Taking Stock: Brexit at 4 weeks old

Rear view mirror

Whilst this was the new arrival that most people in the UK financial services could have done without it has finally happened. Four weeks in is a good opportunity to review the immediate impact of Brexit, and look ahead to what might happen next.

In looking at what has happened a good place to start is the TCA (Trade and Co-operation Agreement) signed between the EU and the UK on Christmas Eve. Whilst this was a relief in some ways it offered slim pickings for financial services and the City of London.

The section on financial services is rather thin and high level with a fair bit of ‘motherhood and apple pie’ thrown in as padding. For example, comments about adhering to international standards and ongoing regulatory cooperation. Where there is more substance, though I use the word in its loosest sense, is where it is agreed that EU and UK firms can apply for licenses in each other’s territory and the agreement to work on an MoU that establishes a framework for cooperation.

The first point feels like stating the obvious and does not feel like a win for firms on either side. The major countries in the EU and the UK already allow this for all overseas firms anyway. This is effectively saying you can apply to have your subsidiary and or branch to be authorised in an EU country or the UK. It is focussed on non-discriminatory access to the process but does not allow for anything to happen cross border. The authorisation decision still sits with the local regulator(s) and was what most firms have been doing for several years to get ready for Brexit. Meaning that it would have been a very big surprise to everyone if this had not been the case, with or without a deal.

The second point on the MOU might be more interesting, but I will not hold my breath, as it does not even sit in the formal TCA but rather in the accompanying declarations. Hence it does not have the legal force of the TCA. Again, much of what is in the (very short) declaration is focussed on regulatory cooperation and whilst all laudable aspirations it does not look helpful for firms doing business cross border.

The MoU which should build a framework for this cooperation is targeted for March this year. Equivalence is mentioned at the end of paragraph, but it is unclear to me if this will be covered in the MoU or by future discussions. As I noted in our blog in December I still think any equivalence decisions for the UK from the EU are a long way off and will need political support in Paris and Berlin. Our friends at Palladris wrote on equivalence recently so worth having a look at their blog if you want more detail.

With all that focus on the TCA and the surrounding political and media hoopla it is easy to forget some pretty material things happened from 1st January 2021:

  • Passporting rights to and from the UK were lost.

  • The UK TPR (Temporary Permission Regime) came into force and will run for up to three years.

  • Some limited exemptions from the EU such as for clearing went live.

  • UK firms can use country by country exemptions, TPRs and cross border licenses (where these exist).

For UK firms there are also a new set of FCA and PRA rules to replace those that used to come directly from EU Regulations e.g. MAR and EMIR. Some of which apply now whilst most are subject until a transitional period ends in March 2022. We are also seeing anecdotal evidence in the media of some trading moving away from UK to EU venues. Time will tell how material this turns out to be. Particular concern in the industry has focused on the STO (Share Trading Obligation) and the DTO (Derivatives Trading Obligation). With the STO there has been significant shift of European share trading to European venues. With the DTO we have the bizarre situation of business shifting to the US because of US venues being deemed equivalent by both the UK and Europe.

There have also been the first signs of the EU authorities warning UK firms that the new licensing reality needs to be obeyed. For example ESMA’s warning on reverse solicitation. By the way, I didn’t think ESMA said anything new here in terms of how they interpret reverse solicitation but rather they are reminding firms not to take liberties with it. In practice my personal view is that building any kind of long-term business model around reverse solicitation is really difficult in most products though some existing business scenarios and low volume businesses can work.

An area that hasn’t changed for business into the UK is the Overseas Persons Exemption which is not impacted by Brexit. It allows some (broadly wholesale) business to be done cross border into the UK without a license. The UK has also granted very broad equivalence to the EU which should help EU firms do business cross borders in the UK.

Eye to the Telescope

Looking forward I think the most obvious thing to say is that this will take several years to really play out. It will be years before we really understand how best to do financial services business between the EU and UK.

However, in 2021 the rubber has been hitting the road. That is where practical challenges of this new operating environment will start to land for those of us in financial services in the UK and EU. Some of these challenges will have been planned for whilst others will be more of a surprise. Firms will need to move quickly where they find problems as forbearance from EU regulators is likely to be in short supply.

For those UK firms that are building out subsidiaries, or locally authorised branches, in the EU then a couple of big items on the to do list will be meeting business plan commitments and data privacy concerns.

We expect EU regulators will increase the pressure on firms to meet the commitments these firms made as part of their business plans submitted in the authorisation process. For example, how many trading staff and assets would move to the European hub. For most firms these plans have already been put back by the delays to the original and the follow up Brexit dates in 2019 which in turn meant that many clients delayed moving activity to the EU subsidiary (nobody welcomes repapering!).

For the last 12 months and particularly since this winter the Covid-19 crisis has made moving staff much harder. Practically it must be awfully hard to move anyone from London to Frankfurt or Paris right now.

Data privacy is challenging for two main reasons. Firstly the UK is no longer formally part of GDPR having become a third country. Secondly the Schrems II ruling in July 2020 invalidated the Privacy Shield with the US.

Whilst the two are unrelated the distrust of the adequacy of US privacy rules will impact other third countries like the UK. Firms have some time to deal with this as there is a six-month bridging mechanism that allows transfers of personal data to continue from the EU to the UK after Brexit however the clock is ticking.

The ruling from the EU Court of Justice does allow for the use of the European Commission endorsed standard contractual clauses (SCCs) as part of a framework for data transfer arrangements to jurisdictions outside of the EEA however they are not a panacea and might require significant updating of agreements and processes.

As I said equivalence is likely someway off. The FCA has been very clear that they deem themselves equivalent to European regulation and see the delay to equivalence as being a political issue. they do not see the risk of regulatory divergence as a valid issue as the UK intends to maintain high international standards. For example, the G20 Pittsburgh 2009 Declaration will still apply in the UK and cover CCP regulation. What the FCA will not do is be a rule taker and follow EU rules line by line as FCA does not agree that is the basis on which equivalence decisions have, or are, being taken by regulators globally.

As we look further forward we move more into the realm of second guessing the future policy directions of the regulators but there are some questions that have been well flagged.

  • UK CCPs – will the EU continue to allow EU firms to clear with London firms or are they likely to try and push this business to EU over time?

  • Asset manager delegation – will EU fund managers come under pressure to only delegate to EU fund managers?

  • Regulatory divergence – will the lack of equivalence or domestic politics lead to the UK increasingly diverging from EU regulations.

Katharine and I have spent more time than we can remember working on Brexit plans in the last few years so please let us know if we can help you at all.

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