Brexit bureaucracy comes at a cost for PE fundraising

Brexit has increased the cost of private equity fundraising and complicated both fund structuring and fund marketing, according to market participants.

Where to domicile a fund, the location of a firm's alternative investment fund manager, or AIFM, and its service providers as well as the relationship between those parties are now key structural questions, as is the cost of those decisions, Paul Ellison, funds regulatory partner at Clifford Chance LLP, said.

Access to EU marketing passports, which allow firms in the bloc to market funds directly to EU-based investors, has also changed.

U.K.-domiciled managers have lost their marketing passports and must now use national private placement regimes, or NPPR, the rules that have always applied to non-EU domiciled fund managers seeking investors in the bloc. They require managers to report to the state regulator of each EU country in which they are marketing a fund, rather than just reporting to their home financial regulator as is the case with the passport.

Existing EU-domiciled managers have temporary marketing permissions in the U.K, but they must ultimately decide whether to register in the U.K. under U.K. NPPR rules. New EU-domiciled managers raising a fund for the first time will have to register in the U.K. immediately if they wish to access the country's investors.

Submitting an NPPR registration with the U.K.'s Financial Conduct Authority is a "very straightforward process" compared with doing so in other European jurisdictions, which can be more time consuming and costly, Jin-Hyuk Jang, international counsel in Debevoise & Plimpton LLP's funds and investment management group, said. "For EU managers it's much easier to continue approaching the U.K. market," Jang said, adding it is "not a level playing field."

Marketing is further complicated by EU rules introduced in August 2021 that were not adopted by the U.K. The Cross-Border Distribution of Investment Funds regulations, or CBDF, aim to harmonize Europe's "pre-marketing" rules — early-stage conversations that managers have with investors before a firm is officially marketing.

This regulatory divergence was not apparent before Brexit because the U.K. had "to a very large extent" onshored funds legislation, Clifford Chance's Ellison said.

"It's just another element that you need to think about when you're advising on post-Brexit marketing, whether of an EU fund or a non-EU fund in the EU," Ellison said, adding: "We're starting to see areas where the EU has a development and the U.K. either says we're not going to do that one — as in the case of CBDF — or we're going to do something similar but slightly different."

Continental expansion

To get around the changes, some U.K. managers are considering setting up an office in Europe. This needs to be staffed according to the size of a fund, and it is a "huge investment decision," Debevoise's Jang said. In the interim, they may use a third-party AIFM "to see how it goes," Jang added.

It is a trend Kroll LLC has seen too, but it requires "deep pockets," Gráinne O'Farrelly, managing director in the firm's Financial Services Compliance and Regulation practice, said. Larger firms are able to carry out that cost benefit analysis, "but the small to mid-tier firms have to think of a different solution."

Kroll's clients are increasingly partnering with third-party distribution firms in Europe, a strategy that has worked for a number of U.K.-based managers, particularly those targeting capital in specific jurisdictions. But this too comes at a cost. "Sometimes it's a basis point fee, which is obviously quite expensive. And then sometimes it's a basis point fee just on the amount raised, but if it's a basis point fee based for the lifetime of the fund, that can be very prohibitive from a cost perspective," O'Farrelly said.

Costs mount if the manager is sourcing a third-party distributor in a number of different countries. Increasingly, Kroll is steering U.K.-based asset managers toward limiting the jurisdictions in which they fundraise — to "really focus on a couple of jurisdictions rather than on a pan-European basis, which may well have been much more common about five years ago," O'Farrelly said.

Despite these issues and associated costs, private equity "is a robust industry and it's innovative," O'Farrelly said. A clear gap in the market has emerged, with "very few, if any, third-party firms offering a pan-European solution to U.K. asset managers."

This is something that could increase over time. "If you look typically in any EU jurisdiction, it's going to take a good sort of 12, possibly even 18, months to get through a licensing process. So whatever change is coming is going to take a few years, I think, before it starts to make itself out," Hannah Rossiter, managing director in Financial Services Compliance and Regulation practice at Kroll, said.