Theresa May is braced for a possible French raid on Britain's £8tn asset management industry, amid fears the sector might be the most exposed part of the City after Brexit.
Paris is vying to expand its slice of the European fund management sector along with Dublin, Frankfurt and Luxembourg, raising concerns in the UK government and the Bank of England that this could become the financial front line in Brexit.
Ministers and BoE officials fear a French-backed move to limit access for British-based fund managers to EU funds in centres such as Dublin and Luxembourg.
“There has been a lot of focus on the impact of Brexit on investment banks, but this is becoming the key issue,” said one member of the prime minister’s Brexit team.
At the heart of the issue is so-called delegation, which allows an asset manager to set up a fund in one country and outsource the portfolio management to investment staff in another country.
Over the past three decades, Ireland and Luxembourg have become the EU's leading hubs in which to base mutual funds, while investment decisions are typically taken in London, Paris, Frankfurt or elsewhere in the world under delegation rules.
The UK's Investment Association, a trade body, estimates that £900bn is managed from the UK on behalf of funds domiciled in Ireland and Luxembourg. "Safeguarding delegation has to be the government's key priority for the asset management industry during the Brexit negotiations," said one IA member firm.
With the UK leaving the EU, there is a new focus on whether delegation rules are strict enough. The fear is that a large proportion of assets regulated in the bloc would be run from a non-EU country, with asset managers having only a token presence in an EU country.
British officials believe French president Emmanuel Macron is personally backing moves to increase supervision of delegation decisions.
The European Securities and Markets Authority, the Paris-based pan-European financial watchdog, last year hit out at the establishment of "letterbox" entities employing only a few people in European countries. It believes national regulators should take a tougher line on policing the sector.
The French regulator AMF has backed Esma’s anti-letterbox stance.
Xavier Parain, head of asset management at the AMF, said he did not envisage massive changes to delegation.
“In July, Esma clarified that a European-based entity needs to have enough substance in order to delegate; substance in this case can mean people, in particular senior people in charge of portfolio management or risk management,” he said.
“When we give authorisation to new managers, we need to be sure that there are enough people to control the delegation. If you have more and more funds, if you have strategies that are more and more complex, you will need more people,” he added.
Keith Skeoch, co-chief executive at Standard Life Aberdeen, one of Europe's largest asset management groups, warned that "any changes to the current delegation arrangements, however great or small, will have reverberations around the world".
The British Treasury said: “The UK is the pre-eminent global centre for financial services, and the asset management industry plays a pivotal part. We are determined that the UK remains a global hub to this important sector.”
The Treasury last month launched a strategy to support the sector.
Jacob Rees-Mogg, a Conservative MP and chairman of Somerset Capital Management, rejected suggestions that the sector was at risk, arguing that changes to the delegation rules would most likely hurt Ireland and Luxembourg.
He said that if the EU tried to stop fund managers in third countries having access to Irish and Luxembourg funds, it would damage those countries and lead to a fight not just with the UK but with "the US, Switzerland and other jurisdictions as well".
Kit Malthouse, a Conservative member of the Commons Treasury committee, agreed that any change to the delegation rules would be more likely to see funds and managers being brought together in London, not Paris.
This article has been amended since original publication. The Conservative MP's name is Kit Malthouse, not Kit Maltby.
– Copyright The Financial Times Limited 2018