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Contract certainty

Contract certainty

I continue to be surprised that some wealth and asset managers have done very little to prepare for Brexit or are only just starting. And I am astounded that some believe it better to wait until the final EU-UK deal is more certain or that they will in any case be able to continue to service clients and sell funds in either direction across the new border. Our summary (PDF 1.41 MB) of the first order Brexit impacts on asset managers and funds may be helpful in understanding why this is a high risk strategy.

Most asset managers, however, have undertaken some form of Brexit risk assessment and developed plans to protect their business against the inevitable loss of EU passports, out of and into the UK. Given the lead time to gain new regulatory approvals (which is increasing as more firms join the national queues), many firms have already applied for extensions to their permitted activities or to set up new entities.

Firms now need to turn their minds to the large number of second and third order impacts of Brexit, one of which is the question of contract certainty.

The European Commission stated in its 19 July Communication to other EU institutions that “there does not appear to be an issue of a general nature linked to contract continuity as in principle, even after withdrawal, the performance of existing obligations can continue”. The Commission therefore does not foresee the need for legislative intervention, although it recognises that “each type of contract needs to be looked at separately”.

There is a ground swell of business and legal opinion that does not concur with this view, believing that action at policy maker level is vital in some areas. Indeed, the UK’s FCA has stated that “the UK and the EU must, together, create contractual certainty, either through an implementation period or by some other means”.

However the policy and political debate plays out, asset managers unquestionably have a major task to complete in only a few months: a thorough review of every contract to which they are party, as principal (with clients, counterparties and suppliers) or as agent (on behalf of clients or funds). Fund documentation will also need to be reviewed.

Here are just some of the types of contracts and documents that firms will need to review:

  • investment management agreements (IMAs)
  • fund constitutional documentation
  • fund promotional or disclosure documents
  • terms of business with brokers
  • derivative contracts
  • stock lending arrangements
  • guarantees
  • distribution agreements
  • outsourcing contracts, whether for regulated or unregulated activities

Within the IMAs and fund documents, for example, references to eligible investments or markets need to be reviewed. Changes to benchmarks could require further amendments to fund documentation and IMAs, and potentially to issues with investment performance histories. If financial contracts (such as derivatives, guarantees etc) are novated by the counterparty to a new or existing affiliate, there could be issues as regards the capital adequacy or market rating of that new counterparty. And so on.

Firms will need to scope and size the task, to factor in the lead times needed to communicate with and secure agreement from clients and counterparties, and to consider what resources they need to be able to complete the task in time. The deadline remains uncertain. A transitional period is still in the frame, but with the risk of the “no deal” scenario increasing, the deadline to complete the task may be as early as March 2019, just eight months away. Better to start today, than leave it until tomorrow.

Key questions for CEOs:

  1. Have we fully bottomed out the Brexit risks to our business and developed risk mitigation plans? Are we progressing sufficiently quickly in implementing those plans?
  2. Have we submitted all necessary applications to national regulators? If not, how quickly can we advance the process?
  3. Have we identified the different types of contracts we have and the Brexit risks?
  4. Have we identified the areas of our fund documents that may need to be amended?
  5. Have we quantified the resources needed for drafting and agreeing with clients, investors and counterparties any necessary changes, within the timeline?

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