The United Kingdom is scheduled to exit the transitional period at 11 pm on 31st December, this will have very significant impacts for the UK financial services industry.
It has been hard to avoid the fevered media speculation in recent weeks about whether there will deal or not between the UK and the EU. Whilst the outcome to this is very important for any number of reasons it is highly unlikely that any putative deal will contain good news for the UK financial services industry. This was made clear by the lack of any equivalence decisions in favour of the UK by the EU earlier this year.
As such it is crucial that UK financial services firms dealing with EU clients and equally EU and EEA firms dealing in the UK prepare for a world without cross border passports and a common rulebook. Nausicaa Delfas (Executive Director of International at the FCA) reminded firms of this last week in a post on the FCA website where she said, “With just a month to go until the end of the transition period, firms need to make sure they are prepared for the end of passporting, and for the new financial services landscape after the end of the transition period.”
1. Outward passports to EU and EEA countries
If your firms deals with clients in EU and EEA countries it is likely that you do some of that business using passports granted by FCA. These passports either allow business to be conducted remotely from the UK into the EU / EEA country or, less commonly, allow you to set up a branch in and EU / EEA country.
All of these passports fall away with the end of the Transition on 31 December 2020 and UK firms need to find other ways to legitimately deal with EU / EEA clients. This might include setting up a directly regulated subsidiary in an EU / EEA country or relaying on country-by-country exemptions that are in place.
Please bear in mind that exemptions are country specific and limited. Whilst you will hear talk of using reverse solicitation or only dealing with wholesale clients there is in practice strong limits on how these concepts can be used or are even relevant across the EU / EEA.
Some EU and EEA countries are offering TPRs (Temporary Permission Regimes) or cross border licenses to UK firms that apply for particular business and client segments however as with a full license these take time and effort to achieve.
2. Inward passports to the UK for EU and EEA firms
In the longer-term EU and EEA firms who wish to continue dealing with UK clients will need to get directly authorised by the FCA or the PRA. However, in order to allow continuity, the FCA are offering a TPR that allows incoming firms to continue doing business in the UK provided that an application is made to FCA within their prescribed deadlines. For most firms this needs to be done via FCA’s Connect system by 30th December.
For EU and EEA fund managers there is also a TMPR (Temporary Marketing Permission Regime) that allows marketing funds into the UK after the end of the transitional period.
Both the TPR and TMPR allow EU and EEA firms to carry on using their existing permissions and existing EU and home state rules during the temporary period.
The TPR is scheduled to last for up to 3 years (end of 2023) though firms should be looking at getting a direct authorisation or UK recognition for funds during this period. For EU and EEA firms who instead choose to wind down their business in the UK there will be the FSCR (Financial Services Contracts Regime) that allows for contract continuity, no application is needed for this.
3. Onshoring of EU regulations to the UK
At the end of the transitional period those EU regulations that applied directly to the UK cease to be in force. Whilst some people might welcome losing some bits of EU regulations in reality this would have left a significant regulatory void in the UK.
As such the UK government have brought most of these regulations ‘onshore’ via Statutory Instruments. This includes some very significant regulations for the UK financial services industry such as MAR, MiFIR, EMIR and CRR. Whilst the UK authorities have tried to largely mirror the existing texts this has not been possible in all cases so there are changes that firms need to plan for.
The good news is that the FCA are making use of a TTP (Temporary Transitional Power) which allows UK firms the option of either following the new onshored rules or the existing EU rules until 31st March 2022. The bad news is that there are some exceptions to this where the FCA expects the new onshored rules to be followed from 1st January 2021.
This is particularly impactful for firms who need to provide transaction reports, for example ESMA FIRDS is replaced by FCA FIRDS and for EMIR reporting these will need to go to an FCA registered Trade Repository.
4. Future options for UK firms
Whilst it is still hoped that the EU authorities might use the equivalence mechanisms to grant some degree of cross border access to UK firms this might be a long way off and is also a political decision as much as a technical one. The main other options for UK firms are to set up a directly authorised subsidiary with passporting rights in an EU country, to set up a directly authorised branch (or subsidiary) in one EU country only or to rely on a hybrid approach of exemptions and cross border licenses.
The first option is the most expensive in terms of set up and ongoing costs but offers the most comprehensive ability to do business and is robust from a regulatory perspective. For example if you set up a full subsidiary in Germany you could then apply to the German regulators (BaFin or Bundesbank) for passports to do business in other EU and EEA countries from this subsidiary. However depending on the scale of this operation it might also require approval from EU authorities such as the ECB.
The second option of a directly authorised branch in a particular EU nation is likely cheaper but would be limited to doing business in that country and would not have EU and EEA passports. For example if you only do material business with EU clients in France it might be worth setting up a branch in France without passports.
The third option of relying on exemptions (such as the Irish Safe Harbour) and cross border licenses should be the cheapest option but is the most limiting and leads to higher regulatory risk.
5. Regulatory obligations management in a more complex Europe
In the past Europe was a predictable regulatory environment for financial services with consistent regulations country by country and cross border passports. That really changes for UK focussed firms with significant EU and EEA business (and vice versa) and this brings with it the challenge of how you ensure you understands the rules that apply to the different part of your business across Europe and particularly for business cross border.
This brings into focus the need for robust and workable obligations management. For example if you are dealing in securities and derivatives from London and your subsidiary in Amsterdam do you know how the different versions of EMIR, MiFID and MiFIR impact your transaction reporting and transparency obligations and can you demonstrate how you meet these requirements.
Equally you might be relying on exemptions and cross border licenses for certain countries and products, do you have an audit trail to show why these decisions were made and what the restrictions are.
There is little doubt of the significant changes this will bring to many of your firms and the challenges of navigating these.
We have extensive experience of implementing solutions to these challenges and are happy to provide bespoke advice or can provide off she shelf solutions to areas like obligations management from our shop.