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London PE funds look to Luxembourg for post-Brexit single-market access

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London PE funds look to Luxembourg for post-Brexit single-market access

The U.K.'s loss of single-market access after Brexit threatens the ability of the London-based private equity industry to raise new funds across Europe, with some managers looking to move as a result, according to industry observers.

Britain's exit from the European Union should not be terminal for the position of private equity in the U.K., but it does create uncertainty, Invest Europe CEO Michael Collins told S&P Global Market Intelligence. "Deal flow shouldn't be too affected," he said. "The biggest issue for the industry is likely to be around fundraising."

Fundraising is set to become more difficult for London-based firms if they lose their EU single-market passports and therefore the ability to raise cash in continental Europe for their vehicles.

"The immediate impact of Brexit is that anyone who currently uses a passport to raise funds from a U.K.-based alternative fund manager loses the benefit of that passport from Brexit day," said Phil Bartram, a partner at Travers Smith.

A different location

Invest Europe data shows that in 2015, 42.5% of all private equity funds raised by European managers came from continental Europe, but many funds that are based in other parts of the world — especially U.S. ones — also access the EU single market via passports they obtain through their U.K.-based units.

The simplest way to get around the loss of single-market access is, of course, to move to a different EU location.

"There are [U.K.-based] managers looking at creating an EU-27 legal entity that will allow them to have an EU marketing passport," Collins added.

Luxembourg is seen as the favored location given its already close relationship with the private equity industry, although some fund managers are said to be looking at Ireland. Yet, these moves are not cheap and will primarily be of interest to larger funds given that regulators require firms to have more than just a brass plate when setting up new offices, industry experts told S&P Global Market Intelligence.

"You need at least three or four serious finance-related professionals," said one lawyer who works for the industry.

Some big U.S. firms such as Carlyle Group LP are therefore thinking about moving some London staff to established Luxembourg locations. But Blackstone Inc., for one, is said to be looking at a new Luxembourg office staffed with new hires rather than existing London employees. Both firms declined to comment on potential moves when contacted by S&P Global Market Intelligence.

Meanwhile, some U.K.-based funds are looking at setting up a shell in Luxembourg, which could be expanded if necessary, industry experts told S&P Global Market Intelligence.

Decline but no fall

None of this should suggest, however, that the London market is about to decamp entirely to Luxembourg. "There is no evidence yet of a mass exodus," Bartram said, adding that an alternative EU-27 office does offer funds "a hedge against uncertainty."

Moreover, a move is not the only option available to U.K.-registered funds that want to maintain access to continental European investors post-Brexit, industry experts told S&P Global Market Intelligence. Managers can, for instance, fall back on reverse solicitation regulations, which prevent funds from marketing in the single market but still allow investors to approach them.

A more likely route, however, are private placement regimes that are available to managers in countries outside the single market. These differ from state to state and can be withdrawn by the relevant finance ministries at will. But large firms such as Apax, CVC and Cinven have all previously raised sizable funds from Channel Islands-based entities, industry experts pointed out.

Indeed, Switzerland is outside the single market and maintains a vibrant private equity industry. The country is close to gaining a so-called third-country passport into the single market, but there have been delays amid some suspicions that the EC is fretting over creating a precedent for Brexit negotiations with the U.K. That said, should the last creases be ironed out then there is, theoretically, no reason why the U.K. could not get a similar third-country deal as an important source of capital — and assets for the rump of the EU, industry experts told S&P Global Market Intelligence.

But whatever the outcome, few expect the private equity industry to sit on its hands for two years as Brexit negotiations get underway. And while few doubt that London will remain a pre-eminent center for private equity in Europe, its relative importance will most likely decline.

"There are lots of reasons for the industry to stay in London," Collins said. "But there are now reasons for some structures, some legal entities to be developed or established in the EU-27."