ESMA's review may affect firms intending to rely on outsourcing or delegation to minimise the business impact of the loss of passporting.

In a speech that was ostensibly on the progress of the Capital Markets Union, Steven Maijoor, the Chair of the European Securities and Markets Authority ("ESMA") announced, that ESMA is planning possible measures to avoid a regulatory "race to the bottom," in which EU member states relax their oversight of regulatory standards in order to attract relocating UK businesses. This comes as UK-headquartered firms consider their post-Brexit options. It particularly impacts those planning on retaining substantial operations and facilities in the UK by outsourcing or delegating to the UK from a subsidiary authorised within the EU to service EU business.

According to Mr Maijoor, ESMA is planning to encourage a common European set of standards (known as "supervisory convergence") for financial services regulators in EU member states and is considering further supervisory powers for ESMA. In pursuance of this end, ESMA says that it will:

  • publish a general opinion on key issues for regulators relating to UK firms transferring business into the EU, which may potentially include new limitations on outsourcing and delegation by EU firms;
  • publish three sector-specific opinions on the relocation of asset management, investment firms, and secondary markets activity; and
  • create a mechanism for national regulators to coordinate a common response to authorising significant relocations of UK firms seeking entry to the EU market.

The issue of supervisory convergence has been brought into sharp focus by Brexit due to the prospect of passporting rights ceasing to work across a UK/EU border. Financial services firms based in the UK who currently rely on passporting to provide cross-border services into the EU27 will need to rely on a different structure to access those markets post-Brexit. In many cases this will involve the establishment of a new EU-based regulated entity to service EU business. ESMA is looking to close any potential "back door" to EU access by firms who use an EU27 entity as a brass-plaque and leave the bulk of their operations in the UK.

There are other signs that EU authorities are worried by the prospect of regulatory arbitrage by UK firms. The European Central Bank ("ECB") has also recently warned of a "supervisory or regulatory race to the bottom" by UK firms seeking to re-enter the EU market. The ECB also confirmed its position that UK firms will not be allowed to avoid regulatory requirements by outsourcing activities back to London from an EU shell company.

Bidding for British business

ESMA's proposal must be understood in the context of competition for British business post-Brexit. Many of the Member States have been making plays to take on UK business as financial institutions try to get their affairs in order before the UK leaves the EU, with active marketing campaigns and even dedicated units within national regulators.

Notably, Luxembourg has claimed the legal right to host the European Banking Authority "EBA" when the regulator leaves London after Brexit. Recently, M&G Investments announced that it will redomicile UK funds in Luxembourg, and AIG has confirmed Luxembourg as its new European base. But Luxembourg's bid may even have contributed to the review with Ireland – another keen suitor of post-Brexit business – allegedly crying foul over Luxembourg purportedly enticing firms with a more relaxed approach to regulation.

New game, new rules

The ECB's comments last month came as no real surprise. There are already prudential rules within a home state regulator's jurisdiction that require a firm to have its mind and management "on location", to have adequate systems and controls over its business and to maintain oversight of any outsourced function. But, if these rules are already in place, what need of ESMA's further guidance? ESMA's intent could be to bring clarity of supervisory approach to the existing framework. Or it could be an opportunistic power play to expand the remit of the EU institutions that risks creating deeper division among the EU27.

In reality, the existing rules on outsourcings are found in a patchwork of directives, directly applicable regulation and domestic implementing measures and are reflected in jurisdiction-specific best practices. The emphasis from ESMA on a harmonised supervisory approach may have advantages in improving clarity and consistency for firms who wish to understand what their options are for using an authorised group entity within the EU27 combined with robust outsourcing to the UK. However a harmonised approach may not work equally well for all Member States.

In any event, this is a reminder that we might think we understand the rules of the game today, but now that we aren't in the game, the rules could change tomorrow.