It seems clear from the published texts that UK firms should continue their no-deal planning. Despite assurances this week of HMG’s desire for a comprehensive trade agreement, the Bank of England has reiterated its expectation that firms are able to operationalise their no-deal plans at the end of the transition period. The UK and EU positions remain far apart, with fundamental issues unresolved as the June ‘stock-take’ meetings between the UK Prime Minister, the President of the European Commission and the President of the EU Parliament draw near.
It does not follow that firms have no interest in the outcome of the negotiations. As set out below, different outcomes in relation to areas such as regulatory co-operation and, in particular the ways in which equivalence may be granted or removed, could make a significant difference. However, for planning purposes, it is clear that anything comparable to the world of the passport is no longer on the table. The conclusion one draws from this will depend on the type of business conducted by the firm and the specific markets in which it operates. It is in this context that firms will want to consider the potential outcomes of the negotiation. However, it is hard to argue with the approach of carrying on no deal planning given that the deal, even on the proposed UK terms, means a significant shift from the status quo.
The UK and EU texts
At a macro level, neither the UK nor the Commission texts provide for positive determinations of equivalence to be made in respect of the market-access granting provisions in either Party’s legal order on exit. Neither text seeks to expand the scope of market-access granting equivalence provisions, either. However, the UK draft text does have certain features which could, together, strengthen the structures of cross-border trade in financial services built on the basis of (autonomous) market-access granting equivalence provisions maintained in either Party’s domestic legal order. Critically, however, this value will only be realised if those market-access granting equivalence provisions are ‘turned on’ by both Parties. There are also other, more subtle pieces of drafting within the UK’s approach which could be helpful to both UK-based and EU-based market participants, and which we outline in this note.
Whilst the draft UK text is more ambitious in the realm of financial services than the Commission’s approach, the key messages for both UK and EU firms conducting cross-border financial services business now are to remain focused on no-deal preparation, and to closely follow developments in the coming weeks and months to understand whether and when such determinations may be made before the end of the transition period.
What does this mean for the future of financial services trade?
Cross-border provision of services
In the political declaration agreed between the Parties, which was intended to record their intentions for the shape of the future economic and other partnerships, there were encouraging references to equivalence assessments being conducted by the Parties, with the implicit intention that cross-border service provision may continue in those limited areas where market access is established through what was the EU law equivalence framework and under any applicable domestic legal provisions maintained in each Party’s respective legal order.
The political declaration itself was very careful to recognise and acknowledge the Parties’ autonomy in respect of market access, following HMG’s decision to pursue a future economic partnership grounded in ‘equivalence’. However, the political declaration did allude to other ambitions; such as conducting assessments by June 2020, keeping the frameworks under review (particularly important in view of the weight of trade which will rest on these legislative provisions) and an ambition to address some of the core weakness of an equivalence-based relationship: ensuring transparency and consultation in the process of adoption, suspension and withdrawal of equivalence decisions.
Neither the UK text nor the Commission’s drafts seek to provide for the determination of the equivalence of both Parties’ legal, regulatory and supervisory regimes for the purposes of the market-access granting equivalence provisions where they exist (most obviously in MiFID II/MiFIR, EMIR and the BMR). There is, similarly no clear intention in either text to expand the scope of these market access granting provisions in either Party’s legal order. This will be a particular disappointment to some as there were hopes in some sectors that the FTA itself would establish a determination to review the scope of provisions in view of their obvious (current) limitations.
The UK’s text seeks to land several of these ambitions in a moderated form in the FTA, in contrast to the Commission’s proposal. Whilst each Party evidently retains autonomy as to decisions regarding market access for financial services providers located in the jurisdiction of the other Party; in our view there are some potentially helpful features of the UK’s approach which, taken together could help to stabilise cross-border service provision premised on market-access granting equivalence measures. Most obviously, the regulatory cooperation provisions (whilst the detail remains ‘TBC’) should ensure that determinations of UK/EU jurisdictional equivalence cannot (in practice, though not necessarily in law) be withdrawn without prior engagement, discussion and deliberation. As set out in more detail below, the UK’s proposals should help to ‘de-politicise’ equivalence determinations; thereby addressing a major perceived weakness in their ability to sustain significant cross-border trade between the UK and the EU. Regulatory cooperation could also be the key to managing the potentially disruptive and distorting effects of divergence over time, providing an institutional framework through which the Parties’ representatives can discuss both legislative and regulatory initiatives, whose development in isolation could threaten the equivalence determinations previously reached.
Unlike the Commission’s draft text, the UK proposal includes a distinct chapter for particular commitments in the sphere of financial services. However, in common with the Commission’s proposal, it is also important to consider the provisions applicable to services more widely which may be relevant to our sector. For example, Article 12.13 within the general ambit of cooperation and liberalisation of measures affecting service provision, contains potentially helpful provisions which encourage competent authorities to consider the equivalence of technical standards adopted or maintained by the other Party, which differ from those set internationally, as equivalent to its own where it can be demonstrated that they meet relevant national policy objectives. In addition, the UK’s drafting seeks to incorporate bespoke provisions to deliver regulatory cooperation in financial services, which is a striking and important distinction to the Commission’s approach.
It is clear that the overall approach to the framework for trade in financial services in both the UK and Commission’s drafting, rests on the comparatively sophisticated and established framework which already exists within the acquis for financial services and which will, in the first instance, be onshored in the UK. Recognising that decisions as to equivalence are within the sovereign rights of each Party, the UK text seeks to build an institutional framework for cooperation so that, once decisions have been made there are constructive processes in place to help ensure they persist. However, as noted above, the text does not seek to entrench the making of these decisions in the first place.
As set out in draft Article 17.19(c) of the UK text, (Annex 17-F establishes mechanisms for regulatory cooperation between the Parties – but we have not seen the details yet) these provisions will doubtless be welcomed by both domestic and European suppliers, as they provide an approach to some of the perceived weaknesses of trade based market-access granting equivalence measures in either Party’s domestic legal order, principally: divergence; transparency; and the ‘off-ramp’.
Without fettering decision-making autonomy, Article 17.19(c) of the UK text explains that the regulatory cooperation seemingly envisaged for Annex 17-F is set to achieve ‘appropriate consultation’ between representatives of either Party on the ‘process’ of adoption, suspension and withdrawal of equivalence decisions. There appears to be a desire to introduce transparency into the process by which equivalence is determined in the first place, so that representatives of either Party can understand the metrics by which the assessment will take place, and can respond accordingly. Of course, these provisions will need to be read in the context of both the IFR and EMIR 2.2 provisions governing equivalence determinations, which have somewhat moved the dial on the detail already provided in the acquis as to how determinations are to take place, and in particular the factors to which (on the European side) the Commission and the European Supervisory Authorities (ESAs) should have regard.
That said, these provisions of the agreement could prove powerful. The hope will of course remain that for services which are capable of being provided following determinations of equivalence (i.e. the ‘current scope’) this will take place in time for exit. However, it is clear (see e.g., revised A.46/47 MiFIR) that equivalence determinations should, effectively be ‘ongoing’. Consequently, providing an institutional framework for dialogue and even consultation to inform those ongoing assessments could provide a very useful mechanism to avoid a determination being withdrawn over time.
The UK’s intention seems fairly clearly to seek, wherever possible, to depoliticise the process by which such decisions are made and withdrawn, so as to provide confidence to market participants that these provisions are capable of bearing some of the heavy weight of cross-border trade in the sector which existed with the UK’s membership of the EU. The UK’s ambition appears, therefore, to aim at transparency, cooperation and also ‘information exchange’ between the Parties on ‘regulatory initiatives’. In practice, these provisions could set the framework for much closer cooperation between UK and EU competent authorities than exists in other trade agreements struck by the EU, even if they necessarily fall some way short of the institutional constructs which exist amongst member states.
If, despite the protocols of regulatory cooperation, either Party ceases to consider the other to maintain a legal and regulatory regime, and supervisory approach which is ‘equivalent’ according to the relevant provisions in their domestic legal order, then it is anticipated that the Annex will provide for a process by which that determination is withdrawn to facilitate market participants to transition their business model to a new normal without cross-border market access. This would be a practical solution which aims to avoid, or mitigate some of the cliff edge risks which have been identified in the period post-referendum. These provisions should, however, be read alongside the prudential carve-out which one can envisage might be engaged in particular circumstances to stifle the intention of such provisions (and on which, see further below).
Of course, since the UK has not yet made public its preferred drafting for Annex 17-F on regulatory co-operation (presumably awaiting the June negotiating round, and TF50’s response the core drafting of Article 17), much of the detail remains in question. However, there are helpful signals within the text of the UK’s draft agreement that a distinct approach to trade in financial services may yet be possible.
The UK draft text contains novel and potentially significant provisions relating to the performance of back-office functions. Although the drafting recognises that the approach to back-office functions will be set by either Party in their legal regime and supervisory approach (and, in a technical sense is therefore of limited weight) it takes aim at some of the supervisory practices which have developed since the UK triggered Article 50, and began the process of withdrawal. The draft text commits the parties to a ‘recognition’ of the importance of back-office functions (whether located inside or outside the territory of a Party) to the financial services provided by a firm, and to the ‘importance of avoiding the imposition of arbitrary requirements on the performance of those functions’.
Depending on its interpretation (which is likely to be undertaken by supervisors), this drafting could go some way to facilitating some continuity between existing internal arrangements at firms, and those which will be required once the UK is a third country so that certain types of non-client facing functionality can remain in either the UK or the EU as appropriate.
The prudential carve-out
The formulation of prudential carve-outs (PCO) within free trade agreements can vary. There is precedent for the establishment of certain limited forms of qualification applied to its use by a Party. It is notable that the UK’s proposed drafting for the PCO set out within Article 17.13 does not contain such qualifications or restrictions, for example through a ‘necessity test’. In contrast to, or perhaps in view of, the relatively close cooperation envisaged by the provisions referred to above, the UK proposes to maintain a broad PCO, affording the UK authorities (most obviously, the Bank of England and the PRA) greater room for movement in the event that measures are required to be adopted for any of the purposes set out.
To a degree, this approach to the PCO reminds market participants that the structures of regulatory cooperation cannot ‘build back’ to the forms of cooperation and, importantly deference to other member states, which are intrinsic to EU legislation in financial services. Indeed, as the UK’s approach to onshoring has made clear, the interests to which UK authorities will generally have regard will obviously reset to UK interests rather than EEA-wide interests, once the transitional period has expired (an obvious example being certain of the UK legislative amendments to the recovery and resolution regime, which pivot back to UK interests in place of EEA interests).
In contrast to cross-border trade in financial services, where market access-granting equivalence provisions already lay the foundations for relations between the Parties, there is no similarly developed approach to the right of establishment which is specific to the sector.
Whilst there is no bespoke framework for financial services suppliers seeking establishment such as that for cross-border services, there are nonetheless a number of provisions within the wider draft which market participants will wish to consider. For example, the drafting provides for so called Mode 4 rights relating to the temporary stay of natural persons for business purposes within Chapter 11. Whilst we anticipate that domestic approaches across member states will continue to be the primary focus of attention, as national and regional variances in approach amongst competent authorities is likely to persist, this is nonetheless an important area which market participants will wish to follow closely to determine whether or not it provides a useful route to mobilise expertise across the business.
We also note that the definition of ‘financial services’ within the UK and Commission drafts differs in scope. In particular, the UK draft includes within it ‘the marketing of financial services’. Whilst this may be simply an area of clarification on which there will be agreement between the parties, its exclusion could pose challenges to interpretation of the agreement in due course and it will clearly be helpful to firms to know that marketing (separately to the activities of financial services supply) are included within scope of the relevant liberalising provisions.