Decoding Brexit for financial services: where are we now? March 2018

Transcription

1 Decoding Brexit for financial services: where are we now? March 2018

2 2 Decoding Brexit for financial services: where are we now? Contents Introduction 3 Selected Brexit problems and solutions 4 1. Licensing 4 2. Contract continuity 8 3. Legal certainty Users of financial services 12 Contacts 14

3 Linklaters 3 Introduction A year after the UK served notice of its withdrawal from the EU and with a year to go until the UK formally leaves, this note explores some of the problems for the financial services sector which have been raised by Brexit and identifies where solutions may have been found. This note examines some of the Brexit considerations for the financial services industry in both the UK and EU27 regarding: > > Licensing; > > Contract continuity; and > > Legal certainty. The note also includes insight from a Brexit perspective on the financial services regimes of Germany, France, Luxembourg and Belgium as well as the insurance, asset management and derivatives sectors. Some of the issues discussed in this note are not unique to financial services and other sectors face similar problems requiring a range of solutions. The impact of Brexit on financial services will also have consequences for those who use the wholesale financial services sector, e.g. for banking and capital raising, and the final section of this note explores these consequences. The considerations raised in this note have assumed that there will be no agreement between the EU27 and UK that would allow special access to each other s markets in financial services after Brexit. Brexit for this purpose means the point at which the existing access to financial markets changes as a result of the UK leaving the EU, which may be at the end of a transition period. This note is inevitably subject to the outcome of the negotiations which are ongoing and any form of improved market access which may be agreed. 1 Linklaters has extensive experience advising financial institutions on the consequences of Brexit which provides us with a uniquely broad picture of the Brexit-related challenges facing firms. We have a thorough and specialised knowledge of the relevant legal and regulatory considerations, as well as market leading expertise on bank reorganisation work and the related licensing and intermediation issues, employment considerations, data protection and other issues. Please contact us if you would like to discuss how we might be able to assist you. 1 See also our recent updates: What transition means and European Council sets out guidelines on the framework for the future UK-EU relationship.

4 4 Decoding Brexit for financial services: where are we now? Selected Brexit problems and solutions 1. Licensing 1.1 The problem > > Losing ease of access to EU markets from the UK: The passporting framework has clarified how the freedom of establishment and freedom to provide services applies to financial services. 2 It allows regulated firms to use the licence they have from their local regulator to perform similar services in another EU Member State, either cross border or from a branch. This means that EU firms do not need to apply for a separate licence in every EU Member State in which they provide services. 3 Passporting rights are only available to EU firms 4 and so will not be available to UK firms after Brexit. > > Dealing with different rules in every EU27 Member State: Passporting significantly reduces the regulatory burden on firms looking to access the whole EU market. From the perspective of UK firms intending to provide regulated services in the EU, this burden returns with Brexit because the EU s regulatory environment effectively fragments into 27 pieces. Each Member State has its own licensing requirements, regulatory approaches and nuances of interpretation of EU law which will need to be navigated by these UK firms. > > Needing to apply for access to the UK market from the EU: Over 8,000 EU firms currently passport their services into the UK 5 and so may need to obtain fresh authorisations from the UK regulators to continue to provide those services in the UK after Brexit. As a condition to granting approval, the regulators could require some firms to set up a subsidiary in the UK which would have regulatory capital implications. > > Becoming subject to new rules: Some UK rules do not apply, or apply in a less onerous way, to passported branches of EU firms. Generally, this is because the rules of the relevant EU Member State apply instead. Once passporting is no longer available, EU firms which continue operating a branch in the UK may be subject to different regulatory standards after Brexit than before. The same is also true for branches of UK firms in the EU Any solutions? > > Analysing the extent to which the business relies on licences: Firms have undertaken a significant amount of regulatory analysis to work out which of their businesses involve cross-border activity and what licences, including passports, they rely on to perform that activity. This must take into account local regulatory interpretations of where the activity is carried out and where the clients are based. > > Identifying if any exemptions might be available: There are few EU-wide exemptions of general use. Reverse solicitation may be an option in some circumstances but it has significant drawbacks, not least that it is difficult in practice to prove that a service has genuinely been sought by the client rather than the firm. Other exemptions may be available for specific activities and/or in particular EU27 Member State(s), meaning that a country-bycountry analysis is required. > > Considering maintaining an EU presence: Relying on exemptions may work for some businesses. However, where broad access to regulated markets across the EU is needed, a possible approach would be to plan to establish or expand a regulated entity in the EU27. The location, size and structure of that EU vehicle may be driven by several factors which will be unique to each firm s business plans. Many firms have started a dialogue with EU27 regulators regarding their Brexit plans and are working on licence applications. > > Applying for a UK licence: EU firms should consider what form of presence they intend to have in the UK after Brexit. The UK regulators may authorise some firms to operate in the UK via a branch, which may have significant capital advantages. Other businesses, such as EU banks with material retail deposits or insurers with material liabilities in the UK may be required to operate from a UK subsidiary. 6 In any case, all EU firms with a passport into the UK will need to apply to the UK regulators before Brexit to ensure that they continue to be appropriately licensed after Brexit. The UK s Prudential Regulation Authority has confirmed that firms may plan on the assumption that this authorisation is only needed by the end of any transition period. 2 Treaty on the Functioning of the European Union, Articles and respectively. 3 There are exceptions to this because not all regulated activities are passportable under a single market directive. For example, to act as a depositary of an alternative investment fund in another EU Member State, an additional top-up licence is likely to be required. 4 Passporting is also available to EEA firms provided that the relevant directive setting out the passportable activities has been incorporated into the EEA Agreement. For simplicity, we have referred in this note to the EU only. 5 Letter from Andrew Bailey, FCA CEO, to Rt Hon Andrew Tyrie MP, 17 August Update on the regulatory approach to preparations for EU withdrawal, 28 March 2018

5 Linklaters 5 In focus Germany > > Frankfurt, the traditional capital of finance in Germany and home of the European Central Bank, located in the heart of Europe, is likely to emerge as one of the hubs which will be used to service the European financial markets after Brexit. > > The German regulator, BaFin, traditionally takes a rather formal view when addressing regulatory issues. We are not a marketing agency and not interested in doing industrial policy, Felix Hufeld, the president of BaFin, has said. However, in light of Brexit, BaFin aims to be as flexible and pragmatic as legally possible and is willing to find bespoke solutions to make the transition easier. > > BaFin addressed the Brexit issue early, published guidance notes, FAQs and held workshops. The ECB, as well as BaFin and the German Central Bank, have publicly encouraged banks and financial institutions to engage with them as early as possible to discuss potential relocation strategies. > > The European Supervisory Authorities have said that they intend to prevent regulatory arbitrage within the EU by, for example, defining specific audit requirements for the national authorities. It is becoming apparent that they will scrutinise any attempt to comply with local regulatory requirements with relatively low staffing levels and overreliance on functions and structures of UK affiliates. The supervisors believe that institutions operating in the European single market must be fully operational and not merely an empty shell or letterbox entity. For example, on back-to-back structures, the ECB has said that it will acknowledge such structures in principle but expects that the risks inherent in banking operations will also be addressed locally, i.e. within the EU.

6 6 Decoding Brexit for financial services: where are we now? 1.3 Sector-specific analysis Insurers > > If passporting rights are lost, whether a UK insurer will be legally capable of servicing EU27 business post-brexit (and likewise whether an EU27 insurer will be able to service UK business) is a matter of local law. > > In general, the rules in EU27 jurisdictions require a licence for insurance businesses where the insured is resident in the jurisdiction or, where applicable, the relevant property is situated or vehicle is registered in the jurisdiction. This contrasts with the position in the UK where a licence is required only where the regulated activities of effecting contracts of insurance and/or carrying out contracts of insurance take place in the UK. In theory, lawful run-off of UK risks by an EU27 insurer is possible provided neither it nor its agent carry on any activity in the UK. > > Many UK insurers with EU business are addressing the potential loss of passporting rights by looking to establish a new insurance subsidiary in an EU27 jurisdiction such as Luxembourg or Ireland. That subsidiary would have EU passporting rights, enabling it to conduct business throughout the EU27. The subsidiary would need to be more than just an empty shell. In July 2017, the European Insurance and Occupational Pensions Authority (EIOPA) issued an opinion to that effect, emphasising that the new insurer must have in place appropriate governance arrangements and must demonstrate an appropriate level of corporate substance. EIOPA also warned against extensive reinsurance arrangements, stating that it envisaged, as an indication, that a minimum of 10% of the business written should be retained (and not reinsured). > > Those EU27 firms that currently passport into the UK may also need to obtain fresh authorisations and have been considering two broad options: either to obtain authorisation for a new UK subsidiary, or as a third country branch in the UK. In March 2018, the Prudential Regulation Authority 7 published a supervisory statement setting out its expectations on when a subsidiary would be more appropriate than a third country branch, some of which relate to the scale of UK branch activity covered by the Financial Services Compensation Scheme. At any level of business, the PRA will consider risk posed by the branch and its proposed business to the wider insurance market and financial system of the UK. In focus France > > The Autorité de contrôle prudentiel et de résolution (ACPR) has created a dedicated Brexit page on its website together with a dedicated address for institutions based in the UK which operate in other EU Member States. > > The Autorité des marchés financiers (AMF) has established a dedicated welcome programme named AGILITY for asset managers and fintech companies based in the UK. The AMF and the Association française de la gestion financière (AFG) have also launched a working group named FROG which intends to increase French funds international competitiveness. > > The AMF has recently amended its position on delegation by asset managers to allow delegation of some financial management of collective investments to non-eu entities, provided they do not delegate management entirely. > > In a recent speech, the Chaiman of the AMF, Robert Ophèle, said: When the main financial centre of the EU is about to leave the Union, it is clear that the European third country regimes as previously defined can no longer be appropriate and hence deserve to be revisited. 7 International insurers: the Prudential Regulation Authority s approach to branch authorisation and supervision (SS2/18), 28 March 2018

7 Linklaters 7 Asset managers > > Many UK asset managers who rely on passporting to provide cross-border services and offer products to EU investors are considering, or already in the process of, establishing operations in an EU27 jurisdiction and obtaining relevant authorisations to ensure business continuity and EU market access after Brexit. Many are also moving fund vehicles, although this is not solely driven by Brexit. > > Many in the asset management industry rely on the ability to outsource or delegate functions to entities established and regulated in different jurisdictions, including outside the EU. It is common practice for portfolio management responsibilities to be carried out in jurisdictions such as the UK, the US and Asia depending on the relevant investment strategy of a fund, regardless of where the fund is established. A key question post-brexit is whether this will be able to continue and with what restrictions. > > The European Securities and Markets Authority (ESMA) has increasingly focused its attention on the regulatory framework for delegation arrangements and has published sector-specific principles for investment management. The European Commission has also published an omnibus legislative proposal giving ESMA a more central role in relation to authorisation applications relying on delegation arrangements. The ability to continue a delegation model will be central to the ongoing attraction of the UK as a base for the asset management industry and will remain a hot topic this year. A recent ESMA statement suggests a possible softening of approach to delegation, which would be good news for the industry. > > Certain asset managers (particularly private equity) are considering advisory models rather than relying on delegation. The ability to run this depends on the local regulatory framework where the advice is received. > > The approach to distribution of products into the EU27 is also of concern to asset managers, particularly as some regulators consider that marketing involves MiFID-type activities such as receipt and transmission of orders. Managers are considering a variety of approaches including moving some of their front office functions to the EU27. > > To mitigate risks of a regulatory cliffedge for EU27 firms, the UK s Financial Conduct Authority has indicated that it will operate a temporary permissions regime so that EU27 firms and funds can continue to operate in the UK. It is expected that these firms would need to notify the FCA of their desire to benefit from this permission before the UK exits the EU. > > Longer-term, it will be open to the FCA to require EU27 firms to establish operations in the UK and be authorised directly by the FCA if they wish to access the UK market. However, this will be subject to the outcome of Brexit negotiations and what (if any) form of mutual access between the EU27 and UK is agreed. In focus Luxembourg > > The Luxembourg finance minister, Pierre Gramenga, has recently indicated that insurance firms, asset management companies and some major American banks had chosen to move to Luxembourg but he has stressed that Luxembourg was not there to take business from the UK. Instead, he has referred to a kind of bridge between London and Luxembourg. > > Luxembourg has said that it stands ready to conduct preparatory work on agreements that would allow asset managers to continue to delegate to the UK in the event of a no-deal Brexit. Under UCITS and the Alternative Investment Fund Managers Directive, delegation to non-eu entities can only take place when a memorandum of understanding (MoU) is in place between the EU Member State and third country regulators. > > Claude Marx, Director-General at the Luxembourg regulator (the CSSF) has said that, in light of the real risk of a nodeal Brexit, national regulators should take steps to prepare these agreements. Mr Marx has said: [In the same way] that supervised entities should start to seriously prepare for a no-deal scenario, [we] regulators should get ready with MoUs so that no matter what happens business will continue in a smooth way. [ ] After all we re also responsible for making sure there is financial stability and no disruption to the market.

8 8 Decoding Brexit for financial services: where are we now? Selected Brexit problems and solutions 2. Contract continuity 2.1 The problem > > Servicing existing contracts could be difficult without a passport: Where a UK firm loses its licence under the passporting regime, it will need to ensure that it can continue to perform any cross-border contracts it has which span Brexit. A failure by the UK firm to have in place the licence required to perform its contractual obligations could result in a regulatory breach and/ or the contract being unlawful and unenforceable. 2.2 Any solutions? > > Clarifying what regulated activities might be triggered by the contract: From the perspective of UK firms dealing with counterparties in the EU27 after Brexit, the analysis will depend on the regulatory regime that exists in the relevant EU27 jurisdiction (and vice versa). Factors that may be relevant include where the activity is deemed to take place and the place of residence of the counterparty. > > Identifying any helpful exemptions: From the perspective of EU firms performing activities in the UK after Brexit without a licence, some exemptions from the UK licensing regime may be helpful, such as the overseas persons exemption. Likewise, certain exemptions in EU27 Member States may be available for UK firms. 2.3 Sector-specific analysis Insurance contracts > > As noted above, if passporting rights are lost, whether a UK insurer will be legally capable of servicing EU27 business post-brexit (and likewise whether an EU27 insurer will be able to service UK business) will be a matter of local law. > > Issues could arise both from the sale and administration of new crossborder insurance business and from the run-off, potentially over the course of many years, of existing business. For example, where a UK insurer has entered into an insurance contract with a UK-based policyholder but that policyholder subsequently moves to an EU27 jurisdiction, the current position is that passporting rights should automatically allow the insurer to continue servicing the contract. However, if those passporting rights are extinguished and no new authorisation is put in place, then, after Brexit, the insurer may find itself in the difficult position of either continuing to receive premiums, pay claims and generally to service the contract technically in contravention of local law, or of failing in its obligations to the policyholder. > > Grandfathering existing passported business is being raised by the industry as a potential solution. However, to date no agreement has been reached between the UK government and its EU counterparts on the point. In December 2017, HM Treasury indicated that it will, if necessary, bring forward legislation to mitigate risks to the continuity of EU27 firms outstanding contracts in the UK. However, an equivalent reciprocal statement from EU27 authorities has not yet been made. > > In the absence of any agreement on either grandfathering or transitional relief, firms are working to obtain the necessary authorisations, in some cases in parallel with establishing new carriers and/or transferring existing contracts, depending on their particular circumstances. Derivatives > > The relevant scenario is where a derivative transaction is entered into before Brexit between a UK counterparty and an EU27 counterparty which is intended to extend beyond Brexit. > > As for insurance contracts, whether the counterparties can perform their respective obligations under a derivative transaction is a matter of local law. > > The focus has been on events which typically arise during the life of a derivative transaction ( lifecycle events ) under the derivative contract (e.g. exercising an option, portfolio compression, unwinds) and whether these could constitute a regulated activity such as trading on own account. Again, this is a matter of local law. Where the activity is regulated, the counterparty will need to rely on an exemption or seek a local licence to perform these lifecycle events. In focus Belgium > > Belgium has a specific regime for third country institutions that complements the MiFID II third country regime. > > It allows institutions established in third countries to provide MiFID services into Belgium on a cross-border basis to (i) MiFID professional clients and eligible counterparties where there is no European Commission equivalence decision or, more generally, to (ii) expats in Belgium (i.e. natural persons from the country where the institution has its main establishment or a branch). > > The third country institution must obtain a registration with the Belgian supervisory authorities to be able to operate under this socalled light licence regime.

9 Linklaters 9 Selected Brexit problems and solutions 3. Legal certainty 3.1 The problem > > Some aspects of EU law may not work when it is brought into UK law: To provide legal certainty, it is intended that EU law as at exit day will continue to be applied in the UK. However, adopting rules created by and for a multi-state framework and applying them solely to the UK may result in deficient legislation. > > Fixing deficiencies involves policy decisions: The Withdrawal Bill, which is currently being debated in the UK Parliament, will grant powers to UK government ministers to fix deficiencies in the EU law which is retained after Brexit. However, fixing deficiencies is likely to be more involved than a mere mechanical copy and paste and will require some policy direction. > > The EU will also need to adjust its law because of Brexit: As well as evolving its body of law in the ordinary course 8, the EU will need to change its rules in certain areas as a result of Brexit. An example > > MiFID II requires some companies to be authorised to enter into commodity derivatives. > > There is an exemption intended for companies which enter into these derivatives as a hedge to support their operations. > > Whether a company can benefit from the exemption or needs to be authorised depends on the scale of its activities in the EU, determined by certain thresholds. > > Depending on whether and how these thresholds under MiFID II are recalibrated in the UK, a company may no longer be (or might become) exempt from authorisation requirements. > > When translated into UK law, will the threshold calculation continue to refer to the company s Europewide activities? Or will it be limited to its activities in the UK? In which case, are the thresholds specified in the rules appropriate for a smaller geographical market? > > Conversely, where a significant amount of activity in the EU currently takes place in the UK (e.g. metal derivative trading), the EU may need to adjust its thresholds to reflect that the absolute amount of trading happening in the EU might be much smaller after Brexit. 8 For example, see: A timeline of EU legislation which is due to come into force during the proposed transition period.

10 10 Decoding Brexit for financial services: where are we now? 3.2 Any solutions? > > A proposed alternative to a line-byline approach: Section 7 Withdrawal Bill gives ministers the power to make regulations to prevent, remedy or mitigate any failure of EU law to operate effectively or any other deficiency in retained EU law arising from Brexit. The quantity of legislation required to be made using the clause 7 powers would be massively reduced if the UK government were to follow the recommendations in our report The Great Repeal Bill Domesticating EU law. 9 This report proposed five new rules of statutory interpretation to remedy most of the deficiencies in one go, giving a consistent basis for interpreting all of the affected legislation, regardless of subject matter. This would save a significant amount of work to free up valuable resources and time, as well as providing certainty and clarity much sooner than can be done by detailed amendments made through hundreds of statutory instruments. > > Making consistent policy decisions: In any case, many deficiencies will require consistent policy decisions to be made across a wide range of legislation and regulation. It should be acknowledged that, in some areas, the appropriate policy decision may be determined only after the outcome of negotiations between the UK and the EU27. > > Involving regulatory expertise to fix deficiencies: There is much direct EU law which is very technical in nature. As we argued in our report on The Architecture for Regulating Finance after Brexit, 10 in the field of financial services it is appropriate that the regulators should be able to use existing powers of amendment to avoid regulatory sclerosis in relation to EU-derived provisions of financial regulation. The government has proposed transferring responsibility for certain direct EU legislation to the UK regulators, including, but not limited to, the power to correct deficiencies in preparation for exit. This proposal applies to what the government calls Binding Technical Standards (and to certain technical elements of one other delegated EU act) which the government intends to designate in an instrument. This approach of specific designation of instruments that should be capable of amendment by delegated powers is one that could be followed more broadly, enabling the general powers under the Withdrawal Bill to be limited but sufficient flexibility to be granted to regulators or ministers in specified areas. 9 The Great Repeal Bill Domesticating EU law, Linklaters LLP and the IRSG (June 2017) 10 The Architecture for Regulating Finance after Brexit, Linklaters LLP and the IRSG (December 2017)

11 Linklaters 11 Selected Brexit problems and solutions 4. Users of financial services The financial services industry is an interconnected network of service providers and clients. The users of wholesale financial services may be considering their own Brexit contingency plans but will also be interested in what the changes to the regulated sector will mean for them. > > As a guiding principle, financial services firms want to ensure that any changes made, due to the cessation of passporting, to their service models (such as booking location for investment banks) and their client contracts provide continuity of contractual commitments and service to their clients with minimal business and technical disruption. > > Firms are in the process of identifying which clients may be impacted by their Brexit plans. Whether a client is in scope will be fact-specific and depend on the nature and level of interaction that the firm and client have, the relevant jurisdictions as well as the precise services that are provided. > > Clients should be prepared for the possibility of some operational impact (e.g. changes in service provider or legal counterparty) and perhaps changes to documentation (e.g. terms of business). > > Financial services firms are keeping under review what, if anything, will need to be brought to the attention of clients to ensure that timely information is provided on the impact of EU withdrawal. Clients should expect to be contacted by their service providers but this may not happen until there is greater political and business clarity which is only likely to materialise later in the Brexit process.

12 Contacts United Kingdom Belgium Luxembourg Sir Christopher Bellamy QC Chairman, Global Competition Practice, London Tel: Dr. Bernd Meyring Partner, Belgium Tel: Hermann Beythan Partner, Luxembourg Tel: Charles Clark Partner Consultant, London Tel: Etienne Dessy Partner, Belgium Tel: Patrick Geortay Partner, Luxembourg Tel: Lucy Fergusson Tel: Michael Kent Tel: Matthew Keogh Tel: France Germany Paul Lignières Partner, Paris Tel: paul.lignieres@linklaters.com Marc Perrone Partner, Paris Tel: marc.perrone@linklaters.com Netherlands Poland Dick Hofland Partner, Amsterdam Tel: dick.hofland@linklaters.com Adrian Horne Counsel, Warsaw Tel: adrian.horne@linklaters.com Peter Bevan Tel: peter.bevan@linklaters.com Carl Fernandes Tel: carl.fernandes@linklaters.com Ulrich Wolff Partner, Frankfurt Tel: ulrich.wolff@linklaters.com Dr. Frederik Winter Partner, Frankfurt Tel: frederik.winter@linklaters.com Portugal Spain Carlos Pinto Correia Consultant Partner, Lisbon Tel: carlos.correia@linklaters.com Harry Eddis Tel: harry.eddis@linklaters.com Alexander Vogt Partner, Frankfurt Tel: alexander.vogt@linklaters.com Paloma Fierro Partner, Madrid Tel: paloma.fierro@linklaters.com Duncan Barber Tel: duncan.barber@linklaters.com Victoria Sander Tel: victoria.sander@linklaters.com Italy Andrea Arosio Partner, Milan Tel: andrea.arosio@linklaters.com Sweden Patrik Björklund Partner, Sweden Tel: patrik.bjorklund@linklaters.com linklaters.com Linklaters LLP. All Rights reserved 2018 Linklaters LLP is a limited liability partnership registered in England and Wales with registered number OC It is a law firm authorised and regulated by the Solicitors Regulation Authority. The term partner in relation to Linklaters LLP is used to refer to a member of Linklaters LLP or an employee or consultant of Linklaters LLP or any of its affiliated firms or entities with equivalent standing and qualifications. A list of the names of the members of Linklaters LLP and of the non-members who are designated as partners and their professional qualifications is open to inspection at its registered office, One Silk Street, London EC2Y 8HQ, England or on and such persons are either solicitors, registered foreign lawyers or European lawyers. Please refer to for important information on our regulatory position. 7820_MARCH_F/03.18