Money managers running their European businesses out of London are facing the prospect of additional expenses from post-Brexit requirements in Europe. Adding to the uncertainty, the U.K. government must still convince Parliament to accept a withdrawal agreement with the European Union.
U.K.-based money managers spent the past two years assessing the magnitude of preparations they needed to undertake after the U.K. embarked on an exit from the EU's single market following a referendum on June 23, 2016. At a summit April 10, EU leaders granted the U.K. a second extension to complete Brexit before Oct. 31 with one caveat, that the U.K. will participate in elections to the European Parliament, which are taking place between May 23 and May 26.
The U.K. can leave the EU as soon as members of Parliament reach an agreement but if the U.K. hasn't held elections, the extension will be void on May 31, which would mean a hard exit.
These developments are adding to the ambiguity when it comes to determining the costs of Brexit for money managers.
The U.K.'s withdrawal forced managers running assets for European clients to enhance their Europe-based headquarters by obtaining new or extended permissions and split out assets managed on behalf of European clients from funds domiciled in London. At the very least, sources said, managers had to cover the cost of legal advice, with many obtaining extended licenses under the Markets in Financial Instruments Directive II for their European hubs.
Behemoths including Blackstone Group LP, Janus Henderson Group PLC, T. Rowe Price Investment Management, Schroders PLC, Aberdeen Standard Investments, Wells Fargo Asset Management, MSF Investment Management opened new offices or obtained extended licenses. David Yim, asset management partner at KPMG U.K. in London, said: "We know that 40% of U.K. money management firms are planning some form of partial relocation as a result of Brexit."
But sources said permissions and licenses are only the beginning of changes and costs that managers will be facing as part of the relocation to Europe, including revamping their distribution capabilities or reporting structures in new locations — ultimately adding to ongoing costs of running two separate businesses — one in the U.K. and one in Europe.
"At the moment, firms have also been using existing resources to manage Brexit," said Marina Cremonese, vice president and senior analyst at Moody's Investors Service. "Going forward the situation is still very fluid," she said.
Although the regulators provided some comfort by ensuring through memoranda of understanding a continuity in market operations, there is still uncertainty about what future adjustments European regulators could require, she warned.
"When you combine the cost of more people with legal and consulting fees, a midsized asset manager would comfortably be spending £1 million ($1.3 million) on Brexit preparations," Mr. Kim said. "Those firms without any existing foothold offshore could be spending much more. Every penny spent on Brexit represents an opportunity cost for investment."
Another concept that managers are grappling with is the concept of "dual hatting." Existing staff can initially hold roles in multiple locations, but six or 12 months from the Brexit date — depending on jurisdictions — these roles will need to be held by separate employees, sources said.
Specifically, in Ireland, managers are expected to name country heads.
"The Irish central bank has been flexible," said Kieran Fox, director of business development at Irish Funds Industry Association in Dublin. "What managers have had to do on Day One is less than what they will be doing in six or 12 months' time" to comply.
"In order for the manager to be authorized, individuals that fulfill different roles would have to meet certain requirements," he said. "Currently, an employee (may be) based in London but they could be fulfilling a role in Dublin for three of four days a week," he said by way of example.
After Brexit, "On Day One you could need to have 10 (staff members in Dublin) but after 12 months it will be 10+X," he said.
M&G Prudential said in its financial report March 13 that charges of £27 million incurred in preparing the business for the U.K.'s proposed exit from the European Union were deducted from the operating profit and included the cost of migrating assets to its Luxembourg-domiciled SICAV platform.
An M&G spokeswoman said: "Our enhanced SICAV fund range and MiFID distribution platform mean we can go deeper into Europe and offer a greater breadth of investment opportunities to clients globally, including traditional and alternative, public and private investment capabilities. As well, it brings our product range in line with our client's investment vehicle preferences."
Aberdeen Standard Investments' Brexit charges were £14 million in 2018, according to the firm's annual report.
In 2018, on average, managers spent between 0.1% to 0.6% of operating profit on Brexit-related preparation, according to a Moody's analysis.
As U.K. Prime Minister Theresa May asked EU capitals on April 5 for a second extension, sources said firms grew frustrated.
"There is a huge frustration in the industry. The damage has been done and people feel let down," said Lisa Cawley, partner, investment funds at law firm Kirkland & Ellis International LLP in London.
"People would have (already) invested in their preparation. They can't assume," Ms. Cawley said. "Managers needed to get advice on what they can rely on and make a plan. That's already a cost."
And now, Ms. Cawley's clients are frustrated because it is unclear what the extension to the Brexit deadline will mean, she said. "Does it mean additional cost and for how long?" Ms. Cawley questioned, and "what does it mean for people who have invested in the early planning?"
KPMG's Mr. Yim also warned: "Moving forward, firms will incur additional ongoing costs in order to continue to operate across two markets — the European Union and the U.K."
Sources said managers might have not seen the absolute costs of Brexit yet because European regulators' requirements are going to be implemented in stages.
Firms have been establishing new offices or beefing up their existing offices, typically in Luxembourg and Dublin. A study by think tank New Financial, published March 11, found that 75 money management firms have announced relocation plans. Some 43% of them selected Dublin as a new hub for their EU business, followed by 35% that chose Luxembourg, while 7% picked Frankfurt and 7% picked Paris.
Ms. Cawley said among the factors driving cost expectations talked about in the last 12 months is the "concept of substance," meaning the types of roles that are expected to be located in Europe, potentially including risk managers, portfolio managers and compliance staff.
But she said: "People aren't closing offices. The reality is that London will remain the main hub."
Ms. Cawley said managers are working out if they need to have "substance" in these new offices and the ongoing costs of regulated licenses and costs in the new jurisdictions where they have relocated. "The cost will be different for different firms," depending on their individual circumstances, she said.
But Ms. Cawley noted: "Increasingly, the message we are getting is that it is getting harder to find people to fill these roles," as the job market in places like Luxembourg is small.
Sources said staff holding distribution roles are particularly vulnerable to Brexit. In the absence of equivalence with EU markets, London-based sales managers will need to be located in the country of their clients. To tackle a lack of sales staff on the ground, managers are looking at substitute measures to obtaining enhanced licenses.
Ms. Cawley said that "certainly some firms are reticent about changing their structures and will look at alternative pathways."
Firms may choose to appoint "placement agents" or find third-party distributors instead of transferring distribution staff to Europe, she added.
Deirdre Flood, head of distribution at Wells Fargo Asset Management in London, said: "We are not relocating them on full-term basis yet but we are looking for client-facing people to go on six-month assignments to Europe until we have greater visibility into how the future will look."