multiple investments and offices across Western Europe, said there would be no changes made to its office network.
Meanwhile David Bailey, managing partner of private equity fund administration firm Augentius Group Ltd. ,agrees. “Anyone seriously investing in pan-Europe already has and has maintained very close contacts with the local markets,” he says. “Otherwise they would just be being ripped off on their deals.”
“If you are investing in a private company, you have to be very close to and understand that company’s market.”
For Bailey, as for many in the financial services industry, the much bigger question is whether the U.K. retains its “passporting” rights under the EU’s Alternative Investment Fund Managers Directive. Britain has fully implemented the directive, which allows any firm with a base in the U.K. to market its funds, including private equity limited partnerships, across Europe, and vice versa. Whether the U.K. retains those rights following Brexit or is subject to the “equivalency” rules applying to non-EU jurisdictions such as the United States or Canada, is still subject to negotiation.
Most commentators believe that, while equivalency is the more likely outcome, the fact that Britain’s existing laws are fully in line with those of the EU should make it a simple matter for the European Securities and Markets Authority to recommend full passporting permission. That’s a better deal than the partial permission ESMA recommended for the United States, for example, where U.S. restrictions on foreign funds access to retail investors have meant U.S. funds are not cleared to market to retail investors in Europe.
Things could still go wrong. As Tim Thornton, chief operating officer of MUFG Investor Services’ fund services business, warns in a recent statement: “If the UK’s regulatory landscape substantially changes, we can expect the European Securities and Markets Authority (ESMA) to take a tougher line on passporting, pushing the UK further down the queue. Any gap in passporting rights could create significant upheaval and high costs for re-routing and restructuring funds. It would also raise questions about pre-existing investors around ongoing marketing, and parallel vehicles may need to be established.”
However, Accordion’s Kaji is assuming that passporting rights will continue. He’s also making the assumption that the negotiations will go smoothly enough for people not to need to consider moving their European bases out of London altogether or raising separate European Union and U.K. focused funds.
If those assumptions are too optimistic, he adds, “all bets are off.”
by Jonathan Braude
Compliments of The Deal – a member of the EACCNY