The post-Brexit regulatory landscape for UK investment firms has come into increased focus after it was announced on 26 February 2019 that the Council of the EU and the European Parliament had reached a provisional agreement on a new regulatory and supervision framework for investment firms.
Different requirements for different risk profiles within the EEA
Investment firms in the EEA are subject to the same capital, liquidity and risk management rules as banks. However, the current framework does not take into account the specificities of investment firms in comparison with firms in the banking sector. For example, risk sensitivity in the existing framework is based upon the underlying type of investment service and activities for which the firm is authorised; however, it does not consider matters such as risk of harm to customers, market impact, or risk to financial stability. The new EU framework will change this.
While investment firms will continue to be subject to the same key measures as banks, for example as regards capital holdings, reporting and governance, the new framework will see specific requirements for investment firms vary according to the size, nature and complexity of the firm.
Investment firms holding high value assets (exceeding EUR 15 billion) and providing “bank-like” services will continue to be treated as credit institutions and fall under the full banking prudential regime. Nothing much will change for these “class 1” firms.
Smaller firms that don’t have the same weight in the financial stability system will “enjoy a new bespoke regime with dedicated prudential requirements” different from those applying to banks. The draft legislation provides for a five year transitional period to enable smaller firms to adapt. However, competent authorities will allow smaller firms (on a case by case basis) to continue applying bank requirements in order to avoid disrupting their business models (subject to a safeguard to prevent firms exploiting this option for regulatory purposes).
New equivalence requirements for third country firms
Of particular note to UK-based firms, the agreement also clarifies and strengthens the equivalence regime that would apply to third country investment firms. These rules will apply to all non-EEA countries and will be relevant to UK firms after Brexit.
Last year, the UK Government legislated for a temporary permissions regime that will temporarily allow EEA firms currently operating in the UK to continue providing their services after Brexit. Those firms will be able to apply for full authorisation from UK regulators while on the temporary passport. However, these measures are unilateral: without reciprocal steps being taken by the EU to maintain UK firms’ access rights to the EEA, UK investment firms will be treated in the same manner as those of third countries. For more information read our legal update on financial services.
Under the new EU regime, and in the absence of an agreement to the contrary between the UK and EU, UK investment firms will have to comply with tighter rules in order to operate within the EEA. Under the terms of the provisional agreement, additional powers are granted to the European Commission to make sure that third country requirements, in particular capital requirements applicable to non-EEA firms providing bank-like services, are “equivalent”. Moreover, in situations where the activities undertaken by the third country firm are considered to be of “systemic importance”, the Commission will have the power to impose specific operational conditions to any previously made equivalence decision to ensure that the European Securities and Markets Authority (ESMA) and national competent authorities are able to engage in ongoing monitoring of such firms and to reduce the potential for regulatory arbitrage opportunities.
What can UK firms do to prepare?
The new EU framework provides some welcome clarity in respect of the regulatory requirements that the UK financial services industry may be required to adhere to following Brexit, in the absence of any agreement between the UK and the EU to the contrary. Under the EU regime, close compliance with EU standards will be required, and UK investment firms will have to navigate additional hurdles in order to gain access to the EEA financial market.
It is expected that the proposed new framework will be adopted by the European Parliament and the Council of the EU in due course.