Brexit and financial services – beyond the EU passport
Loss of EU passport - what is it about?
The EU passport represents a key achievement of the single market, allowing members of the EU financial services sector to conduct cross-border business throughout the EU/EEA – either directly from the home member state or through a branch office - on the basis of their home country license. The passport is not available to financial services entities located in third countries (not a member state of the EU/EEA).
Whatever the specific outcome of Brexit negotiations, it seems highly unlikely at this stage that the current passport regime will be able to continue to apply, and affected companies will need to look for alternative arrangements to engage in cross-border EU/EEA business from and to the UK.
EU and UK regulators make clear the time to plan is now
With the Brexit clock ticking, both UK and in EU regulators have kicked contingency planning into higher gear. The below examples are just 2 recent illustrations of this trend:
- The Bank of England’s Prudential Regulation Authority has recently notified banks, insurers and investment firms with cross-border activities between the UK and the rest of the EU to undertake appropriate contingency planning for the UK’s withdrawal from the EU, including for the most adverse potential outcomes. Affected firms are requested to present their contingency plans by no later than 14 July 2017.
- On the EU side, the ECB has already made a number of publications, including recent further guidance for banks that are looking to relocate to the Euro area in the context of Brexit.
If no passport, what is the next best thing?
Under current EU law a number of arrangements are available that may to some degree offer solutions to UK firms engaging in cross-border business into the EU. The below overview provides a concise summary of some of the main alternatives.
- Outsourcing of activities
Some EU legislation (e.g. MiFID 2, UCITS, AIFM) provides financial services providers with the option to outsource part of their activities to a third party. As such, this may be an option for EU based entities to keep part of their operations effectively managed from the UK. Nevertheless there are limitations to the scope of permitted outsourcing, and a number of further conditions apply. Broadly speaking, EU legislation provides safeguards to ensure that outsourcing will not affect the quality of services or the relationship with clients, and will not be used to circumvent certain conditions of the financial services firm’s home state authorisation.
The extent to which this option will also be available to UK companies that are looking to outsource to a party located in the EU, will depend on the future UK legal framework.
- Using third country equivalence
In its most advanced form third country equivalence provides for access to companies from non-EU member states whose regulatory regime is deemed “equivalent” to that of the EU. Since third country equivalence is typically based on reciprocity, the above regime may thus also come to benefit EU firms engaging in cross-border business with the UK.
However, equivalence falls short of being a genuine substitute to passporting. It can only be applied when specifically provided for in EU legislation and is not included in some key financial services directives (such as UCITS), or in some cases does not result in providing access to the EU market (such as CRD IV). In addition, equivalence is based on a decision by the European Commission and can thus be revoked. Lastly, past experiences show that the process of getting to an equivalence regime can be quite time-consuming.
- Establishing a local branch
As a second alternative, a financial services company may choose to establish a local branch office. A branch will serve as a local place of business without having a distinct legal personality from the head office. As a downside, a branch will not be able to benefit from an EU passport and thus will require a local authorisation from the relevant host country regulator. A similar approach will also apply vis-à-vis any future UK branch established by a EU financial services provider.
- Establishing a local subsidiary
One step further in the restructuring process would be the creation of a local subsidiary. In this context a subsidiary will be approached as a separate entity, having own legal personality and being required to be licensed by its own home country regulator. As such, a subsidiary will be able to benefit from an EU passport. However, because of its qualification as a standalone entity, the establishment of a subsidiary is bound to impact on the activities of the parent company. Both from an EU and a UK perspective, regulators will want to ensure that any newly established subsidiaries are sufficiently funded and staffed to perform their activities standalone basis.
- Going down the Swiss route?
Alternative arrangements that go beyond the present legal framework of EU or UK law are largely speculative at this stage. Nevertheless, previous negotiations between the EU and Switzerland may offer some guidance in this respect. More in particular, the cooperation regime put in place by the 1989 bilateral agreement on direct insurance (other than life) can potentially serve as a precedent for future EU-UK arrangements. While the bilateral agreement does not offer mutual passporting rights, it puts place an ad-hoc procedure that uses the home state regulator to perform certain verifications in respect of the authorisation dossier. The result is a so-called “fast-track authorisation” by the host state regulator, occurring on a reciprocal basis.
Be ready for Brexit
While still other workaround solutions may be available in particular instances, the above overview makes it clear that no approach offers a perfect alternative and that no one-size-fits-all solution exists. It goes without saying that careful, creative and timely planning is key to minimize any potential adverse impact resulting from Brexit.