On the morning of the Referendum result, the Financial Conduct Authority issued a statement on BREXIT. It included the following:

“Much financial regulation currently applicable in the UK derives from EU legislation. This regulation will remain applicable until any changes are made, which will be a matter for Government and Parliament. Firms must continue to abide by their obligations under UK law, including those derived from EU law and continue with implementation plans for legislation that is still to come into effect.”

The short term impact of BREXIT

The short term legal effect which the FCA statement highlights can be summarised as follows:

Issue

Right/duty

Impact

Current EU laws

Both

No immediate impact – UK law giving effect to EU Directives such as MiFID, CRD, AIFMD, the UCITS Directive and Solvency II continue to apply. EU Regulations such EMIR, the ELTIF Regulation and MiFID, AIFMD and UCITS Level 2 Regulations continue to apply.

Powers of EU authorities

Duty

Immediate impact unlikely – powers of European Supervisory Authorities (EBA, ESMA and EIOPA) to take action against FCA or PRA for non-compliance with EU law continue – extent to which ESAs would be willing to take action is less clear

Passporting

Right

No immediate impact – rights of UK authorised firms to provide cross-border services into, operate branches in or market products in other EEA Member States and same rights for EEA Member State firms passporting into the UK continue.

Forthcoming EU laws

Both

Immediate impact unlikely – UK is obliged to implement EU Directives and enforce EU Regulations – the extent of the UK’s influence until BREXIT on negotiating the content of such laws is less clear.

Legal uncertainty prior to exit?

“An important proviso to the statement is missing. New uncertainties could affect the viability of regulatory developments in the short term. Although, in fairness to the FCA as the UK authority charged with implementing and enforcing rather than making UK law, it would be difficult to set this out as”, said Andrew Henderson, partner at Eversheds.

"The telling point is that EU law and regulations continue to apply until changes are made, which the FCA states will be a matter for the government and parliament. There is nevertheless a 'but', which the statement does not highlight," he said.

Henderson, a former constitutional law lecturer, said the mechanism for leaving the EU was set in Article 50 of the Treaty on European Union, which says the Treaty ceases to apply from the date of entry into force of a withdrawal agreement or failing that, two years after the notification of withdrawal was notified.

Before that should happen, he said there was legal uncertainty whether a court in the UK would allow any attempt by a Westminster Parliament to interfere with rights provided under EU financial services directives or the scope of any directly applicable EU regulation.

"Any such interference could come, for instance, in the Westminster Parliament seeking to amend the Financial Services and Markets Act 2000 to change its scope or giving the power to the FCA or Prudential Regulation Authority to make rules,” Henderson said.

"If UK legislation was enacted seeking, for example, no longer to recognize the inward passporting rights of an European Economic Area firm before the UK formally left the EU, a UK court could, under current judge-made constitutional law principles, refuse to apply the amended act," he said.

The hypothetical FCA criminal prosecution

Henderson explained a hypothetical scenario assuming that, before BREXIT, a French asset manager should market its services into the UK, having complied with requirements under Article 31 of the Markets in Financial Instruments Directive offers its services to retail investors, and the FCA should seek to prosecute the asset manager for breach of the General Prohibition and Financial Promotion Restriction because FSMA no longer recognises EEA firms as authorised persons.

He said the asset manager could challenge the prosecution on the grounds that the FSMA amendment was improper because, until the UK formally left the EU, parliament was still bound to observe EU law.

"The uncertainty is whether a court, faced with an act passed by the Westminster parliament, acting as a sovereign parliament under the basic constitutional principle of 'what the Queen in Parliament enacts is law', underpinned by a recent expression of popular will, would, in effect, strike down the FSMA amendment," Henderson said. “The recent Supreme Court decision High Speed Rail 2 suggests that the current Supreme Court would give priority to fundamental UK constitutional principles over EU law. However, the position is uncertain.”

UK rules interfering with directly applicable EU regulation

He said if, in another hypothetical scenario, the FCA should decide to make rules removing or adding requirements under, for example, the UCITS V level 2 EU Regulations governing depositaries, an interested party could judicially review this on the basis that a member state may not alter the content of a directly applicable EU regulation.

"So long as we remain a member of the EU, the question of the government's and Parliament's freedom to make rules interfering with EU law remains," he said.

He said if a UK government started to relax laws for UK firms but not for inward passporting firms in preparation for BREXIT, there could be a risk of legal challenge.

"There are very clear principles of EU law, that any rules made by a member state must not favour its citizens ahead of the citizens of other member states.

"If the UK said that it was imposing more onerous rules on the passported branches of European Economic Area firms, this would be a clear breach of this principle."

The worst case scenario for UK asset managers

Turning to a different issue, he said once BREXIT happens, asset managers risk a worst-case scenario that they cannot exercise a third country right under the Alternative Investment Fund Managers Directive or, later, MiFID II and offer services into an EEA member state. Instead they would have to establish a fully authorised subsidiary.

"This would happen if the European Commission refused to make an equivalence determination."

He said if the content of UK regulation should change significantly from as at present, or if it did not follow changes in EU law, the worst case scenario could arise.

"Such an outcome cannot be ruled out, although the UK would be subject to international standards set by, for example, the International Organization of Securities Commissions, which would limit divergence."

EEA Membership

Henderson said, alternatively, the UK could be a member of the EEA, and then would become like Norway, in which case passporting rights would apply. As far as financial services regulation was concerned, it would generally be business as usual.

Third country rights under the AIFMD and MiFID 2 but not under the UCITS Directive

As a third alternative the UK could seek to rely on third country rights, expected under the AIFMD and MiFID II, which meant that, subject to satisfying certain conditions, the UK could set up in whatever member state of reference it nominated or, under MiFID II, become registered with the European Securities and Markets Authority.

"This outcome depends on the European Commission recognising the UK as equivalent and it is likely to happen if the UK does not diverge from EU law."

He said the third-country rights assumed that asset managers only targeted professional clients. "Where they target retail clients by, for example distributing UCITS funds, third country rights would not be available unless the current regimes are changed."

The article was first published on complinet.com (subscription required)