Aware of the risks of regulatory arbitrage developing post-Brexit, a key feature of the Commission’s proposals allows ESAs to monitor the practices of EU27 regulators.

On 20 September, the European Commission (the Commission) published its proposals on strengthening the role of the European Securities and Markets Authority (ESMA) and other European Supervisory Authorities (ESAs) such as the European Banking Authority (EBA) and the European Insurance and Occupational Pensions Authority (EIOPA) in relation to integrated supervision and the furtherance of the Capital Markets Union. The Commission’s proposals take into account the decision of the United Kingdom to leave the European Union (EU). A key feature of the Commission’s proposals is that which allows the relevant ESA to monitor the practices of EU27 regulators in allowing market players such as banks, fund managers, and investment firms to delegate and outsource business functions to third countries to ensure that risks are properly managed and to prevent circumvention of the rules, and to intervene where a national EU regulator intends to carry out the registration or authorisation of a firm looking to outsource or delegate certain activities to third countries.

To UK firms planning for a worse case, “hard” Brexit scenario, whereby the UK becomes a “third country” and UK participants lose their passporting rights, this will be an unexpected development. UK financial market participants have been giving serious consideration to setting up an affiliate in one of the EU27 countries which intends to outsource or delegate its key functions back to the UK in order to retain their passporting rights post-Brexit, without relocating to one of the EU27. Accordingly, many in the UK financial sector will see this as a calculated political move by the Commission to tame the City of London’s influence and to remove from it its ‘centre-stage’ position in European Finance.

However, whilst ESMA and the other ESAs may intervene, the Commission has not gone so far as to give them a definitive veto on the decision of the national EU27 regulators. Instead, the Commission has given ESMA and the other ESAs the power to monitor and opine with the added tool of being able to issue a recommendation to a national EU27 regulator to review a decision or withdraw an authorisation. The extent to which a national EU27 regulator will or must follow an ESA’s recommendation is up to the regulator in question. However, it is clear that ESMA and the other ESAs will be able to exert significant pressure on national EU27 regulators in relation to the registration and authorisation process. The implication is that the Commission is concerned that some national EU27 regulators may be less rigorous when vetting applications by UK firms looking to establish an affiliate in the EU27 to benefit from post-Brexit passporting which intends to outsource or delegate their key functions back to the UK. In short, ESMA is concerned that Brexit may trigger a regulatory race to the bottom whereby national EU27 regulators loosen standards in order to grab some of London’s financial market share. Nevertheless, one practical consequence of these proposals will be to slow the registration and authorisation process of the national EU27 regulators, leading to delays.

Article 31(a) of the Commission’s proposals, which is ominously titled “coordination on delegation and outsourcing of activities as well as risk of transfers”, imposes a number of obligations on national EU27 regulators where they intend to allow an applicant firm to outsource or delegate into third countries:

  1. To notify the relevant ESA of its intention to carry out registrations or authorisations where the business plan of the applicant(s) entails (i) the outsourcing or delegation of a material part of its activities or any key functions, or (ii) the risk transfer of a material part of its activities into a third country, to benefit from the EU passport while essentially performing substantial activities or functions outside the EU. This notification must be sufficiently detailed to allow for a proper assessment by the authority;
  2. To wait, where the relevant ESA considers it necessary to issue an opinion as regards the noncompliance of an authorisation or registration with EU law, guidelines, recommendations, or opinions adopted by it, until it has received that opinion before granting authorisation or registration. The relevant ESA may take up to a maximum of two months to issue an opinion;
  3. To provide, within 15 working days from the date of the relevant ESA’s request, information on its decisions to authorise or register a financial market participant under its supervision with regard to its outsourcing or delegation activities;
  4. To inform the relevant ESA of the notifications it has received from financial market participants in respect of the obligations of the financial market participant set out below; and
  5. To provide within 15 working days where it does not follow the recommendations of the relevant ESA and its reasons for not following the relevant ESA’s recommendation. The relevant ESA shall then make its recommendations public together with the national EU27 regulator’s reasoning.

The Commission proposes that the relevant ESA should be empowered to monitor whether the competent authorities concerned verify that outsourcing, delegation, or risk transfer arrangements are concluded in accordance with EU law, comply with guidelines, recommendations, or opinions from the relevant ESA and do not prevent effective supervision by the competent authorities and enforcement in a third country.

Comparatively, the burden imposed on financial market participants is a light one:

  • The financial market participant must notify the national EU27 regulator of the outsourcing or delegation of a material part of its activities or any of its key functions, and the risk transfer of a material part of its activities to a third-country branch or entity.

Whilst the Commission’s proposals do not constitute a binding authoritative instrument, firms should be mindful of the tone and direction of the proposals emanating from the Commission and factor that aspect into their post-Brexit planning.

The Commission also makes proposals on third country equivalence, the technique whereby the EU can allow market participants based in regulated third countries to do business in the EU on a passported basis. The proposed amendments to Article 33 of the ESA regulations confirm that the ESAs shall assist the Commission in preparing equivalence decisions. In addition, the proposals confirm that the ESAs shall, on an ongoing basis, monitor the regulatory and supervisory developments and enforcement practices in third countries on which the Commission has taken an equivalence decision.