This was a quiet week for Brexit news in the financial services sector. Her Majesty’s Government has yet to publish any detailed information about the proposals that it has announced for EU/UK financial services after the UK leaves the single market. Detailed analysis of the impact of Brexit (by UK parliamentary committees) is restricted to looking at how regulation/DRC would operate under the EU’s proposals (which offer much reduced market access/DRC under its third country framework). There is continued interest in the EU’s plans for developing this third country framework ahead of Brexit. Despite the optimistic position of HMG, the Brexit timetable (as well as the outcome) remains uncertain.

Where we stand: The draft Withdrawal Agreement provides for a transition period from 29/03/19 to 31/12/20 during which the EU single market legislation, and its dual regulation coordination (DRC)/mutual recognition, would continue to apply to the UK. The UK has proposed (see Philip Hammond's speech of 7 March) that after the transition period, the EU/UK relationship in financial services should be a bespoke bilateral arrangement for DRC and mutual recognition of each side’s rules, based on international standards and equivalent outcomes (without requiring identical rules on each side). The rationale is that the EU and UK will start with fully aligned regulatory regimes (because the UK is transposing all EU regulation into the UK domestic regime) and DRC should therefore continue, until there is divergence in the regulatory regimes. This would provide much greater access for UK firms (possibly full single market DRC) than the EU’s current regime for third country mutual recognition/DRC offers. The EU position is that it will offer the UK no more than is available to other third countries - regulatory cooperation on a voluntary basis and DRC via (unilateral and revocable) decisions by the EU under its third country “equivalence” legislation. In our report on Brexit and FS in April 2017, we provide detailed analysis of these two regimes and the extent of mutual recognition/DRC under each proposal.*

HoL EU Financial Affairs Sub-Committee: Government response to Brexit report: The future of financial regulation and supervision

Further to its January 2018 report, the Committee has published the Government’s response to the recommendations, which fall under the following broad categories: the origins of regulation and supervision; incorporating the EU acquis in financial services; possibilities for a transition period; alignment and market access; supervisory cooperation and regulatory innovation/fintech. In addition, it has published an update letter on the March negotiations from HMT (dated 19 April 2018). Click here to access the response, here for the 26th March letter and here for the 19th April update letter.

None of this material from HMT provides any substantive information or detail about HMG’s proposals for financial services after the transition period (see ‘Where we stand’ above). This lack of detail precludes any discussion about the specific DRC arrangements that HMG is advocating as an alternative to the EU’s proposals (see above). The latest letter of 19th April adds little to the earlier response.

The Committee had raised the idea of adding a duty (on the Bank of England and FCA) to promote international competitiveness (because of the increased international competition facing the UK post-Brexit). HMT rejects this idea. It confirms the role of the proposed Withdrawal Agreement and Implementation Bill (which will be a separate/additional piece of legislation from the European Union (Withdrawal) Bill that is currently before Parliament) in implementing the UK/EU Withdrawal Agreement and the transition period (with effect from exit). HMG refers to action on the part of the UK to mitigate cliff edge risks and provide clarity on single market continuation during the transition period; it urges a similar response on the EU side.

HoC European Scrutiny Committee: 26th Report of Session 2017/19

Sections 3 and 4 of the report consider proposals with regard to asset management (specifically, cross-border distribution of funds within the Single Market) and nonperforming loans and also details the latest ministerial response to the Committee’s specific concerns. These matters are still under scrutiny by the Committee. Section 12 of the report looks at long-term EU regulatory plans in the financial services sector, including with regard to fintech and the Capital Markets Union. It includes a table that sets out current and upcoming EU legislative proposals in relation to financial services. Click here to access the report.

HMG is saying very little about its plans for financial services beyond the high-level ideas summarised above. UK parliamentary committees are providing more analysis. The House of Commons and House of Lords scrutiny committees review proposals for new EU legislation and now look at the impact of Brexit; this is providing detailed analysis of the mechanics of Brexit in the financial services sector – albeit limited to a few specific (and prospective) pieces of EU legislation.

Section 12 of the report notes the EU’s development of its third country regime in FS ahead of Brexit (see ‘Where we stand’ above and previous coverage of this topic in our updates for the week ending 4th May and 27th April). It refers to the Commission’s document “EU equivalence decisions in financial services policy: an assessment” (February 2017), the call in March 2018 by the EU-27 for unspecified improvements to the equivalence framework in light of the UK’s departure from the EU and the April draft European Parliament Report (which will be debated by the full Parliament in September). These all highlight the operation of the third country framework - including the ‘deference’ (i.e. DRC) mechanisms for third country firms – and suggested improvements/development of the framework. This is an important area of interest for UK firms, given the uncertainty over the broader DRC arrangements proposed by the UK government. The committee continues to consider the possibility that the proposed transition period will be extended beyond 31/12/20 – ‘…the date when the UK will ultimately leave the Single Market (and can begin disapplying EU law)...is scheduled to occur in December 2020, when the post-Brexit transitional period is due to end. However, the Government has not ruled out seeking an extension if necessary in view of progress in making domestic preparations for life outside the EU and the state of the negotiations on a new UKEU trade agreement.’

Section 12 summarises the effect of the UK leaving the single market in the context of the three policy papers considered in the Report. ‘UK-based firms would still be able to issue investment prospectuses - including, in the future, ‘Green Bonds’—to EU-based investors, but they would have to do so under the terms of the EU Prospectus Regulation and under the supervision of the domestic regulator of an EU country. Prospectuses issued pursuant to UK law (even if it is identical to the Regulation) would only be valid if the UK obtained a formal ‘equivalence’ decision to that effect (see above); the new Crowdfunding Regulation will not apply to UK crowdfunding platforms, which will therefore be ineligible for a ‘passport’ to offer their services across the Single Market from a UK base; UK-based investment advisers will not be able to market their services into the EU based on their passport, and so will have to establish a new business within the European Economic Area or provide more limited services on a cross-border basis depending on the legislation of each individual EU country; and UK asset managers will continue to be able to perform their services for EU based investment funds under ‘delegation’, but the European Commission is seeking to restrict such practices where it effectively leaves the EU-based entity as a ‘letterbox firm’ with all substantive operations carried out in the UK.’

The report refers to HMG’s proposals (for better market access - see above) for a ‘post-Brexit financial services trade agreement that preserves preferential market access based on intensive (but non-binding) regulatory cooperation to ensure similar supervisory outcomes’. It notes that the ‘Treasury has not published a draft legal text on the workings of this system in practice’. It also expresses concern that ‘while not placing the UK under a legal obligation to implement the EU acquis, [the proposals] could still lead to de facto long-term regulatory alignment with the EU rulebook to avoid the risk of a sudden loss of market access.’

Section 3 of the report looks at the impact of the UK leaving the single market in the context of proposed legislation on UCITS and AIFs. ‘The exit from the Single Market means that UK-registered UCITS and AIFs will automatically become non-EU alternative investment funds when marketed within the EU. The impact on UCITS funds of this change may be mitigated relatively easily, as they can be re-domiciled to an EU country while their effective management can be retained in the UK (as EU law already permits the portfolio management of UCITS to take place either in or outside the Union). Many UCITS funds are already domiciled in Ireland and Luxembourg but have appointed managers in the UK. However, the British Bankers Association (now UK Finance) has noted this will not necessarily be as straightforward after Brexit because marketing of portfolio management services within the EU by third country firms is restricted under MiFID. Moreover, delegation of UCITS operations to a UK entity will become subject to additional regulatory requirements that do not apply while the UK is still in the Single Market. For UK-based AIFs (and UCITS funds that are not re-domiciled to an EU country after Brexit, and therefore automatically become a non-EU AIF for the purposes of EU law) aimed at EU investors, the situation will be more complicated. AIFs, unlike UCITS, are regulated at the manager rather than fund level by EU law. As a result, even if a British AIF was re-domiciled to an EU country after Brexit, it would not enjoy a ‘passport’ to service the entire Single Market unless the manager also relocated to the EU. Instead, UK-based funds could only be marketed in an EU country where it has a “national private placement scheme” in place for non-EU AIFs. While the AIFM Directive contains an equivalence regime which can extend the ‘passport’ to AIFs and AIF managers in non-EU countries where the latter apply regulation that effectively mirrors the Directive, this has not to date been activated. To overcome these issues, UK AIFs or AIFMs could re-domicile to the EU to keep their ‘passport’ (allowing them to access the entire EU investor base) and then delegate some of their functions back to the UK. However, as is the case for UCITS funds, this will become subject to restrictions that do not apply when delegation is made to EU-based entities. Given the absence of operational ‘third country’ regimes for both UCITS and AIFs, in practice the UK asset management industry is likely to rely largely on delegation to continue servicing the EU’s investor base after withdrawal from the Single Market. While this will already require some additional regulatory hurdles to be passed once the UK leaves the EU’s common legal framework, the Committee notes with concern that the UK’s decision to withdraw from the EU has led to calls for further restrictions on the use of delegation by EU-based investment funds. The European Commission and the European Securities & Markets Authority (ESMA) have repeatedly expressed concern about the extent to which asset management activity would take place outside the EU if the current levels of delegation to the UK persist after Brexit. While the recent proposals on cross-border distribution of funds do not alter the ability of non-EU entities to carry out investment management activities for EU-based funds, the Commission has already proposed separately to use Brexit as a reason to increase EU-level oversight of the overall use of delegation. Any further restrictions on delegation of asset management by EU funds overseas investment services providers, whether through new legislation or supervisory practice, would have a detrimental impact on the EU’s access to asset management expertise.’

Section 4 of the report looks at the proposed legislation on ‘credit servicers’ and the impact of Brexit -‘After the UK leaves the Single Market, credit servicing companies based in the EU would no longer have a right to ‘passport’ their activities into the UK domestic market (and vice versa for British debt management agencies). At that point, UK-based credit servicers would only be able to operate within the Single Market if they establish a separate legal entity in an EU country, subject to authorisation and supervision by that country’s domestic regulator. (There is no provision in the proposed Directive for the recognition of a third country’s regulatory approach to debt management as ‘equivalent’ to the EU’s.) Similarly, once the UK is a ‘third country’ vis- à-vis the Single Market, British firms would not be able to purchase loan agreements from EU banks unless they appointed a legal representative within the EU (and this representative must, in turn, engage an EU-based bank or credit servicing company to actually manage the loans).’

Other publications from the RegZone Brexit news feed

HoL: European Union (Withdrawal) Bill

Click here for a link to the transcript of the report stage on 8 May 2018 follows. Amendments discussed covered clauses 14, 15 and 19 of the Bill. A new draft of the Bill, as at report stage and published on 8 May 2018, is also available via the link. The third reading of the Bill is scheduled for 16 May.

*See also an older report by the EP on Financial services in EU trade agreements here.