On 31 May 2017, the European Securities and Markets Authority (ESMA) issued an opinion to provide further guidance to the national competent authorities (NCAs) of the remaining EU member states (EU27) on permitting UK market participants access to the single market.

Following the Brexit vote, many UK financial market participants are exploring ways to assure continued EU market access. In response, various national stakeholders have engaged in promotional activities in an attempt to entice UK market parties to set up shop in their jurisdiction.

By issuing the opinion, ESMA announces practical tools for NCAs in order to further regulatory convergence among the various NCAs. ESMA purports to address regulatory and supervisory arbitrage risks that arise as a result of increased requests from financial market participants seeking to relocate in the EU27 within a relatively short period of time. The ESMA opinion has insisted on existing rules and principles for third country access by stating nine general principles that are to be applied by NCAs in the context of relocation of entities, activities and functions following UK’s withdrawal from the EU.

According to ESMA, third country firms should only be allowed access to the internal market by relocating to an EU27 member state if key activities and functions are also relocated and minimum requirements regarding substance, delegation, outsourcing, own funds and liquidity are met.

The ESMA opinion mainly targets activities under UCITS, AIFMD, MiFID I and MiFID II which will be transferred to EU27 states in order to keep the EU passport.

These are the 9 ESMA principles

  1. No automatic recognition of existing authorizations: Authorizations granted by third country authorities, including those in the UK, are not recognized under EU law. Accordingly, a new authorization process by the relevant NCA is required. For UK parties, this means that the licence application process should be initiated in time in view of the expected date of Brexit becoming effective (being 10 March 2019).
  2. Authorizations granted by EU27 authorities should be rigorous and efficient: In general, the thresholds should be set high for any authorization of a third country entity and all conditions under the relevant legislation must be met from day one. If licensing seems to be requested with a view to regulatory arbitrage, such request should be denied.
  3. NCAs should be able to verify the objective reasons for relocation: A company’s business plan should provide a clear justification for the change of location, including prospective investors or the location of development of products and services. ESMA expects that NCAs will particularly scrutinize applications where it appears that an entity intends to pursue the greater part of its activities in other member states and will only grant authorization if fully satisfied that the member state of establishment was not chosen for the purpose of evading stricter standards in force in other member states.
  4. Special attention should be granted to avoid letterbox entities in the EU27: NCAs have to focus on outsourcing and delegation arrangements and deny the authorization if extensive use of such practices is being made with the intention of benefitting from an EU passport, while essentially performing all substantial activities or functions outside the EU27.
  5. Outsourcing and delegation to third countries is only possible under strict conditions: Only tasks and functions can be outsourced, not responsibility. The ESMA opinion further reminds the NCAs that under certain Union legislation, outsourcing or delegation to a third country entity are conditional on prior cooperation agreements between the NCA and the third country authority.
  6. NCAs should ensure that substance requirements are met: Outsourcing and delegation arrangements have to be clearly structured and must not hinder supervision. NCA’s access to all data and premises, including those in third countries, has to be ensured. Key activities and functions cannot be outsourced or delegated outside the EU27. This is at least the case for the substance of decision making.
  7. NCAs should ensure sound governance of EU entities: Board members and senior managers in the EU27 need to have effective decision making power and have to be effectively employed and work on a proportionate basis (if not full time) in the respective EU27 state.
  8. NCAs must be in a position to effectively supervise and enforce Union law: NCAs must have enough capacity and resources to guarantee accurate ongoing supervision with regard to these principles, including for on-site inspections.
  9. Coordination to ensure effective monitoring by ESMA: ESMA will establish a forum for reporting and discussions among NCAs regarding relocation to the EU27.

More specific guidance by ESMA on the application of the principles on the respective directives and regulations is expected in due course.

Relevance for Swiss and UK entities

Even though the ESMA opinion is clearly influenced by Brexit and targeted at relocations by UK firms, it is relevant to any third country market participant that wants to obtain access to the EU internal market. Such firms should anticipate on the principles set out above and carefully structure their substance.