3 june 2016
Financial Services Regulatory Group Bulletin: Brexit
in this issue: Introduction
Brexit and Financial Services Q&A 2 Brexit: Implications for Ireland's Financial Service Providers 5 Brexit: Implications for UK Financial Service Providers 7 Key Contacts
Financial Services Regulatory Group Bulletin
in this issue: Introduction Brexit and Financial Services Q&A 2 Brexit: Implications for Ireland's Financial Service Providers 5 Brexit: Implications for UK Financial Service Providers 7 Key Contacts
Ambrose Loughlin Partner, Head of Financial Services Regulatory Group
John Cronin Partner, Head of Brexit Group
Introduction
On 23 June 2016 the United Kingdom will vote in a referendum to decide its future in the European Union - to remain or to leave (Brexit). A vote to leave the EU will have significant consequences for the financial services industries in the UK and Ireland.
For the UK, the consequences of a Brexit could include a challenge to the City of London's competitive advantage, restrictions on the freedom to provide services to the post-Brexit EU and on rights to establish businesses, and the UK becoming, in EU parlance, a so-called "Third Country" for financial services purposes. In addition, certain euro-denominated markets (eg wholesale banking) may, or may be forced to, move to the EU, and future liberalising initiatives such as the Capital Markets Union may happen in the EU but not benefit UK based banks and financial institutions.
For Ireland, the interests of our financial services industry are closely aligned with those of the UK. A Brexit could bring short and medium term gains - for example, there are some Irish solutions to a number of potential issues that could arise for UK investment funds - however, the longer term position would be uncertain and could be somewhat insecure. We have benefited from the UK's market strength and size in policy discussions regarding, and legal and regulatory changes affecting, financial services and without its presence at the negotiation table our interests could be impacted adversely.
McCann FitzGerald has established a cross-sector group that advises and represents Irish and international business clients on the legal, regulatory and tax implications of a possible Brexit. This special edition of the FinReg Bulletin considers some of the possible consequences of a Brexit on Ireland's financial services landscape.
Financial Services Regulatory Group
The Financial Services Regulatory Group forms part of McCann FitzGerald's wider Finance Group which is the leading practice in the Irish market. Our Financial Services Regulatory Group advises credit institutions, (re) insurance undertakings and other clients on the complex regulatory and compliance issues that arise in the area of financial services including the administrative sanctions process, regulatory capital requirements, the provision of retail and wholesale financial services, insider dealing and market abuse issues, consumer credit matters and anti-money laundering issues.
1 | mccann fitzgerald 3 june 2016
Financial Services Regulatory Group Bulletin
in this issue: Introduction Brexit and Financial Services Q&A 2 Brexit: Implications for Ireland's Financial Service Providers 5 Brexit: Implications for UK Financial Service Providers 7 Key Contacts
Brexit and Financial Services Q&A
What is Brexit?
On Thursday 23 June 2016 the UK will vote on whether or not it wishes to remain part of the EU, referred to as the Brexit (British exit) referendum. The legal basis for the referendum is established by the European Union Referendum Act 2015. The question that is to appear on the ballot paper is "Should the United Kingdom remain a member of the European Union or leave the European Union?" with the responses to be marked with a single (x):
Remain a member of the European Union
Leave the European Union
Why is the UK holding a referendum on EU membership?
The referendum is a consequence of an electoral promise made by David Cameron, in respect of his 2015 election campaign, to hold a referendum on Britain's EU membership following a renegotiation of its membership terms.
The UK's initial decision to become a member of the EU's predecessor, the European Economic Community ("EEC") was approved by 67% of UK voters. However, UK enthusiasm for EU membership has consistently lagged behind that of other EU member states and David Cameron's promise was made in response to vocal Euro scepticism both among conservative backbenchers and the general public.
What will happen in the financial services sphere if the UK votes to remain in the EU?
If the UK votes to stay in the EU a new settlement altering the terms of the UK's existing relationship with the EU will enter into force. This settlement was agreed in February 2016, following negotiations between the British Prime Minister, David Cameron, and the European Council. In so far as financial services are concerned, the settlement means, among other things, that:
the UK will not be obliged to sign up to EU measures aimed at deepening economic and monetary union;
natural or legal persons established in the UK will not be discriminated against on the basis of its currency;
EU law on Banking Union will only apply to credit institutions in the euro area and in other EU member states that have opted-in to Banking Union;
the UK will not have budgetary responsibility for measures to safeguard the Euro area;
it is for the UK to implement measures to preserve its own financial stability, unless it wishes to join common mechanisms open to its participation; and
the UK will be able to participate in all deliberations of the EU's Council of Ministers including deliberations on matters where the UK does not have a vote.
These benefits will not apply exclusively to the UK, but more generally to other member states not participating in the operation of the Eurozone.
What will happen if the UK votes to leave the EU?
Opinion is divided regarding the likely repercussions of a Brexit. However, the IMF's World Economic Outlook Too Slow for Too Long, published in April 2016, states that "a `Brexit' could do severe regional and global damage by disrupting established trading relationships". According to that Outlook:
"A British exit from the EU could pose major challenges for both the United Kingdom and the rest of Europe.... A UK exit from Europe's single market would also likely disrupt and reduce mutual trade and financial flows, curtailing key benefits from economic cooperation and integration such as those resulting from economies of scale and efficient specialization."
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Financial Services Regulatory Group Bulletin
in this issue: Introduction Brexit and Financial Services Q&A 2 Brexit: Implications for Ireland's Financial Service Providers 5 Brexit: Implications for UK Financial Service Providers 7 Key Contacts
Brexit and Financial Services Q&A (continued)
Will the financial services "passport" survive a Brexit?
The post-Brexit fate of the financial services passport depends largely on the contours of the UK's relationship with the EU, when it becomes a "Third Country". However, it is unlikely that the passport would continue to apply in its current form. For example, countries which are part of the European Economic Area ("EEA") have the closest relationship with the EU outside of actual membership. However the passport does not apply to EEA member states in the same way as it does to EU member states. Specifically, before EU legislation applies to EEA member states it must be incorporated into the EEA Agreement and currently there are several significant pieces of financial services legislation which have not yet been incorporated, including EMIR. Other types of arrangements entered into between the EU and other countries do not include passporting rights either at all or in the area of financial services. For example, the EU's bilateral arrangements with Switzerland do not provide for free access to the single market for financial services.
What other impact is a Brexit likely to have on financial services?
A Brexit is likely to have a number of broader implications for financial services. Specifically regulatory divergences between Ireland and the UK could increase over time, depending on the framework regulating the UK and EU's post-Brexit relationship. However, the fact that the EU's financial services law is heavily influenced by international regulatory measures may help minimise the extent of future divergences in at least some areas.
Politically, Brexit is likely to change the balance of power within the EU, again with possible implications for financial services. Currently, the UK's presence at the EU's negotiating tables carries significant weight, based in part on the City of London's pre-eminence in financial services. In most cases, Ireland takes a similar position on the direction of EU policy. Following a Brexit the weight of
Ireland's voice will inevitably be diminished. The UK's departure is also likely to impact on the EU's global standing, again with potential repercussions for financial services.
How would the UK exit the EU?
Article 50 of the Treaty on European Union sets out the process for leaving the EU. Under that Article, when a member state decides to withdraw from the EU, it must notify the European Council of its decision. This then triggers a two year period during which the EU must negotiate and conclude an agreement with the departing member state setting out the arrangements for its withdrawal, and taking account of the framework for its future relationship with the EU. The EU Treaties will cease to apply to the member state either when the withdrawal agreement enters into force, or, failing that, two years after the notification to leave. However, the two year period can be extended, albeit only on the basis of the unanimous agreement of both the UK and the European Council.
Will there be a second referendum if the UK votes in favour of Brexit?
The UK Government has discounted the possibility of a second Brexit referendum. Moreover, the Article 50 withdrawal procedure does not provide for the revocation of a withdrawal notification and it is at least legally doubtful whether this is even possible. It is also worth noting that the European Council has agreed that, should the result of the referendum be a vote to leave the EU, the new settlement for the UK, agreed in February, would cease to exist. This means that in addition to the possibility that the UK would be able to negotiate a more favourable settlement, there is also the risk that the terms currently on offer would no longer be an option.
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Financial Services Regulatory Group Bulletin
in this issue: Introduction Brexit and Financial Services Q&A 2 Brexit: Implications for Ireland's Financial Service Providers 5 Brexit: Implications for UK Financial Service Providers 7 Key Contacts
Brexit and Financial Services Q&A (continued)
How long will it take for the UK to exit the EU?
It is difficult to forecast how long the exit process is likely to take as there are many variables at play. According to the UK Government, if voters support Brexit it will trigger the withdrawal period immediately. The question then arises as to whether or not a two year period will be sufficient to negotiate and conclude the UK's withdrawal. This is unlikely. For example, Greenland's exit from the EEC in 1985 took the best part of three years to conclude although the exit negotiations were largely focussed on fishing rights. The EUCanada Trade Agreement has taken seven years to negotiate so far and still has to be ratified by the Council of Ministers, the European Parliament and the national parliaments.
What should Irish FSPs and UK FSPs ("FSPs") that have passported into Ireland be doing to prepare for a Brexit?
A vote to leave the UK will signal the start of the Brexit process. While the UK's withdrawal is likely to take a number of years, FSPs will have no time to waste if they wish to prepare for a changed financial services environment. It is our strong recommendation that FSPs start planning for a Brexit immediately following a yes vote, including putting in place an internal review and policy team to assess the impacts of Brexit on the relevant FSP's business model and engaging external advisors where necessary.
UK exit negotiations are likely to be complex and detailed given both the size of its economy and the depth of its integration in the EU. According to the UK Government it could take up to a decade or more for the UK to fully withdraw from the EU. This of course presupposes that another EU member state does not veto an extension of the withdrawal process, which would lead to the UK leaving the EU at the end of the two year period, potentially without any final agreement regarding future EU-UK relationships.
4 | mccann fitzgerald 3 june 2016
Financial Services Regulatory Group Bulletin
in this issue: Introduction Brexit and Financial Services Q&A 2 Brexit: Implications for Ireland's Financial Service Providers 5 Brexit: Implications for UK Financial Service Providers 7 Key Contacts
Brexit: Implications for Ireland's Financial Service Providers (Irish FSPs)
The UK's departure from the EU will have particular implications for many Irish FSPs, given the strong links between the UK and Ireland's financial services sectors. The two key questions for Irish FSPs would be whether they would continue to have access to the UK's markets and, if so, under what conditions. To a large extent, the response to both questions depends on the regulatory framework governing postBrexit EU-UK relationships.
Post-Brexit Options
So far there is little to indicate what sort of post-Brexit EU relationship the UK would seek. There is also very little indication as to what the EU would be prepared to accept. Broadly, there are five existing potential models for consideration.
Joining the EEA - the Norwegian Model: the EEA currently comprises the EU member states, in addition to Norway, Iceland and Liechtenstein. It is based on the EU's primary legislation which was in force at the time of the EEA Agreement's entry into force, and on secondary legislation (EEA-relevant regulations, directives, decisions and certain non-binding instruments). The common rules of the EEA Agreement are updated continuously with new EU legislation.
EU financial services rules largely apply to the EEA, including passporting rights. This means that if the UK becomes part of the EEA, there is relatively little scope for regulatory divergence. However, as previously mentioned, before EU rules apply to the EEA member states they must first be incorporated into the EEA Agreement. While recent years have seen some acceleration in the incorporation process, there are still a significant number of acts awaiting incorporation, including for example, the Alternative Investment Fund Managers Directive, EMIR and CRD IV.
Joining EFTA - the Swiss Model: EFTA is an intergovernmental trade organisation and free trade area. It comprises the EEA member states plus Switzerland. Switzerland has also entered into a series of bilateral sectoral arrangements with the EU. While these
arrangements do not cover financial services, Switzerland has unilaterally decided to keep its laws and regulations close to that of the EU and around 40% of Swiss legislation derives from EU law. Consequently while there are no passporting rights between the EU and Switzerland, there is a substantial overlap between the applicable legal and regulatory requirements.
Customs Union - the Turkish Model: the EU and Turkey are joined by a Customs Union agreement which came into force on 31 December 1995. The Customs Union covers all industrial goods but does not address agriculture (except processed agricultural products), services or public procurement. Bilateral trade concessions apply to agricultural products.
Bilateral Trade Agreement - the Canadian Model: the EU and Canada have concluded the Comprehensive Economic and Trade Agreement ("CETA") which removes all tariffs on goods and most agricultural products and includes substantial commitments on services and other regulatory issues. However, the agreement does not include passporting rights nor does it provide for the free movement of capital. Moreover, Canada is not required to comply with EU financial services measures.
Third Country Access - the Australian Model: the UK and the EU could conclude an exit agreement that does not provide for any formal UK-EU relationship, in which case trade relations would be governed by the rules set by the World Trade Organisation. Passporting rights would not apply and there would be considerable scope for regulatory divergence, the extent of which would depend on the relevant area.
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Financial Services Regulatory Group Bulletin
in this issue: Introduction Brexit and Financial Services Q&A 2 Brexit: Implications for Ireland's Financial Service Providers 5 Brexit: Implications for UK Financial Service Providers 7 Key Contacts
Brexit: Implications for Ireland's Financial Service Providers (Irish FSPs) (continued)
Commentary
With the exception of the EEA model, the adoption of each of the potential models discussed above is likely to mean more restricted access by Irish FSPs to the UK's financial markets.
Those models may also mean increased regulatory divergences, raising the prospect of Irish FSPs being required to meet two sets of regulatory requirements. However, initially at least we do not expect there to be any significant changes in UK post-Brexit financial services regulation and while regulatory divergences may happen over time, this is not a foregone conclusion. In particular, continued access to EU markets on the part of UK FSPs is likely to depend on the UK having in place a regulatory regime which is equivalent to that applicable in
the EU. Moreover, as previously mentioned (pg 3), some areas of EU financial services legislation are heavily influenced by international standards and these standards would continue to impact on UK financial services regulation.
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Financial Services Regulatory Group Bulletin
in this issue: Introduction Brexit and Financial Services Q&A 2 Brexit: Implications for Ireland's Financial Service Providers 5 Brexit: Implications for UK Financial Service Providers 7 Key Contacts
Brexit: Implications for UK Financial Service Providers (UK FSPs)
A significant number of UK FSPs operate in Ireland (and in other EU member states) on either a freedom of services basis or through the establishment of a branch. A vote to leave the UK would raise specific issues for these firms, again depending on the regulatory framework governing a future post-Brexit UK-EU relationship. This section outlines the extent to which "Third Country Firms" (eg, firms established in a country which is not an EEA member state) can currently provide financial services within the EU, as well as considering other potential options for accessing EU markets, such as establishing an Irish branch or subsidiary.
Credit Institutions
On the positive side, a UK bank would still be able to offer loans to Irish SMEs as this is not a regulated activity in Ireland. However, any UK Bank that is relying on passporting rights to provide regulated services in Ireland to consumers on a crossborder services basis or through an Irish branch would either need to:
requirements apply depending on whether the relevant client is a) a retail client or an opted-up professional client (eg, a retail client who has requested to be considered a professional client), or b) a per se professional client or eligible counterparty.
Retail Clients and Opted-up Professional Clients
apply for authorisation as a third country branch;
establish a subsidiary in Ireland; or
establish a subsidiary in another EU member state and passport into Ireland on a cross-border services or branch basis.
Each of these options could involve significant restructuring operations, including transferring senior staff members. Depending on the degree of divergence between post-Brexit UK and EU financial services requirements, it could also mean complying with two different legal and regulatory regimes.
MiFID Investment Firms
Under MiFID II, the ability of a UK FSP to offer investment services or perform investment activities, either on a cross border services basis or by way of an EU branch, will depend largely on the status of the relevant client. Specifically, under MiFID II different
Under MiFID II Ireland will have the option of requiring any Third Country Firm seeking to offer investment services or perform investment activities to retail clients and opted-up professional clients in Ireland to establish a branch in Ireland and obtain a prior authorisation from the Central Bank ("Authorised Branch"). The MiFID II Directive sets out a number of conditions that must be fulfilled before such an authorisation can be granted. There is no EU passport available for an Authorised Branch in respect of the provision of services to retail clients or opted-up professional clients in other member states.
MiFID II is silent as to whether or not a Third Country Firm may provide investment services or perform investment activities to retail clients and opted-up professional clients in an EU member state where that State does not require the firm to establish a branch in the State. It appears that in such circumstances, national rules continue to apply.
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Financial Services Regulatory Group Bulletin
in this issue: Introduction Brexit and Financial Services Q&A 2 Brexit: Implications for Ireland's Financial Service Providers 5 Brexit: Implications for UK Financial Service Providers 7 Key Contacts
Brexit: Implications for UK Financial Service Providers (UK FSPs)
(continued)
Per Se Professional Clients and Eligible Counterparties
MiFID II provides that a Third Country Firm may provide investment services to eligible counterparties and per se professional clients on a cross-border basis where it is registered with the European Securities and Markets Authority ("ESMA"). ESMA will only register a Third Country Firm where certain requirements are fulfilled. These include that:
the European Commission has adopted an equivalence decision to the effect that the Third Country Firm's home country applies prudential and business conduct requirements equivalent to those set out in MiFID II and CRD IV; and
there is a co-operation arrangement in existence between ESMA and the Third Country Firm's national competent authority which, among other things, relates to the exchange of information and co-ordination of supervisory activities.
If at any time there is no effective Commission equivalence decision in respect of any Third Country, member states may permit investment firms from that Third Country to continue to provide investment services to eligible counterparties and per se professional clients, in accordance with national law.
Where a Third Country Firm has established an Authorised Branch in an EU member state to provide MiFID services that firm will be permitted to provide its investment services to, and to perform investment activities throughout the EU for eligible counterparties and per se professional clients without the need to establish further branches as long as that firm is established in a country whose legal and supervisory framework is recognised as broadly equivalent by the European
Commission. The Authorised Branch will need to comply with the information requirements for the cross-border provision of services and activities under MiFID II. In these circumstances, it appears that there is no requirement for the branch to register with ESMA as a permitted Third Country Firm when providing cross border services.
Insurance
Following a Brexit, a UK established insurance firm will no longer automatically be able to passport into Ireland on either an establishment or a services basis in order to underwrite risks or commitments in Ireland. A UK firm with an existing Irish branch, or that wished to establish such a branch would have to apply for authorisation from the Central Bank. The branch would not enjoy any passporting rights and, as in the case of banks, in order to avail of such a right, a UK-established insurance firm would need to establish a subsidiary within the EU, which could then passport to other member states. The provision of services would depend on the UK meeting EU equivalence criteria.
Investment Funds
UK alternative investment fund managers ("AIFMs") will be treated as non-EU AIFMs and will only be able to market alternative investment funds to EU investors under private placement arrangements. While AIFMD provides for a non-EU passport permitting non EU domiciled and managed funds to be marketed within the EU if the manager is authorised and certain other conditions are met, it is not yet clear whether such a passport will be introduced.
8 | mccann fitzgerald 3 june 2016
Financial Services Regulatory Group Bulletin
in this issue: Introduction Brexit and Financial Services Q&A 2 Brexit: Implications for Ireland's Financial Service Providers 5 Brexit: Implications for UK Financial Service Providers 7 Key Contacts
Brexit: Implications for UK Financial Service Providers (UK FSPs)
(continued)
UK domiciled UCITS would be fundamentally impacted as, on the basis of current requirements, these would need to be EU domiciled and managed by an EU UCITS management company. This also holds true for European Long Term Investment Funds.
Payment Service Providers
Brexit could also mean restricted EU market access for UK payment service providers. It is likely that certain UK payment service providers would need to become authorised in a member state following a Brexit if they wish to continue doing business in the EU. However, once authorised, those payment service providers would then benefit from passporting rights throughout the EU.
EMIR
UK Central Counterparties ("CCPs") would be likely to be treated as "Third Country CCPs" meaning that they would have to be recognised by ESMA if they wish to continue offering their services to EU based financial institutions. Before granting such recognition, ESMA would need to be satisfied that the UK regulatory regime is equivalent to that of the EU. This would not necessarily be a straightforward process, especially in light of the protracted and controversial negotiations surrounding the equivalence decisions for US CCPs (see our related briefing here).
Commentary
At the moment, UK FSPs enjoy passporting rights to Ireland and other member states encompassing both the right to offer cross border services and the right to establish a branch. These rights could be significantly impacted in the event of a Brexit, although the scope of that impact will largely depend on the terms of the agreement governing UKEU relations post Brexit.
The combination of uncertainty and the prospect of disappearing passport rights will undoubtedly mean that some UK FSPs will wish to consider how to manage their future relations with the EU and what measures they need to put in place in this regard, should the UK vote in favour of a Brexit.
UK FSPs thinking of establishing a branch or subsidiary within the EU may be advised to consider establishing in Ireland. This would minimise the disruptive potential of moving to a new location given Ireland's closeness to the UK, particularly in linguistic and legal terms. For the most part, Ireland has implemented EU financial services legislation with little or no "gold-plating". Consequently, to the extent that there are differences between the UK and Irish legislative frameworks, these are likely to mean that UK FSPs will find the Irish framework less, rather than more, restrictive that that currently applicable in the UK.
On the regulatory side, while UK FSPs may find that there is less published guidance on the applicable requirements, Ireland has an excellent professional services offering which can help alleviate any difficulties in this regard.
We expect the option of establishing in Ireland to be very attractive to firms with a European-wide presence and, in particular, to those operating in areas where Ireland has already developed a significant industry, for example, in the area of lease finance.
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Financial Services Regulatory Group Bulletin
key contacts
Financial Services Regulatory Group
in this issue: Introduction
Brexit and Financial Services Q&A 2 Brexit: Implications for Ireland's Financial Service Providers 5
Brexit: Implications for UK Financial Service Providers 7 Key Contacts
Ambrose Loughlin Partner, Head of Financial Services Regulatory Group
ddi +353-1-607 1253
email ambrose.loughlin@ mccannfitzgerald.com
Fergus Gillen Partner, Head of Finance Group
ddi +353-1-611 9146
email fergus.gillen@ mccannfitzgerald.com
Adrian Farrell Partner, Finance
ddi +353-1-607 1312
email adrian.farrell@ mccannfitzgerald.com
Josh Hogan Partner, Finance
ddi +353-1-607 1720
email joshua.hogan@ mccannfitzgerald.com
Judith Lawless Partner, Finance
ddi +353-1-607 1256
email judith.lawless@ mccannfitzgerald.com
Darragh Murphy Partner, Finance
ddi +353-1-607 1433
email darragh.murphy@ mccannfitzgerald.com
Peter Osborne Consultant, Finance, Corporate
ddi +353-1-611 9159
email peter.osborne@ mccannfitzgerald.com
Roy Parker Partner, Finance
ddi +353-1-607 1249
email roy.parker@ mccannfitzgerald.com
Brian Quigley Partner, Dispute Resolution & Litigation
ddi +353-1-607 1471
email brian.quigley@ mccannfitzgerald.com
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McCann FitzGerald, June 2016
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