First let’s set out the terms of engagement. I’ll keep this one politically neutral. I’ve got an opinion like everyone else, but this post is about the practicalities and not how we got here. Let’s put the tribal warfare on hold for a few minutes.
I’m not going to BS you with 1,000 words on Brexit-proofing your portfolio either. The idea that we can take back control (of market volatility) with a quick shimmy into this fund or that is delusional.
What I am concerned about, as a passive investor, is whether I’ll still be able to buy and sell my ETFs and index funds as needed in the midst and aftermath of a no-deal Brexit.
Specifically, what are the chances that a UK-based investor who owns index trackers domiciled in the EU (mostly Ireland and Luxembourg) will experience some kind of disruption?
Could your investments be stuck in the financial equivalent of a lorry park outside Dover?
To stop asking questions for a sec and to start answering them, I’m glad I’ve looked into this because I’m much less worried now than I was.
The relevant authorities seem to have taken the steps necessary to ensure that it’s business as usual – even in the event of no-deal.
Just in case I misrepresent the scale of my expertise, I’d like to state upfront that I’m not a world expert in the dissolution of 47-year-old international treaties.
I’ve reached my conclusions by triangulating the announcements and actions of the various institutions and groups with direct control, influence, or interest in the outcome.
That list of party guests includes:
- UK Government
- The Financial Conduct Authority (FCA) – the UK financial markets and services regulator
- European Securities and Markets Authority (ESMA)
- Central Bank of Ireland – the Irish financial regulator
- UK fund industry
- Irish fund industry
- UK financial media
- UK mainstream media
- UK and Irish law firms
- Platform managers
- London Stock Exchange
I expected to find plenty of cracks in the facade between those groups given their competing interests, but closer inspection of the Brexit timeline reveals a reassuring pattern:
- Uncertainty is raised and speculated upon by the media.
- Advice is issued by the law firms.
- Industry stakeholders pressure their governments.
- Governments wake up.
- Regulators issue some fix or patch.
- Media move on to the next concern.
It’s quite the civilised waltz when you view it over a few years worth of cached pages. The level of cross-Channel interdependence is unsurprisingly huge and nobody has an interest in screwing it all up.
Obviously, there are unknown unknowns and you can’t entirely discount the possibility of someone sticking a cosmic spanner in the works. But the loss of EU domiciled investments is no longer on my list of nagging concerns.
If you care to know why then let’s keep going…
The potential problem
If you own an ETF in your portfolio then it’s probably domiciled in Ireland. You may also own ETFs domiciled in Luxembourg.
(Your ETFs are overwhelmingly likely to be listed on the London Stock Exchange but this isn’t the same thing.)
Meanwhile your index funds are likely to be a mixed bag, predominantly domiciled in the UK or Ireland.
As a UK-resident investor I don’t need to worry about disruption to UK-domiciled funds, but Brits abroad may well be concerned.
European domiciled investments use ‘passporting’ rules to take advantage of the single market. The passporting rules allow any firm or fund authorised in one European Economic Area (EEA) state1 to conduct their business in any other EEA state without further hoop-jumping. Passporting enables EEA-domiciled trackers to be marketed at ‘retail’ investors (that is, the likes of you and me rather than institutions) across borders.
Passporting to and fro the UK goes up in smoke in a no-deal Brexit scenario.
ETFs are generally domiciled in Ireland and listed across the rest of Europe because the Irish regulatory regime is the easiest and cheapest for fund companies to navigate.
My immediate concern is that the end of passporting could:
- Prevent trading in my investments until the regulatory log-jam is sorted.
- Decimate my choice of investments. (For example, I’d be allowed to remain in my EU domiciled trackers but not to add to them.)
My longer-term concern is:
- Costs go up due to an increased regulatory burden or lack of choice in the UK.
- Some useful new trackers aren’t made available in the UK.
If you like dwelling on problems then enjoy this meaty list of Brexit-related investing issues.
The Temporary Permissions Regime ‘backstop’
Vanguard told me that it will be able to continue selling and marketing their Ireland-domiciled funds and ETFs in a no-deal scenario thanks to the UK Government’s Temporary Permissions Regime (TPR).
This checks out.
The UK’s financial markets regulator, the FCA, states:
The temporary permissions regime will allow EEA-based firms passporting into the UK to continue new and existing regulated business within the scope of their current permissions in the UK for a limited period, while they seek full FCA authorisation, if the UK leaves the EU after 31 October and there is no deal.
It will also allow EEA-domiciled investment funds that market in the UK under a passport to continue temporarily marketing in the UK.
The key takeaways from the underlying detail are:
- The temporary permissions regime solves the passporting problem for UK-resident investors in a no-deal scenario.
- Temporary means the arrangement lasts for three years after Brexit.
- Firms can obtain UK authorisation for their EEA-domiciled funds during that three year period.
- The FCA says the temporary permissions regime is now law.
- Firms must sign up to the temporary permissions regime and the FCA recently extended the deadline to Oct 30 2019.
I’m assuming that global corporate giants like Vanguard and BlackRock (the owner of iShares) have the wherewithal to get their paperwork sorted by the deadline.
I’m also assuming that this open door to the UK market won’t be closed by the EU. They’re no more likely to block your access to EU-domiciled trackers than to deny you a new BMW or a wheel of Brie.
I didn’t come across a scheme that waves UK-domiciled funds through EU passport control, but I wasn’t specifically looking for it, either. A few UK investment firms have commented and don’t appear concerned. More on that below.
One wrinkle to watch out for is if you own funds that aren’t labelled Undertakings for Collective Investment in Transferable Securities Directive (UCITS) or Alternative Investment Funds (AIFs).
The temporary permissions regime specifically states that it covers UCITS and AIF funds.
The vast majority of index trackers are UCITS but it’s possible you own stuff that doesn’t qualify.
- Some fund-of-funds aren’t UCITS, though Vanguard’s LifeStrategy product is. (It’s also domiciled in the UK.)
- Exchanged Traded Commodities (ETCs) aren’t UCITS. You may well own a gold ETC.
Look out for sneakiness like iShares labelling its gold ETCs as UCITS eligible. That doesn’t mean the ETC is a UCITS fund. It’s not. UCITS eligible means the ETC can be invested in by a real UCITS fund.
I couldn’t find out whether ETCs are somehow covered by the temporary permissions regime. The regulatory tenor is to minimise disruption but this is one doubt I couldn’t dispel.
Worst case scenarios
Perhaps you’re tiring of my optimism and would like some good ol’ reptilian brain food as brought to you by Project FearTM?
Let’s turn to the FakeNews media to undermine our faith in this great country of ours. What’s the worst Brexit nightmare they can conjure?
The Money Observer came up with this blood-curdler:
A worst-case scenario would be that UK investors face less choice when it comes to selecting funds.
The Investors Chronicle chilled my spine with:
Exchange traded fund (ETF) providers could face higher costs and investors might have less choice of ETFs if Brexit (a UK exit from the European Union) brought with it the end of single-market trading agreements whereby Ireland and Luxembourg domiciled funds are automatically granted access to the London Stock Exchange.
In a worst-case scenario, providers would have to list separately in the UK, an exhaustive process involving high fees and an administrative burden.
And some managers of EEA UCITS funds may not seek UK authorisation once the temporary permission regime expires, foretells law firm Allen & Overy.
Whatever you think of experts these days, it’s plausible that UK regulators will make it extremely simple to rebadge EEA UCITS funds as UK UCITS funds. If so then the ‘less choice, increased cost’ nightmare scenario shouldn’t come to pass. Fingers crossed that British administrators don’t replace red tape with red, white, and blue tape.
The lack of incentive for our government to create friction for UK plc’s financial services industry dovetails nicely with the incentive for companies like Vanguard and Blackrock to ensure their index trackers remain widely available, given that scale is a critical component of their business model.
What do the investment platforms say?
Remarkably little given you’d think they’d want to address any customer concerns. There’s plenty of ‘Hey, don’t stop investing because of a leetle bit of Brexit uncertainty’ but virtually no guidance from the major players on how no-deal could affect access.
At least back in October 2018, AJ Bell didn’t see a problem with trading ETFs on the London Stock Exchange:
ETFs are very rarely domiciled in the UK, however all our investments are in ETFs listed on the London Stock Exchange. Although the underlying fund may have to consider any regulatory effects due to not being domiciled in the UK, we will be able to continue to buy and sell our holdings through the secondary market, trading on the LSE.
Although it also speculated that costs could rise post-Brexit:
Announcements made to date by the FCA indicate temporary permissions would be put into place to allow existing funds to be held and traded after Brexit for a period of time. However it would create a cloud of uncertainty.
It is likely that fund groups will look to set up UK-domiciled vehicles and transfer investors across, which could incur costs for both the fund group and the underlying investor, depending on the mechanism used (such as a scheme of arrangement).
EU investors using UK domiciled funds
I came across a couple of UK investment firms who made reassuring noises about continued access to products for EU residents. Generally the information was scant and buried in Brexit FAQs but I ran out of time to pursue this angle.
There doesn’t appear to be an EU equivalent of the temporary permissions regime and the FCA advised back in February:
If the UK leaves the EU without a withdrawal agreement (a no-deal scenario), UK firms’ ability to continue to service EEA-based customers (including UK expats) remains a concern.
EEA-based customers (including UK expats) holding retail investment products serviced by UK providers could be affected if their UK provider cannot operate in the EEA after Brexit.
I don’t want to worry you unduly. The general thrust is that bridges are being lashed together rather than wired to detonate. There were some rumblings about EEA access to the London Stock Exchange a few months ago but the EU regulator seems to have rowed back on their intransigence since.
Interdependence creates workarounds and there’s a reason that both Vanguard and Blackrock have been busy expanding their European branch offices while maintaining their European headquarters in London.
Many other firms have been doing the same thing.
Nothing to worry about?
Obviously I can’t say nothing could go wrong. I’m personally reassured by the FCA’s moves but if you’re still nervous then:
- You could switch your investments into a near-identical portfolio of index funds domiciled in the UK. There’s plenty of good, cheap funds available via the major index fund providers. Look out for the letters GB at the start of the fund’s ISIN number which you’ll find on its webpage, Key Investor Information Document or factsheet. GB means that it’s domiciled in the UK.
- Or you could leave things as they are knowing you can always continue to pound-cost average into UK-domiciled funds if there is a no-deal Brexit interregnum.
- It might also be wise to fatten up your emergency fund with extra cash to cover any extended period of disruption. I’m doing this right now but that’s more with an eye on the gathering clouds of global recession.
- Go straight to the sources below for more reassurance (or worry-fodder!)
Aside from that, when it comes to no-deal Brexit, I’m making like a good passive investor and doing absolutely nothing.
Take it steady,
Further reading: A no-deal Brexit linkfest for the fastidous
- FCA Brexit page
- FCA temporary permissions regime page
- Bank of England Brexit page
- Bank of England temporary permissions regime page
- UK Government – investment fund legislation background
- The European Securities and Markets Authority (ESMA) Brexit page
- Central Bank of Ireland Brexit FAQ
- EEA = EU member states plus Norway, Iceland, and Liechtenstein. [↩]