Brexit: the implications for financial services

The implications for the UK’s financial services industry following the UK's vote to leave the EU will be significant. Much will depend on the exact terms concluded by the UK with the EU in connection with its exit. Nevertheless, a number of legislative and regulatory changes for financial services firms in the UK will inevitably follow. These changes will require firms to consider how their businesses are structured and, assuming relevant EU passports cease to be available should the UK not remain within the single market, how they will continue to provide services and market products cross-border into the EU.


Find out the impact of Brexit on your business:


Impact: LOW

UK permission still intact and no freedom of services.


Impact: MEDIUM TO HIGH

Premise of UK operations based on EU law and question whether home regulator and UK regulator will permit the continuation of the business without significant changes, whether capital, oversight, etc.

Recommendation:

  • Initially, start a dialogue with home state regulator as to likely outcome.
  • Await UK stance on branch operations of EU firms post Brexit.

Impact: LOW

Based on current business model.

Recommendation:
Confirm status of current business and seek advice for future plans.

Impact: HIGH

If any future plans include pan-European operations.

Recommendation:
Confirm status of current business and seek advice for future plans.


Impact: HIGH

Freedom of services (cross-border and branch) will disappear.

Recommendation:

Consider options including third country cross-border licences (very limited), and/or consider alternative EU location for set-up.

Impact: MEDIUM TO HIGH

Premise of UK operations based on EU law and question whether home regulator and UK regulator will permit the continuation of the business.

Recommendation:
Speak with home state regulator as to likely outcome.


Impact: MEDIUM TO HIGH

Freedom of EU UCITS Management Company to provide services in the UK is based on EU law. Question whether home regulator and UK regulator will permit the continuation of this service.

Recommendation:
Speak with home state regulator as to likely outcome.


Impact: LOW

UK permission still intact and no freedom of services.

Recommendation:
Confirm status of current business and seek advice for future plans.

Impact: HIGH

If any future plans include pan-European operations.

Recommendation:
Confirm status of current business and seek advice for future plans.


Impact: LOW

UK permission for UK UCITS Management Company would remain intact.

Recommendation:
Confirm status of current business and seek advice for future plans.

Consider options, including setting up an EU domiciled UCITS (self-managed/EU Management Company/local contractor) with UK Management Company as delegated investment manager.

Impact: HIGH

Freedom of UK Management Company to manage EU UCITS will disappear.

Recommendation:
Confirm status of current business and seek advice for future plans.

Consider options, including setting up an EU domiciled UCITS (self-managed/EU Management Company/local contractor) with UK Management Company as delegated investment manager.


Impact: MEDIUM

EU UCITS will become unregulated fund for UK purposes and will have to be marketed as permitted by UK financial promotion restriction.

Recommendation:
Confirm whether target investors fall within financial promotion rules. If not, consider alternative options (including setting up a UK fund).


Impact: HIGH

UK UCITS will become an AIF and need to be registered under Article 42 AIFMD.

Recommendation:
Confirm whether the existing NPPR regimes would be sufficient for the purposes of the funds marketing efforts.

If NPPR not viable speak with target regulators re continued recognition of UK UCITS or consider setting up a UCITS in an EU member state.


Impact: LOW

  • UK permission for UK Management Company would remain intact.
  • UK AIF will have to be marketed to EEA investors under Article 42 AIFMD.

Recommendation:

  • Consider their marketing intentions, in terms of jurisdiction.
  • Consider the filings that will be required.

Impact: HIGH

UK AIFM would no longer be an authorised EU AIFM. Whether it could continue to manage the EU AIF would depend on the AIF’s home state rules.

UK AIFM’s permission to market the EU AIF in the EU would disappear.

Recommendation:

Consider requirements of regulator in AIF’s jurisdiction as to whether UK AIFM can continue to manage EU AIF and/or alternative options such as use of AIFM service provider (with delegation of PM to UK manager), making AIFM self-managed, redomiciling AIF).

Consider availability of private placement rules of individual member states.

Ask the client to consider their marketing intentions, in terms of jurisdiction. Will need to consider the filings that will be required.


Impact: MEDIUM

UK permission for UK Management Company would remain intact.

UK AIFM may no longer have to comply with AIFMD Article 36 regime and "depo-light" requirements.

Marketing of fund not impacted - same route, however ability of UK AIFM to market the fund will disappear.

Recommendation:
Ask the client to consider their marketing intentions, in terms of jurisdiction. Will need to consider the filings that will be required.


Impact: LOW

No change in respect of management of non-UK AIFs.

UK AIFs will cease to be EU AIFs and become non-EU AIFs.

Regime for marketing into the UK may change. FinProm would continue to apply.

Marketing of AIFs by non-EEA AIFMs should not be affected by Brexit.

Recommendation:
If a UK AIF, pay attention to UK regulatory developments.

This note considers some key areas of financial services regulation which are most likely to be affected.

Expand all
The post-Brexit legislative framework
  • From a financial services regulatory perspective, disengagement from the EU would have been easier to achieve prior to the recent financial crisis than now. Since 2008, not only has there been a significant increase in the amount of EU legislation dealing with all aspects of the financial sector but there has also been a move away from Directives and towards Regulations.

    The method of introducing EU legislation has an important impact on the UK’s position. Member States are obliged to implement EU Directives by transposing them into their national law. As a result, a framework already exists in the laws of the UK and in the Financial Conduct Authority’s (FCA) Handbook giving effect to the various Directives which have been passed. A recent example of this was the Alternative Investment Fund Managers Directive (AIFMD), which was implemented within the UK through a combination of HM Treasury’s AIFM Regulations and changes to the FCA Handbook. The AIFMD’s text was then supplemented by “Level 2” Regulations issued by the European Commission which are directly applicable in UK law.

    EU Regulations apply to Member States without the need for transposition. Regulations will fall away when the UK is no longer an EU Member State, even if the determination of when that will occur will depend on how the UK chooses to exit. As the UK will lack equivalent rules in its own national framework, the situation could cause problems for firms wishing to access the EU market in areas where a third country’s regime needs to be adjudged to be "equivalent"’ to that in the EU.

Authorisations and passports
  • A central feature of the EU model for the post-crisis financial services regime is the requirement for firms to be authorised within a Member State. The conditions of authorisation then impose a number of obligations on firms - such as operational or transparency requirements - irrespective of the Member State in which a given firm is established. Authorisation in a Member State under such model is to a great extent a pre-requisite for being able to conduct business in the EU. Once authorised, a firm can use relevant passports to provide services and/or market funds cross-border into other Member States without additional registration, authorisation or licensing obligations being imposed by that host Member State.

    Following the UK’s exit from the EU, UK firms will cease to benefit from the ability to provide services cross-border or establish branches under relevant passports, subject to the terms of any new treaty. New licences are likely to be required and networks of branches in the EU are likely to need to be restructured.

UCITS
  • A UCITS fund must be EU domiciled and either self-managed or managed by an EU management company.

    Unless specifically provided in a new treaty, funds established as UCITS in the UK will no longer fall within the UCITS Directive. To the extent that those funds benefit from the UCITS passport and their managers wish to continue marketing the fund in the EU, then such funds would need to be migrated to an EU Member State. For so long as the fund remains in the UK, it is likely that the FCA would regard the fund for UK regulatory purposes as a type of non-UCITS retail fund, which would be categorised as an Alternative Investment Fund (AIF) under the AIFMD. This means that, to the extent that the fund is marketed in the EU, then it will be subject to additional marketing restrictions and largely unavailable to retail investors - it will also need to comply with the different operational, reporting and transparency obligations that AIFMD brings with it.

    UCITS management companies established in the UK wishing to continue acting for non-UK UCITS would need to redomicile into an EU Member State or be replaced by EU entities.

AIFMD
  • EU AIFs can currently be marketed by EU AIFMs to professional investors in other Member States following a passporting procedure with the AIFM’s home regulator. Third country AIFMs (ie, those from outside the EU) are, at present, unable to become authorised and, in order to market to investors within Europe, must currently either (i) make use of local private placement regimes (NPPRs) where these exist or (ii) rely on reverse solicitation (the rules of which vary greatly between different Member States and can be complex). The intention is for the European Commission to allow the AIFMD passport to be extended to third countries’ funds and managers, following approval by the European Securities and Markets Authority (ESMA) that the legislative and supervisory regime in the third country concerned meets certain standards. This work is ongoing but some way behind schedule.

    Following the UK’s exit from the EU, UK AIFMs will cease to be EU AIFMs. The UK would be able to impose a lighter post-Brexit regulatory regime on its asset managers. However, a UK AIFM wishing to market its funds to investors in the EU will be required to either (a) use local NPPRs where available (or rely on reverse solicitation) or (b) wait for the UK to be assessed and approved by ESMA and for the AIFMD passport to be extended to it (and to the third country in which any relevant non-EU AIF is established).

    Non-EU AIFMs who market AIFs to investors in the EU must still comply with certain transparency and reporting obligations (including "Annex IV" reporting to local regulators). Where access to the marketing passport is allowed and the non-EU AIFM elects to make use of it, however, the full provisions of the AIFMD will apply. As ‎NPPRs may be phased out over time, the option of relying on NPPRs may, consequently, only be temporary.

    A non-EU AIFM making use of the marketing passport will need to select an EU Member State of reference to act, essentially, as its “home regulator” within Europe. A UK AIFM could in time, therefore, find itself subject to the same regime as before the UK’s departure from the EU, but with an EU Member State regulator, in addition to the FCA, to deal with.

MiFID
  • Negotiations around the terms of exit are likely to take until at least 2019 to finalise. In the meantime, MiFID2 and MiFIR will become effective in all EU Member States. Departure from the EU would allow the UK to determine whether it wished to (a) follow the rules which will be implemented across the remaining Member States, (b) create a regime of its own or (c) do both, by allowing parallel regimes into which firms could opt. No longer being part of the EU will mean that UK firms undertaking MiFID-type business (UK MiFID firms) will no longer be able to make use of the MiFID licensing passport, under which a firm licensed in one Member State is able to provide its services cross-border throughout the EU without further local requirements being imposed. However, on the basis that ESMA may ultimately assess the UK’s regime as being equivalent to that of MiFID2/MiFIR, it would be open for UK MiFID firms, as third country firms, to take advantage of the third country access rules, once these are in force. The new third country regime would allow a UK MiFID firm to be able to register a branch within the EU, either with the EU national competent authority in the relevant Member State or centrally with ESMA (depending on the customer type with which the firm deals). The third country rules are not immediately effective when MiFID2 comes into force and UK MiFID firms would, therefore, risk facing a period of time during which they are neither MiFID firms, nor able to benefit from the third country licensing regime.

    Further, under the existing MiFID regime (and to continue under MiFID2/MiFIR), investment firms from one Member State are permitted access to regulated markets, central counterparties (CCPs) and clearing systems in other Member States. As with AIFMs and UCITS, a consequence of the UK no longer being a Member State is that (subject to the terms of any new treaty), such firms will no longer be able to take advantage of these provisions.

EMIR
  • The key client categories under EMIR - “financial counterparties” and “non-financial counterparties” - refer to undertakings "established in the Union" (except in the case of AIFs, where it is the AIFMD status of the manager that is relevant). Since, post-Brexit, a UK undertaking will no longer be "established in the Union", under EMIR, UK undertakings which are currently financial counterparties or non-financial counterparties will become third country entities (TCEs).

    UK undertakings will not be able to avoid EMIR altogether, as a number of its provisions have extraterritorial effect, including in relation to key requirements such as margin for uncleared trades and mandatory clearing. The reporting obligation, however, does not apply to third country undertakings, but it must be expected that HM Government would introduce similar requirements domestically - particularly given the size and importance of the UK derivatives market.

    If UK undertakings became TCEs, they will be required to determine what their status would be if they were established in the EU, an exercise which, on the face of it, would appear relatively straightforward as the status would only recently have changed.

    In any event, UK undertakings subject to the clearing and margin requirements of EMIR while the UK is an EU Member State, will remain subject to such requirements when entering into derivatives transactions with EU firms post-Brexit. Importantly, for UK pension scheme trustees who currently benefit from an exemption from the forthcoming mandatory clearing requirement, that exemption will cease to apply if such schemes become TCEs as it only applies to EU entities. An equivalent exemption may be introduced in any future UK domestic legislation, but a UK TCE pension scheme will not be able to rely on the EMIR exemption when facing an EU counterparty.

    The City of London hosts some of the world’s largest clearing houses (CCPs), and a UK CCP authorised by the Bank of England (following the process set out in EMIR) is permitted to provide clearing services to clearing members and trading venues throughout the EU. Following the UK’s departure from the EU, however, a UK CCP will become a third-country CCP.

    Under EMIR, a CCP established in a third country can only provide clearing services to clearing members or trading venues established in the EU where that CCP is recognised by ESMA. This would require, amongst other things, clearing houses operating out of London to apply to ESMA for recognition, the Commission to pass an implementing act on the equivalence of the UK’s regime and relevant co-operation arrangements to be in place between the EU and the UK. Such arrangements are likely to take some time. Given the size and importance of UK CCPs, an interim solution would need to be reached to ensure that London clearing houses can continue to provide their services into the EU.

    A further point to consider is whether London clearing houses will be permitted to continue handling significant Euro-denominated transactions. The original stance of the European Central Bank (ECB) was to require that all clearing houses which handle a large volume of Euro-denominated trades were based in the Eurozone. Following the UK’s challenge, the EU General Court ruled against the ECB, saying that the location policy was ultra vires. That decision seemed to make the location issue go away, but there may now be some in Europe who would push for it to be revisited.

Other issues to consider
  • The above article looks at the implications of the UK’s departure from the EU for a firm in the financial services sector primarily from the regulatory perspective. However, it is also crucial to consider the issues arising from the exit beyond those relating to financial services regulation.

    For more information on taxation issues for such a firm, please see here.
    For more information on employment issues, please see here.
    For more information on data protection issues, please see here.
    For more information on intellectual property issues, please see here.

For further information, please refer to Brexit: the legal implications.

This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.