As we approach the date for leaving the EU, the government has been publishing a series of statutory instruments (U.K. secondary legislation), on-shoring and amending EU regulations ahead of Brexit. This is being done under the European Union (Withdrawal) Act 2018. During the past weeks risks in this sector linked to a no deal scenario have increased significantly. However, despite an impasse in parliament, civil servants have been operating behind the scenes to (hopefully) create a smooth(ish) transition after Brexit. The financial system is likely to work effectively in the event of a “hard Brexit” (I haven’t defined hard Brexit as I’m unsure what it is). The Treasury, in particular, has been working on statutory instruments to make a compliant framework for financial services. If nothing changes, these are set to kick in on 29 March 2019.
On November 23, 2018, the Financial Conduct Authority opened a consultation on necessary changes to the Financial Conduct Authority (FCA) Handbook and guidance to ensure a functioning legal and regulatory framework for financial services in the event of a “no-deal” scenario, ie, a situation where no ratified withdrawal agreement is in place.
With increasing uncertainty surrounding the Brexit process, there are many implications for firms based in the United Kingdom seeking to do business across Europe, and of course vice-versa. Pan-European provision of services has long been a key part of the European project and this is now coming to the end. In many ways, trade between EU member states is ‘freer’ than between US states and British firms will lose this benefit as a result of Brexit.
Passporting of financial services is a feature of pan-European legislation, beginning with the Markets in Financial Instruments Directive in 2004 (now updated with MiFID2, with which we are primarily concerned in this note) and other directives, which implemented the single market in financial services. MiFID and its successor have enabled authorised investment firms to provide investment services across the EU, subject to making a notification under Article 34 of MiFID2. Firms operating in one member state may operate in another member state of the European Economic Area (EEA) subject to 28 days notification. Note that this is a registration, not authorisation process. For appointed representatives (AR) of UK principal firms, passporting is also possible under MiFID. The representative is referred to as a tied agent, and the principal firm must register each AR separately in each jurisdiction and for each of the MiFID activities it wishes to perform.
Many financial service providers in the United Kingdom rely on Article 34 to provide financial products across Europe. In the event of a no-deal Brexit, we shall see the UK exit from the single market and lose intra-EU passporting. While we have heard several points of view, it is likely that UK investment firms would be forced to halt providing services to clients in EEA countries, or establish an authorised MiFID investment firm within the EU in order to provide services to those clients.
For most firms the cost of establishing and capitalising a new legal entity in the EU, and subsequently operating that entity after obtaining local authorisation, is likely to be prohibitive. In terms of potential solutions, the UK is likely to seek the EU’s agreement to a grandfathering provision that enables UK investment firms to continue to deal with EU clients with whom they had a prior relationship. This would only be a temporary solution. It would mean that investment firms that do not expect to establish new EU client relationships would be able to avoid establishing a new entity in the EU.
As part of an agreed transition period, it has been assumed that UK firms will be able to continue to provide services to existing and new EU clients on the basis of their pre-Brexit authorisation status in the UK. This is still the base case outcome, but cannot be guaranteed, and we’d emphasise again that in the event of a no-deal Brexit all passporting rights will be lost. Some European legislators are working to protect the interests of their consumers and finance industries by providing relief at a national level. A draft German law on the books suggest that if Britain were to leave the EU on 29 March without a deal in place, then BaFin, the German regulator would allow U.K. firms already providing banking and financial services to keep operating in Germany until the end of 2020 minimising the disruption of a disorderly Brexit. It is likely that these bilateral agreements would lead to a multiplication of regulations for UK investment firms.
Upcoming changes and areas of interest
The distance-marketing directive: After Brexit, firms within the EEA would need to be treated as coming from third countries. Hence the Financial Conduct Authority Handbook will be revised to reflect this.
Money laundering regulations: Similarly, the regulations will require EEA members to be treated as third counties. This will require domestic firms to move from simplified to enhanced due diligence for institutions in the EEA. The definition of a high risk country will remain the same as under the current regime, but the list will now be updated by the FCA and the FCA only and is therefore likely to diverge from the European standard over time.
The FCA has created a temporary permissions regime for inbound passporting EEA firms and funds. This may be reciprocated by the EU but it cannot be guaranteed.
The temporary permissions regime will enable financial service firms and investment funds that currently passport into the UK market to continue operating here, even if the passporting regime falls away abruptly when the UK leaves the EU. The MiFiD tied agent regime will also be narrowed to refer only to FCA-registered tied agents.
If there isn’t an implementation period and the passporting regime falls away when the UK leaves the EU, the temporary permissions regime will provide a backstop to relieve operational strain so that firms and funds can continue their business with minimal disruption.
November’s consultation paper also sets out proposals about the application of FCA rules to firms in the regime. These include rules relating to but not limited to:
- the Senior Managers and Certification Regime (SMCR) and the Approved Persons Regime (APR);
- the Financial Services Compensation Scheme (FSCS);
- the Financial Ombudsman Service; and
- the disclosure of the authorisation status of a firm in the regime.
- The post gives the views of its authors, not the position of LSE Business Review or the London School of Economics.
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Dan Tammas-Hastings is managing director and founder of outsourced compliance and regulatory hosting firm RiskSave. After a successful career as a fixed income trader specialising in GBP derivatives at Merrill Lynch and as a hedge fund manager, managing multi-billion £ portfolios across credit and rates, he is now a specialist in risk management and is in charge of strategy and investment at RiskSave. Dan has been awarded both the CFA and FRM charters and is a graduate of LSE and the University of Cambridge.