Do hedge fund documents need to be updated for Brexit?

As the United Kingdom nears exit from the European Union – perhaps as soon as 12 April 2019 – with no settled plan in place, even the most sanguine observers of the process will be feeling some nerves about the prospect of the UK without a deal or a transitional period. This note, which is aimed primarily at UK hedge fund managers, looks at how Brexit will affect fund documentation and what changes might need to be made to such documentation before the UK’s exit.

1. Summary

UK managers should initially focus on investment management agreements, distribution agreements and similar agreements:

• In agreements with funds and clients that are either outside the European Economic Area or in the UK, references to EU regulations should be amended to reflect the UK’s post-exit-day regulations – ideally before exit day.
• Agreements with funds and clients in the EEA should be reviewed more urgently to determine whether amendments are needed to ensure continued compliance after exit day.

Other changes to fund documentation arising from Brexit are less likely to be required before exit day.

2. The effect of Brexit on UK regulations

UK investment managers are subject to numerous regulatory obligations, one type of which is directly applicable EU regulations such as the AIFMD delegated regulation, MiFIR, the various EMIR regulations, SFTR and the PRIIPs regulation. References to EU regulations (especially the AIFMD delegated regulation and EMIR) are common in investment management agreements, distribution agreements and the like.

EU law will cease to apply in the UK on “exit day”. Provided the government issues the necessary regulations to amend the definition of “exit day” in the European Union (Withdrawal) Act 2018, this is now likely to be 12 April 2019 if there is no deal, or at the end of a transitional period if a deal is agreed. Other dates remain possible. At that point, whenever it might be, all of these directly applicable EU regulations will be “onshored” to form part of UK domestic law.

EU-related rules that are already part of UK domestic law, such as relevant provisions of the FCA rules and the Alternative Investment Fund Managers Regulations 2013, will generally remain in place.

In both of the above cases, amendments to the regulations will be made upon exit to ensure that they continue to make sense once the UK is outside the EU’s legal framework. In most respects, that will mean that the domestic regulatory obligations applicable to a UK manager will not change in substance on exit day. (Cross-border issues may be more complex – these are relevant to marketing, for example, but generally not to the type of operational compliance issues addressed in investment management agreements.)

3. Agreements with non-EEA funds and clients or with UK funds and clients

Because there will be no change to the substance of the operational regulations applicable to a UK manager, no change should be necessary to the substantive content of investment management agreements with funds and other clients, so long as that client is not in the EEA. So, for example, a best execution provision in an investment management agreement with a Cayman fund that was correct immediately before exit will still be correct in substance immediately after exit.

Where many agreements will no longer be correct, though, is in their references to the regulations that apply to the manager. An investment management agreement that refers to the AIFMD delegated regulation or EMIR will instead need to refer to the UK’s onshored version of those regulations. On exit day itself the two versions of the law will be the same in substance, and so the issue will initially be only a technical one, but they may diverge over time.

Best practice will be to amend such agreements before exit day, to be effective upon exit. That said, these changes are not significant, and the legal risk arising from the changes not being implemented before exit day (and instead being implemented afterwards with retroactive effect) will be low in most cases. Simmons & Simmons can help managers amend relevant agreements in a simple, standardised way, keeping the work involved to a minimum. They amendments can be made to be effective whenever exit day falls, and so it isn’t necessary to wait until the outcome of the political process is clearer.

Distribution agreements are more likely to refer to cross-border rules that will change on exit day. These should be checked, but in many cases it will not be necessary to amend the agreement before exit day.

4. Agreements with EEA funds and clients

On exit day, UK managers will cease to be EEA AIFMs or MiFID investment firms for the purposes of any EEA regulations. That change of status might necessitate more complex changes to agreements with EEA clients (such as funds established in Ireland or Luxembourg), but this will depend on the rules of the EEA jurisdiction in question. Managers in this position are advised to seek advice more urgently on whether amendments should be made to relevant agreements.

5. Offering documents

As with the IMAs and similar agreements, certain references to regulations contained in prospectuses and offering memoranda will cease to be correct after exit day. In addition, any existing disclosures in this documents regarding distribution in the EEA ought to be amended or supplemented to cover the UK’s parallel post-exit-day regime, and any risk factors relating to Brexit would also need to be updated.

These changes are not material, and offering documents only speak as of their date. Funds will therefore not usually need to update their offering documents solely for this reason. Where offering documents are being updated in any event, these changes should of course be made.

6. Application forms

Some fund application forms (though by no means all) contain references to AIFMD, MiFID 2 or the PRIIPs regulation. In many cases the references to these regulations will still be correct in respect of applications by EU investors, even if not in respect of UK investors. Additional references to the UK’s onshored equivalents could therefore be included.

Such provisions are usually included to help evidence compliance, but are not usually a requirement. In most cases it will therefore be enough to wait until the forms are next updated to amend the provisions.

Where a GDPR privacy notice is set out in full in the application form, similar issues arise. The disclosures relating to transfers outside the EEA, in particular, should be amended. Again, though, the other substantive elements will remain correct because the UK will onshore GDPR (with amendments) and so it is not necessary to amend application forms solely for this reasons. Managers who have privacy notices on websites might consider making amendments immediately following exit day.

7. Marketing

A detailed review of the marketing issues arising from Brexit is beyond the scope of this note. As well as being scenario-dependent, it is still not yet clear in many cases what, if any, preparatory steps can or must be taken in advance of exit day.

However, for EEA AIFs that are currently marked in the UK under passporting arrangements (currently only available to EEA managers outside the UK), the FCA’s “temporary permissions regime” will permit marketing to continue in the UK on the same basis. To take advantage of this, the AIFM must submit a notification to the FCA no later than 11 April 2019. (This was changed by the FCA on 25 March, from the previous date of 28 March 2019). If that deadline is missed, there is a risk of a UK marketing blackout if the memorandum of understanding between the relevant regulator the FCA is not immediately put in place.

8. Timing of exit

The issues discussed in this note should be considered now because of the prospect of EU law ceasing to apply at 11 p.m. (UK time) on 29 March 2019. If exit is deferred by an extension of the Article 50 period or through a transitional period (or both), then the same issues will be relevant at whatever point EU law ceases to apply.

9. Further information

Please get in touch with your usual contact at Simmons & Simmons if you would like to discuss any issues relating to Brexit.

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