The result of the EU Referendum announced on the morning of 24 June 2016 will bring about fundamental changes to the UK (some anticipated, some not) and will have a significant impact for financial institutions. Reactions to the vote have already been seen in the financial markets. From a legal perspective, so much of our financial services law and regulation has an EU dimension; the decision to leave the EU will inevitably involve changes to that law and regulation. The legal and regulatory landscape we end up with will depend very much on the nature of the agreement we reach with the EU, including whether or not the UK negotiates membership of the single market (by remaining part of the EEA through signing up to the European Free Trade Agreement or via a bespoke agreement).

We have set out below some initial questions and answers of relevance to our financial services clients.

What is the immediate impact?

Clearly there have been immediate impacts to financial markets and the value of sterling, and this is only a few days in. However, the legislative framework has not yet changed and until we withdraw from the EU we continue to be a full member of the EU, required to implement EU Directives and subject to the EU Regulations which are directly applicable to Member States.

The process of exit involves the UK using the procedure set out in Article 50 of the Treaty on European Union. Withdrawal will be the earlier of the date of a withdrawal agreement or two years from the date of notification. Given the potential complexities of negotiating our exit - a process not done before - two years seems a very short time and agreeing a withdrawal agreement any earlier appears unlikely. As a result the process in reality is going to take at least two years and the notification under Article 50 has not yet been given, and it is currently unclear when such notification will occur.

What should we do about forthcoming EU legislation, e.g. MiFID II?

The answer must be to continue with implementation as planned, and this has been confirmed by the FCA in a statement released shortly after the Referendum result was announced. As MiFID II is to be implemented in Member States by January 2018, within the two year period mentioned above, industry organisations, such as the Investment Association, have established working groups to review implementation plans for MiFID II.

What will happen to existing EU financial services legislation?

In the past much European financial services legislation was in the form of directives which Member States were required to implement e.g. MiFID I. The UK has implemented this legislation into our domestic legal and regulatory framework via UK legislation and rules, including the FCA Handbook, and these will continue to apply unless and until amended to reflect the fact that we are no longer part of the EU. However, more recently there has been a greater tendency for EU law to be in the form of regulation being directly applicable on Member States (aimed at ensuring more consistent implementation across all Member States), most recent examples include the Capital Requirements Regulation and EMIR. Following withdrawal from the EU these regulations will cease to be directly applicable and the UK would need to implement domestic legislation to provide for UK application subject again to such amendments as necessary to reflect the UK's altered status.

Will there be less regulation and/or any relaxations in regulation?

In practice we suspect there to be little reduction or relaxation in regulation. It is important to remember that many of the recent EU regulatory changes impacting the financial services sector have been borne out of global initiatives following the financial crisis, as seen in the enhanced prudential requirements which apply to financial institutions as well as the requirements regarding clearing for derivatives under EMIR. The UK government was a key proponent and participant in many of these initiatives. In addition the UK regulators have traditionally set high standards for financial services firms in the UK both at a prudential level and in relation to conduct standards aimed at protecting the consumer, and so they are unlikely to want to be seen to be lowering standards.

In any event depending on negotiations for withdrawal the UK may well want to be considered to have "equivalent" standards meaning that the scope for relaxations or ignoring new EU legislation is likely to be limited. The subject of equivalence will be one to monitor as negotiations on the UK exit commence. There is however a potential opportunity for the UK to prepare and implement clear and practical financial services legislation which while equivalent to the EU does put the stability and prosperity of the UK's financial services sector at its core.

What will be the impact on passporting rights?

The impact on passporting rights under EU Directives is a key issue for those firms which use them. If a firm's target market is very much UK focused with no European distribution or marketing then this is much less of an issue. For firms looking to access markets in Europe this is a significant issue.

Passporting rights which allow a firm to provide services on a cross-border basis or to set up a branch in another EU country on the basis of authorisation in the firm's home Member State have been an important aspect of a number of European directives including MiFID. Once the UK ceases to be a member of the EU these passporting rights will cease unless we re-join the EEA or otherwise conclude an exit deal which retains them. Without passporting rights firms would need to set up a local subsidiary in the EEA state. This obviously adds to the costs and complexity of doing business.

However, certain recent EU directives have provisions which would allow access to the EU market for non EU firms (third country firms) where the regulatory regime of that third country is considered by the EU as equivalent. Such status takes time to achieve however if the UK chose to retain all existing EU legislation and adopt new incoming EU legislation it would be in a strong position to argue for a prompt declaration of equivalent status. This status would be useful under MiFID II as a firm in the UK would (if we were deemed equivalent) be able to provide services to per se professional clients and eligible counterparties on a cross border basis provided it is listed on a register maintained by the EU regulators. In relation to dealing with retail clients under MiFID II this depends on the target Member State's national regime, but it is likely that the UK firm would have to set up a branch in the target Member State and such Member State would need to be satisfied that the UK met certain key regulatory requirements e.g. as regards anti-money laundering and tax co-operation agreements would be needed. Again the UK would be on strong ground here.

What is the impact on investment funds?

This is likely to be one of the key issues for our clients. There is a difference between funds which fall under the UCITS regime and those that fall under the AIFMD regime. The UCITS directive does not have an equivalence regime for third country firms; a UCITS must be domiciled in a Member State and self-managed or managed by an EU manager. As a result unless there is some concession agreed as part of our exit negotiations, existing UK UCITS would need to be redomiciled or cease being UCITS. This has knock-on implications for investors who require UCITS status as well as master feeder structures involving UCITS funds which have become increasingly popular not least by managers looking to access the EU market via EU feeder vehicles into UK domiciled master UCITS. Two further considerations arise in relation to funds falling under the UCITS regime. First, the ability of UK banks to act as depositaries of UCITS following the UK's exit from the EU needs to be negotiated. As it stands UK banks would not be able to act in such capacity. Secondly, for UCITS funds there is a regulatory 30% restriction on the amount a UCITS can invest in non-UCITS schemes. More widely fund managers and investment managers of segregated investment mandates will need to review investment restrictions in light of the UK's altered status.

AIFMD on the other hand does envisage third party passporting regime for non-EU Member States for equivalent jurisdictions (although this has not yet been implemented) and therefore potentially this status could be negotiated for UK AIFMs, and UK depositaries.

Conclusion

The aftermath of the Referendum result has placed the UK in a position of uncertainty and the decision to leave the EU has significant impact on the financial services sector. A calm, considered approach to the negotiations and a commitment to the importance of the City to the UK's economic stability and future prosperity is clearly required. Negotiating membership of the EEA would, we believe, provide continuity and clarity for the financial services sector however at this stage we have not had any statements from government as to whether this is their preferred approach. Whether or not there will be scope to implement amended legislation which is more practical for UK firms as part of that process is unknown but a potential opportunity for the financial services sector. We shall be working closely with our clients and industry bodies to assist in a positive outcome from the forthcoming negotiations.