Financial services regulation – what impact will Brexit have on regulated firms established in the UK, Europe and third country jurisdictions?
Bed & BREXIT? OR Room Only?
Neil Mathias is managing director and founder of compliance and regulatory risk firm Compliance CRG. After a successful career as a Stockbroker specialising in GBP derivatives at HSBC and as a Prop Trader, managing futures, credit swaps and rates, he is now a specialist in Compliance, regulatory risk management and training and is a Director at International Training Specialist Company InterFima.
Neil is an External Specialist in Risk & Compliance, Trainer, Tutor and Author at the Chartered Institute for Securities & Investment.
Financial services regulation – what impact will Brexit have on regulated firms established in the UK, Europe and third country jurisdictions?
Bed & BREXIT? OR Room Only?
On 29 March 2017, the UK Government triggered a rule known as ‘Article 50’, which started Britain’s withdrawal from the EU. It was passed through Parliament, and dictated that we would leave exactly two years later, on 29 March 2019. Since then, the UK has been negotiating with the EU over what kind of arrangement we’ll have with other countries in Europe once it departs.
On 14 November 2018, the UK Prime Minister Theresa May announced that a ‘withdrawal agreement’ had been reached with the EU, outlining the basis of a deal for when it leaves. However, this deal was rejected by a large majority of MPs in a crunch vote on Tuesday 15 January.
The UK Parliament voted on a number of amendments to Theresa May’s Brexit deal on Tuesday 29 January, and now the PM will go back to the EU and try to renegotiate some parts of her deal, based on the result of those votes. If she’s unable to get a deal that MPs and EU leaders are happy with, though, as things stand, we’ll leave the European Union with no deal at the end of March.
As the UK approach’s its D-Day – the date for leaving the EU, the BREXIT debate continues with governments on both sides of the Channel publishing a series of updates many citing the European Union (Withdrawal) Act 2018.
The latest news on this tug-of-territory, continues to centre on a “no-deal” BREXIT. For the markets this impasse inevitably leads to volatility – for Compliance – there are many Heads of Department left scratching their heads.
London hosts the largest financial centre in the European Union (EU).
The City of London houses a wide range of multi-national global banks and other financial services providers. Although a number of foreign financial institutions have a City of London address to participate in the UK financial markets, a large number of non-EU financial institutions also use the UK as a ‘hub’ to access clients and markets across the EU, with a number of EU firms maintaining a branch presence in the City.
Therefore, it is clear that Brexit, in whatever form it takes, will have a significant impact the financial services industry.
As each day passes and we edge closer and closer to the cliff edge, the risks linked to a “no deal” scenario increase. Good news for speculative market traders, as the volatility in the markets will increase, but not – perhaps so good for the longer term investors, who prefer the stability that the markets normally offer. However, we are not expecting the markets to collapse or any major long term effect should the UK leave with a “Hard Brexit”
However, that said, given the increasing uncertainty surrounding the Brexit process, there are many implications for firms seeking to do business across Europe, and of course vice-versa.
It is not at the time of writing any clearer – what will happen. There is still a lot of unease over the Irish backstop, and with the original vote to leave just over the 50% mark, there are a number of key Pro EU voters that are calling for another referendum given that the original was – in their minds unclear as to the implications.
The Irish backstop is proving to be a bone of contention. Some commentators believe that Theresa May will offer the UK and EU a choice of accepting her deal (which so far they have rejected) or – face a lengthy delay… The issue that could cause in itself is a concern as it is feared that a long extension of Article 50 could ultimately lead to BREXIT being cancelled altogether.
The UK Government is – it is fair to say – in unchartered waters at the moment, and whilst it remains, there is a lot yet of this Chapter to come. Some MP’s have signalled that they are prepared to resign – in a bid to force Theresa May’s hand rather than allowing her to “gamble” on a last minute change of heart by the Party’s
The perceived risks linked to a “no deal” scenario have increased as we get closer and closer.
However, the markets are more than used to volatility and it is widely hoped and expected that even in the “worst case” of a “Hard Brexit” (No Deal). Speaking to analysts in the City of London, the consensus opinion is that the markets are likely to work effectively in the event of a “Hard Brexit”.
However, that said, given the increasing uncertainty surrounding the Brexit process, there are many implications for firms seeking to do business across Europe, and of course vice-versa.
“Passporting” of financial services – UCITS – for example – has long been a key feature of European legislation, MiFID – MiFID II and other directives implemented the single market in financial services have enabled authorised investment firms to provide investment services across the EU.
Firms operating in one member state may operate in another member state of the European Economic Area. Many financial service providers in the United Kingdom rely on the Capital Requirements Directive Article 34 to provide financial products across Europe. Should the UK end up with a no-deal Brexit, the UK will depart from the single market and lose the EU passporting rights.
The consequences of this could well resort in UK investment firms being unable to provide their services to clients in other EEA countries. Equally, establish an authorised MiFID investment firm within the EU in order to provide services to those clients. The financial implications of establishing a new legal entity in the EU, and obtaining local authorisation, is in the most part thought to be highly like to be too costly for the majority.
Some commentators have suggested that a potential solution, would be the UK seeking the EU’s agreement to a grandfathering provision. This would therefore enable the UK to continue to deal with EU clients, but it is thought likely that this would only be a temporary solution.
Elsewhere in Europe, a draft German law 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.
As noted by the FCA, in terms of immediacy, much UK regulation derived from EU legislation will remain applicable until changes are made by the UK Government and Parliament post-Brexit. Having said this, Brexit will inevitably have an impact on present and future regulatory implementation. The longer-term impacts of the decision to leave the EU on the overall regulatory framework for the UK is dependent, in part, on the future relationship that the UK seeks with the EU.
There is considerable speculation over what form this will take, with some commentators referring to models such as the Norwegian EEA, the Swiss bilateral model or the Turkish Customs Union. In reality, the future proposition is largely unknown as it will depend on the outcome of negotiation with the EU, but in all likelihood, there will be a bespoke UK solution, not wholly aligned to any existing “EU-like” model.
Back in the UK, the Financial Conduct Authority opened a consultation in November 2018 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.
https://www.fca.org.uk/publication/consultation/cp18-36.pdf
Thoughts:-
The distance-marketing directive: Post Brexit, firms within the EEA would need to be treated as coming from third countries. Therefore the FCA Handbook will be revised to reflect this.
Money laundering regulations: With this in mind the regulations will require EEA members to be treated as third counties. The consequence of this being that firms will be required to enact enhanced due diligence for institutions in the EEA, as opposed to the current Simplified Due Diligence. To aide Firms, 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.
4th EU AML Directive
With an official implementation timeframe for June 2017, the European Commission has requested all Member States to adopt the directive by the end of 2016. UK AML legislation is largely compliant with the requirements of the 4th EU AML Directive, so should not pose significant impact. There is unlikely to be any move to dilute the 4AMLD proposals, however, some of the more infrastructural elements may be affected, such as the creation of central registers for beneficial owners. There may also be changes to how the risk-based approach is applied in other EU countries, particularly with regard to the treatment of UK PEPs.
MiFID / MiFID II
The biggest impact of Brexit will be the loss of passporting rights. MiFID requires “third country firms” (outside the EU) to open a branch within EU borders. Many countries, e.g. Hong Kong, have been using a London-based subsidiary for this reason. One option would be to establish a subsidiary in a Member State to rely on passporting rules through the EU (MiFID I) or be recorded in an ESMA-held registry (MiFID II) if granted equivalency the European Commission. The above points are, of course, contingent on whether the UK exits the EEA as well as the EU.
Margin Requirements – Non Centrally Cleared Derivatives
Originally due for Phase 1 implementation by September 2016, this regulation has now been postponed until mid-2017. While this is a global initiative rather than EU-centric legislation, the UK may still seek to delay implementation and may no longer be bound by ESMA RTS. It is unclear whether or not the UK will have to comply with this regulation once they have notified their intention to leave the European Union.
EMIR
Applicable to all Member States, EMIR will not apply to the UK (unless grandfathered) once the exit is complete. However, like the Margin Requirements, this is a G20 commitment, so the UK will still need to adopt principles underscoring the provisions of EMIR. Equivalency decisions relating to clearing, risk mitigation and reporting techniques will need to be assessed on exit and UK firms will need maintain arrangements with central counterparties. UK CCPs are likely to be treated as “third country CCPs” and will need to apply for “recognition” under EMIR in order to be able to continue. A more tangible implication involves the treatment of FC and NFC, which would transition to a “Third Country Entity (TCE)” status.
Data Privacy
The GDPR comes into effect in May 2018. This regulation will no longer apply to the UK on exit (as regulations are not transposed into national legislation). That being said, owing to the extra-territorial reach of the GDPR, provisions will continue to apply to UK companies offering goods and services to EU citizens. There has been much scrutiny in recent months over transfers of data outside the European Union. As the UK national standards are at a comparable level to other EU countries, it is unlikely there will be a big effort in terms of equivalency and they will most likely be whitelisted for transfers outside the European Union. The data protection impacts may require changes to data access rules and controls for UK-based resources. Data protection equivalency rules for non-EU countries will need to be reviewed given that EU-specific rules will no longer apply.
UCITS
Existing UCITs/Management Companies may be able to retain authorisation and permissions within the UK market but will lose their passporting rights and could potentially transition to an AIF-style regulation, imposing restrictions on retail investors. UK-domiciled UCITs will need to be EU-domiciled and self-managed or managed by an EU management company. Key providers may need to change to remain compliant.
AIFMD
The passport is linked to the Fund Manager rather than the product. In reality, a UK AIFM will be most likely be treated similarly to a US-based AIFM. UK-based AIFMs will likely transition to a “Third Country Firm” (foregoing passporting rights) and will not have permission to market the AIF to investors within the EU, but will retain IM permissions.
While it may take up to two years to finalize the Brexit process after the UK serves notice to exit under Article 50 (expected to take place in October 2016 upon the appointment of a new Prime Minister), the UK is under EU pressure to execute a swift and coherent withdrawal procedure.
The distance-marketing directive: Post Brexit, firms within the EEA would need to be treated as coming from third countries. Therefore the FCA Handbook will be revised to reflect this.
Money laundering regulations: With this in mind the regulations will require EEA members to be treated as third counties. The consequence of this being that firms will be required to enact enhanced due diligence for institutions in the EEA, as opposed to the current Simplified Due Diligence. To aide Firms, 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.
As you can see from the brief guide above – one this that IS certain – is that there IS and still remains a LOT OF UNCERTAINTY!
