Brexit and private equity: Why suspense is worse than disappointmentBy Michael Collins on 23 March 2018
In January, Burns Night celebrated the Scottish poet Robert Burns, who famously once said, “Suspense is worse than disappointment”. As the Brexit negotiations continue, the ‘suspense’ around the outcome is unlikely to go away any time soon.
Today we are facing an unprecedented challenge. As well as dealing with the impact of complex international negotiations following the UK’s decision to leave the European Union, the private equity industry needs to keep on top of the ‘business as usual’ EU policy agenda to build on the €50 billion a year it invests in European companies.
With regards to Brexit, the UK and EU are open to talking about a transition period of almost two years. While this is good news, it isn’t going to solve everything and may simply extend the suspense. Also — as the European Commission has always said — it’s preferable to know what you are transitioning from and to. At the moment, this is still unclear.
If we look through the wide selection of pre-existing models the EU currently has for relations with non-Member States, the UK’s ‘red lines’ — no free movement of people, no European Court of Justice jurisdiction, leaving the Customs Union, etc — make it incompatible with each of those existing models.
Many in the UK government will say that these pre-existing models are a red herring, as Britain is seeking a ‘bespoke’ solution. This is a likely outcome, as no agreement between the EU and another party is ever entirely off-the-shelf. There will always be something unique about it. The issue is, whether it’s possible to construct a bespoke deal that satisfies both the UK and the EU’s red lines.
One complaint heard here in Brussels from the EU side is that they don’t have enough clarity about how many red lines the UK has, or how red those lines are. Before a serious discussion can begin, it’s essential to understand the range of movement.
For the moment — in the absence of that clarity — rather than torturing ourselves with Burns’ ‘suspense’, private equity is preparing for ‘disappointment’.
Some private equity fund managers concerned by the prospects of the UK leaving the single market have found it prudent to put in place a contingency plan for all that this could entail. Particularly for those managers seeking to continue to market funds to investors in the remaining 27 EU Member States using the EU’s Alternative Investment Fund Managers Directive (AIFMD) passport.
This industry contingency planning and the timetable for its activation is where there’s now a clear intersection between the twin challenges of Brexit and the ‘business as usual’ agenda. Because we are now seeing how ‘contingency planning’ for the implications of Brexit is also being undertaken by regulators and supervisors which feeds into and influences the ‘business as usual’ agenda.
The most obvious examples of this include the continued absence of any progress on a number of EU-level activities that impact the industry, or have the potential to. Firstly, the proposed AIFMD third country passport, which would allow non-EU Member States to market to EU investors, appears to be on hold. It was in limbo even before June 2016, but the lack of clarity over Brexit is helping to keep it there. Secondly, the recent guidance on delegation structures by the European Securities and Markets Authority (ESMA). This outlines the ‘substance’ needed on the ground in the EU, should UK private equity firms want to maintain access to the AIFMD passport while keeping key activity in the UK. Finally, the Commission’s proposal to revise the powers of the three European Supervisory Authorities could also affect private equity operations, especially in light of Brexit.
While it’s top of mind for many UK-based private equity firms, Brexit doesn’t completely dominate the thinking on every European policy issue. Indeed, the Commission has reasons to feel self-confident, with the EU reporting strong macro-economics, Macron restoring faith in the EU project, the increased likelihood of another German grand coalition under Merkel and the slowing down of the anti-EU parties’ popularity in many recent domestic elections.
The fact that we are now in the last full year of this Commission and Parliament could have ramifications for the planned review of the seven-year-old AIFMD. A new Commission won’t take office until late 2019 or early 2020. Even by early 2020, we may still not really know what the future UK-EU relationship looks like. There could still be considerable uncertainty about how financial services market access will work. And if the AIFMD status quo still seems to be working OK at that point then one can see how a new Commission might decide that its full-scale review can be left on the shelf for just a little bit longer.
We are now just over a year away from Brexit day in March 2019 — a period that will fly by. With the transition period being discussed, a ‘no deal’ scenario with the UK crashing out of the EU next spring is unlikely, but we still can’t rule it out. A transition period would also go quickly. It’s possible that two years from now, we will be no clearer than today about the details of how the UK and the EU will interact and about how our industry will be able to operate cross-border.
Private equity will cope, of course, because this is an industry that knows how to adapt to new circumstances.
But we mustn’t let ourselves be hamstrung by the ongoing uncertainty. Over the next two years, as the Brexit developments unfold, private equity fund managers will continue to work through the possible implications for their fundraising and how to address them. That way managers can continue to focus on their core business: delivering investment into thousands of growing European companies.
First published in Real Deals.