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Regulatory News - Brexit

Regulatory News - Brexit

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In February the UK Government published its White Paper on exiting the EU. This follows the UK Prime Minister’s speech outlining 12 principles for Brexit. So what are the implications for financial services?

The White Paper reiterates the Prime Minister’s announcement that the UK will not be seeking membership of the Single Market, it also recognizes the possible challenges associated with a ‘cliff edge’ exit situation two years after Article 50 is triggered. As such, the UK intends to propose that in areas such as immigration controls and regulatory frameworks, phased implementation of the outcomes of the exit negotiations are put in place.

In the context of financial services, the White Paper states that the UK will be seeking the “freest possible trade in financial services between the UK and EU Member States.” The White Paper also states the UK’s belief that due to the highly integrated nature of financial services in Europe that there would be a “legitimate interest in mutual cooperation arrangements that recognises the interconnectedness of markets.”

Interconnectedness of Markets

As a result of the June Brexit referendum, a number of studies and reports sought to assess both the extent of the concentration of financial services in the UK and the interconnectedness of financial markets across the EU. The following are a number of relevant statistics from these reports.


  • 78% of EU 27 capital markets activity is conducted in the UK
  • 76% of European hedge fund assets are based in the UK
  • 76% of all MiFID passporting is done by UK firms
  • 74% of EU trading in OTC derivatives occurs in the UK
  • 52% of all MiFID firms in the EU are based in the UK
  • 45% of global FX trading in Euro, takes place in the UK
  • 40% of European assets are managed in the UK
  • 37% of EU initial public offerings occur in the UK

These statistics reflect the consistent and concerted effort by EU Member States and EU Institutions to build and develop a single market for financial services. Two of the principal aspects of the single market for financial services are the European Union Passport for Financial Services and the so-called ‘Single Rulebook’ for Financial Services Regulation.

Currently, EU financial services legislation provides for a passporting mechanism which allows asset managers, banks and insurers, authorised in the European Economic Area (EEA), to sell their services freely across the EU, without the need for separate authorization in each of the States where they wish to provide services. The earlier statistics reflect the fact that one of the outcomes of the passporting regime is that the ‘City of London’ has emerged as the pre-eminent centre for Europe’s capital markets, with a large proportion of EU financial market activity, across the asset management, banking and insurance sectors taking place in the UK.

Automatic access to EEA markets via the passport mechanism is recognised as a major benefit and any termination of that access for UK financial services firms will have a disruptive impact on financial markets in the UK and across the remaining EU 27.

Legal harmonization

The second important factor in EU financial services interconnectedness is the legal harmonization that has taken place in the area for more than 25 years. In that time the individual financial services laws of many Member States have been developed or replaced by an increasingly detailed single rule book for European financial services regulation. This rulebook has further assisted the successful use of the passport mechanism by enabling supervisory cooperation between national competent authorities and an increase in regulatory convergence across the EU.

It is planned that existing levels of harmonization will be further integrated by the EU’s Capital Markets Union (CMU) package of reforms that is currently underway and seeks by 2019 to propose a number of pieces of legislation to promote investment, growth and further integration of EU capital markets.

Until the exit negotiations under Article 50 conclude, the UK remains a full member of the European Union and consequently it will continue to implement both the remaining components of the post- crisis legislative reforms such as the Packaged Retail and Insurance-based Investment Products Regulation (‘PRIIPs’), MiFID II and any of the CMU initiatives that enter into force prior to exit. In this regard Brexit presents a challenging outcome as the UK will be exiting the single market at a time of increasing harmonization and integration of EU financial markets legislation. It is also possible that a divergence in rules and supervisory approaches may emerge between the UK and the rest of the EU, which could lead to uncertainty for firms and investors leading to a negative impact on the smooth functioning of financial services markets.

Third Country Equivalence

In the absence of access to European markets by means of the passport, alternative mechanisms will need to be explored.

One such alternative is that of third country equivalence.

In summary, this is an empowerment granted to the European Commission, to decide on whether certain ‘third country’ regulations and supervision suffice for EU regulatory purposes. The equivalence empowerment does not confer a right on third countries to be assessed or to receive a positive determination, even where the third country believes that it has fulfilled the criteria. An equivalence decision is not only a discretionary decision of the EU, it is also a unilateral, in that all of the decisions, including variations and amendments to or any repeal of an equivalence decision is solely at the discretion of the EU Commission. For example, an equivalence decision can in some instances be revoked on as little as 30 days’ notice.

There is no single comprehensive third country equivalence regime across financial services. Where it is provided for it is contained in individual pieces of legislation. As each equivalence decision is developed individually for each specific act, it is not always clear as to what level of assessment is needed. Finally, as a general rule the third country provisions are not as extensive as the EU passporting regime set out in the same legislation. It is also worth noting that equivalence is granted to countries and not individual firms, which could lead to considerable uncertainty for UK financial services firms.

Of the 40 pieces of financial services legislation adopted after the financial crisis, only 15 contain ‘third country provisions’. A more detailed summary of existing financial services legislation with third country equivalence provisions envisaging passporting-like arrangements is set out in the table below.

Examples of existing third country equivalence provisions

Financial services legislation

Financial Services Sector Key EU Legislation Key examples of positive equivalence assessements Overview of
equivalence envisaged which may constitute an alternative to the EU passport
Banking CRD IV/CRR N/A CRD IV/CRR does not provide for ‘passport-like’ third country equivalence. The equivalence that is envisaged is in the limited circumstances concerning the prudential treatment of certain types of exposures to entities located in non-EU countries
Investment Management AIFMD Positive Assessment not yet granted

Facility for management & marketing passport to be granted to non-EU managers. Not yet activated.

National Private Placement Regime may present an alternative in the interim.

UCITS N/A No equivalence contemplated
MiFID II/MiFIR Positive assessment not yet granted 3rd country firms may be able to operate anywhere in the EU to serve professional clients & eligible counterparties
Insurance Solvency II Bermuda, Japan, Switzerland ‘Passport like’ rights for reinsurance companies only
Market Infrastructure and
Securities Markets
Market Abuse Regulation Australian, Brazil, Canada, China, Hong Kong, India, Japan, Korea, Mexico, New Zealand, Singapore, South Africa, Switzerland, UAE, US

3rd Country Central Banks and Public Debt Management companies may be exempt from certain Market Abuse

The Market Abuse Regulation does not contain direct passport like equivalence.

Prospectus Directive Positive assessment not yet granted Prospectuses prepared according to rules of an equivalent third country may be used in public offers in the EU
Transparency Directive Positive assessment not yet granted Non-EU firms subject to EU rules on transparency may be allowed to fulfil those obligations in accordance with third country equivalent disclosure standards.
EMIR Australia, Brazil, Canada, Dubai International Financial Centre, Hong Kong, India, Japan, New Zealand, South Korea, Mexico, Singapore, South Africa, Switzerland, UAE, US (CFTC) ‘Passport like’ rights for central counterparties i.e. provision of clearing services to clearing members or trading venues established in the Union
SFTR Positive assessment not yet granted 3rd Country Central Banks and Public Debt Management companies may be exempt from certain transparency requirements. A trade repository established in an equivalent 3rd country may be recognised

While the UK’s unique position as an exiting EU Member State, should see it well placed in terms of a technical assessment of regulatory equivalence, at least in the short term, the path to previous positive equivalence decisions has often been lengthened by political considerations, such as the importance of the equivalence decision in question to the functioning of the internal market, risks arising from the level of interconnectedness and whether there are any risks of circumvention of EU rules.

So even in cases where third country provisions are currently operating, because equivalence is granted to countries and not individual firms, existing UK financial services firms will still have to wait for the UK to receive a positive assessment before they can avail of the equivalence mechanism in question.

In the event that a positive equivalence decision is reached with respect to the UK, in order to maintain that decision the UK will have to continue to mirror the EU financial services rulebook with little or no influence on how further regulatory initiatives are drafted or implemented. Even where third country equivalence is operational, its effect can be restricted by Member States having the right to ‘opt-out’ of certain third country regimes. For example, under MiFID II it is permissible, for retail clients to be serviced by branches of third country firms but there is no obligation on Member States to allow such branches to be established. In the case of the insurance sector, a limited third country regime exists in relation to the issuing of contracts of insurance. However, Member States enjoy discretion as to whether direct authorization is granted to branches of third country insurance firms.

Accordingly, while third country equivalence can provide a solution to certain scenarios which may result from the cessation of the UK firms automatic access to EU financial markets, it is:

  • Limited in its coverage
  • Idiosyncratic in its application, and
  • Subject to both regulatory and political challenges at European and national level.

By way of an example of the transition from EU Passport to a third country equivalence regime, UK-based Central Counter Parties (‘CCPs’) and Trade Repositories (‘TRs’) as well as the counterparties wishing to use their services are currently subject to EMIR. EMIR contains third country provisions and positive equivalence determinations have been made by the European Commission. Should the UK become a third country, then these UK based CCPs and TRs would have to apply for third country recognition from the European Commission after a technical assessment by the European Securities and Markets Authority (‘ESMA’) in order to continue to provide services to EU counterparties. If this results in a protracted process then it is likely to cause considerable business disruption in the provision of existing services.

Absence of third country provisions

While no substantive proposals have emerged, the European Commission Staff Working Paper on EU equivalence decisions has noted, “ultimately the reduction of regulatory gaps and overlaps with non-EU jurisdictions is beneficial also to the wider EU economy.” It has been suggested that the European Commission is contemplating an examination of the existing equivalence regimes in financial services with the view to proposing legislative reform.

Notwithstanding the challenges noted above with the UK third country equivalence regime, there are a number of areas in financial services that do not envisage a third country regime. Examples of these services include, deposit taking, lending, mortgage lending, insurance mediation and distribution and activities under the undertakings for collective investment in transferable securities (‘UCITS’) legislation.

In the case of UCITS, UK domiciled UCITS will have to re-domicile elsewhere in the EU in order to maintain their brand and status as UCITS funds, otherwise they would become a non-EU (and non-UCITS) retail funds governed by AIFMD. UK UCITS mangers could also be affected in that they would lose their existing right under UCITS to manage UCITS funds based in other EEA domiciles and their automatic right to passport UK domiciled UCITS funds. This may result in affected entities having to consider re-structuring or seeking re-authorisation as UCITS management companies in another EU Member State.

Delegation of certain activities

On the assumption that no equivalent access agreement is concluded between the UK and the EU then the primary remaining option that firms should consider is establishing a subsidiary in another EU Member State and applying for it to be authorised by the national competent authority in that jurisdiction. As an authorised entity in an EU Member State that subsidiary would be able to passport services across the EU. This solution would require UK firms to re-structure their business such that services currently passported from the UK, would be passported by the new subsidiary.

Any new EU subsidiary will have to demonstrate substance in the Member State where it is seeking to be authorised, e.g. that decision making will be vested in the proposed new entity.

A key question for firms to explore is the extent to which it may be possible for the new EU subsidiary to delegate or outsource certain functions/activities to the UK entity. The outcome of these assessments will be based on the specific fact scenario of the firm in question.

Previous articles

June 2017 Insurance distribution: the next steps to 2018
June 2017 EIOPA Priorities
April 2017 Investment Firm Regulations
April 2017 Risk Culture - a regulator's view
April 2017 Best execution - MiFID II

Further information

For more information on previously issued News articles, please contact Margaret Murphy, Director, KPMG Regulatory.

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