For anyone working in the financial services industry one of the main consequences of Brexit is passporting. That this was so rarely referred to during the referendum debate is unfortunate, as the potential loss of passporting rights for UK banks and financial institutions represents one of the biggest potential fallouts from the vote for Brexit.

Although unregulated business may continue to trade across Europe following Brexit, potentially subject to certain restrictions or tariffs, UK based banks and financial institutions may not be granted straightforward rights of access to the EU market.

Although Brexit theoretically frees the UK to adopt its own legislation, such legislative freedom is certainly overstated in the context of financial services. For example, the UK will still need to have in place EU-equivalent legislation or risk being deemed non-equivalent in respect of many EU laws, further restricting the ability of its banks and financial institutions to access the single market.

It should be noted that much of the EU legislation in this area is driven by international organisations of which the UK is an active member. The UK is likely to remain a significant contributor to the work of these international standards setting bodies, such as the Basel Committee on Banking Supervision and the Financial Action Task Force (“FATF”). All operate outside the EU framework and aim to bring global consistency to their various financial services sectors. In reality the UK is unlikely to stop complying with the recommendations of these bodies, or actively shaping their recommendations, simply because it is no longer in the EU.

Whilst it is not possible at this stage to provide concrete proposals on how best UK banks and financial institutions may operate in the EU once the UK formally leaves, this article seeks to outline some of the main issues that UK based banks and financial institutions may face as a result of Brexit, assuming that, as a worst case scenario, UK banks and institutions will be treated as “third country” institutions under EU law.

Banks

Currently UK banks operate across the EEA on a freedom of services and freedom of establishment (i.e. branch) basis. As third country institutions, the most obvious consequence of Brexit will be the loss of these passporting rights; with UK banks no longer permitted to provide banking services on a cross-border basis. This will place significant restrictions on the ability of UK banks to directly engage with EEA customers, potentially limiting them to providing services on a reverse solicitation basis.

UK banks may be able to access the EEA market on a country-by-country basis through the establishment of local branches. Although mention is made of third country branches in the Capital Requirements Directive (2013/36/EU) (“CRD IV”), the applicable rules on access for such branches remain un-harmonised, and whether such authorisation would be available would need to be considered on a country-by-country basis.

In Ireland provision is made for the approval of branches of third country banks under section 9A of the Central Bank Act 1971. Though the approval process is nearly equivalent to the process of obtaining a full banking license and could potentially take a considerable amount of time to obtain. Such an approach would therefore be both time-consuming and onerous, particularly if it was necessary to go through the process in multiple Member States.

UK banks could establish subsidiaries in the EEA that could passport their services into other Member States, but even this approach is not without questions. In particular, the precise arrangements that may be put in place with the FCA/PRA for the purpose of consolidated supervision cannot be anticipated.

There is also a possibility that the relevant group could be required to establish an EEA-based holding company for the purposes of consolidation at EEA-level. How consolidated supervision between EEA subsidiaries and their UK parents will operate is therefore an area of potential uncertainty, which will not only affect any new subsidiaries, but also any existing subsidiaries of UK institutions located in other EEA Member States that are currently consolidated at UK level.

Subject to a determination of equivalence by the Commission, the UK’s change from EU Member State to third country may also affect the manner in which banks’ UK exposures may be treated under the Regulations (EU) No. 575/2013 (“CRR”). Although it is likely that the UK will ultimately be treated as equivalent, the procedural steps required for formal treatment means that until such measures are taken significant uncertainty will remain.

Payment and E-Money Institutions and Fintech Companies

Neither the Payment Services Directive nor the E-money Directive provides for specific access rights for third country institutions on a branch basis or otherwise. The rules relating to access for third country branches of payment and e-money institutions may therefore vary significantly between Member States. Although the E-Money Directive provides for agreements with one or more third countries it is not clear if or when such an arrangement could be put in place between the EU and the UK.

From an Irish perspective, neither the European Communities (Payment Institutions) Regulations 2009, nor the European Communities (Electronic Money) Regulations 2011, make any provision for branches of non-EEA institutions. Therefore, in order to continue providing services, payment and e-money institutions would need to establish a subsidiary in Ireland or another Member State. In theory it may be possible to provide certain services on a reverse solicitation basis, but depending on the nature of those services this may be difficult in practice.

While Brexit will have potentially significant consequences for payment and e-money institutions undertaking regulated activities, the impact on unregulated service providers, for example fintech companies, is less clear. Such entities will not be affected by the loss of passporting rights. However, in light of PSD2, which will pull a significant number of currently unregulated providers into scope, there may be potential issues in future for these providers.

The new regime under PSD2 will provide for payment initiation services and account information providers. This means there may be a significant loss of business and innovation opportunity for UK fintech companies that will not be able to avail of the same rights of access to payment account information and/or payment initiation services as EU-based entities. While a potential issue for all UK entities, since fintech companies are likely to be involved in the processing of customer data, the treatment of the UK as a non-EU country under EU data protection laws will be of particular concern for fintech companies and will need to be considered.

Investment firms

As with payment and e-money institutions, the access regime for third country investment firms is not currently harmonised. It will therefore be necessary for UK investment firms to examine establishing a branch as a non-EU investment firm in each Member State.

As no specific provision is made for the operation of third country branches of investment firms with head offices outside the EEA in Ireland, it will be necessary to establish a subsidiary, or other related company, in Ireland to provide these services generally.

Under both European Communities (Markets in Financial Instruments) Regulations 2007 (“MiFID Regulations”) and the Investment Intermediaries Act 1995, it is possible for non-EEA investment firms to provide services to Irish clients, under what is colloquially known as the “overseas persons exemption”. This provides that an investment firm will not be considered to be “operating in the State” where the investment firm does not have a branch in Ireland, has its head office outside the EEA, and does not provide services to any individuals. This means UK investment firms should be able to continue to provide services to Irish corporate and institutional clients from the UK without the need to establish a subsidiary or otherwise obtain authorisation. For retail clients, however, UK investment firms would be limited to interacting on a reverse solicitation basis only.

For investment firms already operating in Ireland, and which currently use the services of a UK bank or outsource all or part of their services to operators in the UK, Brexit may also affect the considerations and requirements surrounding the continued use of these UK entities. For example, under the Central Bank (Supervision and Enforcement) Act 2013, it is necessary to obtain the client’s consent, inter alia, “where client assets are passed to a third party outside the State or the EEA”.

Whilest the current MiFID regime does not have harmonised provisions on access for branches of third country investment firms, Directive 2014/65/EU (“MiFID II”), which will be implemented across the EEA from 3rd January 2018, seeks to harmonise the requirements for approving branches of third country investment firms. While this harmonisation under MiFID II may create some consistency between Member States, there are still substantive practical prerequisites for permitting third country branches of investment firms. Further, such branches would still lack one of the fundamental advantages of EU and EEA branches, namely the ability to provide services in other Member States.

Notwithstanding the lack of passporting rights generally for third country retail investment firms, Regulation 600/2014/EU (“MiFIR”) does provide an EU-wide third country access regime. However, this will only be available for third country investment firms dealing with professional clients and eligible counterparties. Once registered these third country investment firms will be able to provide services in all Member States.

In summary, for UK retail investment firms seeking to operate in the EU, it will be necessary to go through the third country branch approval process in every Member State in which the institution wishes to operate. The establishment of a subsidiary may therefore remain a more attractive option following the implementation of MiFID II for retail firms. For non-retail firms it would be possible to register with ESMA under MiFIR and provide services in the Member States.

Conclusions

The decision of the UK to leave the EU is a historic decision that will have profound impacts on and implications for the UK’s financial services industry. On the basis that the UK is unlikely to join the EEA or obtain a bilateral arrangement for access for certain sectors, the loss of passporting rights for UK banks and financial institutions seems highly likely.

While UK banks and financial institutions may be able to access the single market in financial services, many questions remain around if and when agreements between the EU and the UK will be put in place and whether such agreements will form part of exit negotiations.