Not many people would have predicted that the third quarter of 2017 – a period that ended six months after Britain gave formal notice of its intention to leave the European Union – would see more private equity investments in the UK than at any time since the financial crisis.   Nevertheless, as widely reported this week, figures published by Unquote” and SL Capital indicate that €13.7 billion (£12.1bn, or $15.9bn) was invested in UK buyout deals between July and September 2017, the highest quarterly total since 2008.

Whether this news represents a sustained resurgence of UK deals after a disappointing 2016, or a misleading blip, is hard to tell.  Certainly, many sceptics argue that sponsors are keen to invest now – before the expected turmoil to come, and while they can raise their next fund in a relatively benign market.  On the other hand, any optimism in the outlook for the UK economy that is implied by the flurry of large deals seems to be shared by the market more widely:  the FTSE 250 (often thought to be a better bellwether for the UK economy than the FTSE 100) is around 18% up on its pre-referendum close.  It is true that the FTSE 250 includes many companies that are internationally diverse – like the large buyouts that largely shaped the Unquote” third-quarter results – so caution is needed before leaping to any conclusions about sentiment for the UK, even if activity levels are sustained in the current quarter.

Meanwhile, however, private equity firms are busy planning for how their structures may have to evolve once the UK leaves the EU.  It remains possible that the UK could leave in March 2019 with no transitional arrangements and no meaningful trade deal – and firms have started planning in earnest for that contingency.  The UK wants to maintain the status quo for a couple of years after its actual departure date to allow time for the details of a meaningful trade deal to be agreed and implemented, but there is still no guarantee that it will get its wish.  That outcome is more likely than not, perhaps, but it is not an outcome that can (yet) be relied upon.

So private equity firms, in common with many other UK-based businesses, are analysing whether they need to relocate all or part of their operations – and a big part of the answer to that question is determined by where their investors are located (and, to some extent, the regulatory status of those investors).  Reaching target investors in some European countries can be tough – in a few cases, almost impossible – if you don’t have an EU marketing passport.  However, many firms have managed without a passport until now, and the rules in several of the most important locations are manageable (for as long as the EU doesn’t change them), so the answer is not obvious.  Other investors may demand an EU structure, especially EU insurance companies which benefit from better capital adequacy rules for investments in EU-regulated private equity funds, but not every fund relies heavily on EU insurance money (and there may be cheaper work-arounds for those that do).

Establishing a private fund manager in another country is a substantial undertaking.  Wherever a sponsor chooses to base its manager – and some are looking hard at Ireland, although most have so far opted for Luxembourg – there will be a requirement to relocate (or hire) some senior people in that country.  EU regulators will not accept a “letter box” entity, and insist on real decision-making power and capability before granting a licence.  For some firms, therefore, the costs of relocation will outweigh the benefits, and each firm will have to make a decision based on its own investor base and the incremental costs.

While many firms are actively contingency-planning, only a few have already taken irreversible steps.  The next few months are likely to represent a crucial phase in their action plan, and the British government could do more to help reassure UK-based firms that it wants them to stay – and will fight hard to keep them.  For example, confirmation that the industry can expect a more stable tax environment (after several years of unsettling changes), and a swift conclusion to an ongoing review of partnership law, would both be helpful.  As the UK’s Chancellor prepares for his crucial budget speech later this month, it is to be hoped that he keeps that in mind.

This post comes to us from Debevoise & Plimpton LLP. It is based on the firm’s memorandum, “European Funds Comment: Contingency Planning For Brexit,” dated November 10, 2017, and available here.