What would happen to the passport under the EU single market directives?
The UK has now left the European Union and the transition period (also known as the implementation period) drew to a close on 31 December 2020. The free trade agreement entered into between the UK and the European Union did not expressly cover financial services (albeit that some general provisions may have some relevance). Instead a MoU was issued stating that the EU and the UK would begin discussions around equivalence by the end of Q1. Consequently, for firms that previously used the passport under EU single market directives, this right is no longer available to them. Presently, this right is only likely to be restored in the event that the EU grants equivalence to the UK (which would need to be granted in respect of each of the single market directives under which UK firms were previously able to access the EU market).
The FCA has put in place a temporary permissions regime, for those firms that applied before the end of the transition period. More information on this can be found here.
Whilst the European Commission has not reciprocated with a similar regime, a number of Member States are putting in place their own emergency transition measures. These are discussed further in our note, Brexit: doing business in the EU.
What impact would Brexit have on the way in which banks are regulated in the UK?
UK banks that conduct cross border business into the EU have been working on Brexit transformation programmes which are very complex, with a myriad of deliverables. These include restructuring local EU entities; designing new ways of operating and transacting; gaining appropriate local regulatory approvals; connecting with new market infrastructure providers (who may be undertaking their own transformation project), moving staff into new premises and drawing up new contracts with suppliers.
When restructuring local EU entities, UK banks have been mindful of communications from the European Central Bank and the European Banking Authority. In relation to the latter, this institution issued an opinion in October 2017 which addressed a number of areas of relevance for EU27 competent authorities, namely the authorisations process, equivalence access for the provision of investment services (whether directly or by establishment), internal model approvals, internal governance and risk management – in particular when it comes to outsourcing and risk transfers using back-to-back or intragroup operations – and resolution and deposit guarantee scheme issues.
Like other UK financial institutions, UK banks are coming to grips with how UK regulation would look in a no-deal Brexit scenario. This involves understanding how EU legislation such as the Capital Requirements Regulation is onshored through UK statutory instruments made under the European Union (Withdrawal) Act 2018. Such statutory instruments are being tracked on our Brexit Pathfinder hub. Conformed copies of UK legislation can be found on Brexit Pathfinder PLUS.
What impact would Brexit have on the UK insurance industry?
The London insurance market is the largest global centre for insuring commercial and specialty risks. A substantial amount of insurance and reinsurance is distributed and underwritten both into and out of the UK. Historically much of this business has been with European customers. Because of the loss of permanent access to the Single Market, UK insurers have established EU authorised branches and transferred their books of European business out of the UK so that they can continue to write new business and pay claims within the EEA.
In an announcement in November 2020, the Chancellor of the Exchequer, Rishi Sunak MP, announced that the UK proposed to recognise the equivalent status of EU financial services laws in a number of key areas. Included in the list of equivalence decisions are the three areas where a third country can be deemed equivalent under Solvency II. The unilateral gesture from the UK to ease access to UK markets sends a signal to the EU to reciprocate with similar recognition of UK standards.
For insurance companies and insurance intermediaries equivalence offers limited access to EU markets. Under the Solvency II Directive (and the Solvency II regime implemented into UK law), there are three situations in which a third-country may be deemed equivalent in terms of the protection and oversight provided by the EU. These provisions are limited in their application and do not provide insurers and reinsurers with anything like the market access between the UK and EEA that was available under the single market passport. Article 172 determines that reinsurance arrangements entered into with a reinsurer in a third country recognised as equivalent must be treated in the same manner as contracts with an EEA reinsurer. Article 227 enables an EEA group with non-EEA subsidiaries to use local, equivalent rules for the calculation of the subsidiary’s solvency. Finally, Article 260 provides that where group supervision rules in a third country jurisdiction, such as the UK, are deemed equivalent, EEA supervisors may rely on the group supervision exercised by the third country national supervisor.
By granting equivalence to EEA Member States in these three areas the UK is acknowledging that insurers and reinsurers established in the EEA have the same capital and governance requirements as UK firms. The benefit to firms under Articles 227 and 260 is relatively limited but should avoid subsidiaries in the EEA having to calculate their solvency on the UK basis (should it move away from Solvency II) and enable the PRA to rely on the group supervision of EEA groups with a UK subsidiary. The granting of equivalence status to reinsurance arrangements under article 172 is more helpful. The decision means that reinsurance contracts entered into with reinsurers in the EEA are treated as equivalent to those with UK reinsurers and that it is not necessary for such reinsurers to retain a specified credit rating. Given the size of the European reinsurance market, this equivalence decision will enable the significant cross border reinsurance market between the UK and EU to continue. The move also sends a signal to the EU that, at least as far as reinsurance is concerned, it is in no-one’s interests to restrict access to reinsurance between such long-established markets as the UK and EU.
If, in a gesture of reciprocity, UK equivalence under Solvency II is determined by the Commission, European insurers could continue to treat reinsurance purchased from a UK reinsurer in the same way as reinsurance purchased from an EU reinsurer. There is currently no ability to treat UK intermediaries as equivalent under the Insurance Distribution Directive so local licenses must be sought if UK intermediary firms wish to continue to distribute within the EU.
The UK has introduced a Temporary Permission Regime (TPR) that can enable both EU insurance firms and intermediaries to continue operating in the UK without passporting rights on a short-term basis while they apply for permanent authorisation under the Financial Services and Markets Act 2000. For firms that do not seek to apply for authorisation, the Financial Services Contracts Regime allows EU firms to wind down their UK business in an orderly manner. These firms are not able to enter into new contracts but are placed into run-off, enabling claims to be paid to UK policyholders from within the UK.
One of the biggest concerns for UK insurers and EU policyholders has been whether or not UK insurers would be able to continue to pay claims without authorisation in each of the remaining 27 Member States. Without authorisation UK insurers could be in breach of local laws by paying insurance claims. To address these concerns, the European Insurance and Occupational Pensions Supervisor (EIOPA) has issued a number of recommendations for Member States to ensure parity across the EU in the treatment of UK firms. EIOPA has recommended that Member States introduce a legal mechanism to facilitate orderly run-off or should require UK firms to become authorised locally. Significantly, EIOPA has made it clear that insurance intermediaries that wish to continue to distribute (re)insurance products to European policyholders must be registered in the EU.
In limited circumstances UK insurers may still be able to cover European insurance risks without seeking local licences. WTO rules enable marine, aviation and transport (MAT) risks to be covered (subject to the application of prudential requirements (e.g. capital and governance requirements)) across borders.
What impact would Brexit have on the UK funds industry?
The big issue for the UK asset management industry is the risk of changes to delegation rules that enable MIFID investment firms, alternative investment fund managers (AIFMs) and UCITS management firms to delegate to a UK based investment manager.
On 1 February 2019, the European Securities and Markets Authority (ESMA) issued a press release announcing that ESMA and EU securities regulators have agreed "no-deal Brexit Memoranda of Understanding ("MoUs")" with the FCA.
In particular, ESMA announced that a multilateral MoU has been adopted between the EU securities regulators and the FCA covering supervisory cooperation, enforcement and information exchange between individual regulators and the FCA, which will allow them to share information relating to, amongst other things, market surveillance, investment services and asset management activities. This allows certain activities, such as fund manager outsourcing and delegation, to continue to be carried out by UK-based entities on behalf of counterparties based in the EEA.
The UK Government has introduced a temporary permissions regime for EEA funds that are marketed into the UK (see above). In particular, the operator of an EEA UCITS which on the date of the UK’s exit from the EU benefits from the temporary permissions regime will also be able to market ‘new sub-funds’ (i.e. those authorised by the relevant home Member State regulator after exit day) in the UK, subject to certain conditions.
Further information can be found on our Brexit Pathfinder hub.
What impact would Brexit have in the financial investors space?
We suspect that Brexit may have limited impact, probably even less so than asset and wealth management unless financial investors are seen to be providing advice or services to third parties. European investors are not a large contributor of funding to UK private equity managers. Also, UK hedge funds and private equity companies may face a relatively easier test than others should they wish to continue providing services to customers in the EU. The key test is the “equivalence” of UK regulation compared with international standards, such as those set by the Financial Stability Board. Other financial institutions such as banks may face a more difficult hurdle with the key test being the equivalence of UK regulation with those in the EU. One would hope that any exit arrangements would deal with any adverse tax consequences relating to where funds are established, assets held or beneficiaries reside, though these are yet to be determined.
Will financial services regulation radically change under Brexit?
Regulatory divergence has been a particular concern for financial services firms. Arguably the threat of such divergence may not be as real as feared in the sense that it would threaten the UK’s access to European financial markets under the EU equivalence regime, thereby offsetting the benefits of any competitive regulatory advantage that the UK may gain. In addition, the UK has played a leading role in the creation of EU financial services regulation which are now very much a product of international standards created after the 2008 global financial crisis.
Will UK financial institutions be part of the new Capital Markets Union?
The EU’s ambition to create an integrated capital market for cross-border investment within the EU, known as the Capital Markets Union (CMU), began in 2014, long before Brexit. The integration of EU capital markets requires changes to many different areas of policy such as taxation, insolvency regimes and financial services law. As such progress on the CMU has proven to be politically tricky and ultimately slow.
European Commission president Ursula von der Leyen has made the completion of the CMU as one of her main goals and the start of the new European Commission term in Brussels is an opportunity to relaunch the CMU initiative. To this end, in accordance with its recently presented 2020 work programme, we can expect the new Action Plan on the CMU to be published by the Commission in Q3 2020. The key issue facing the new Commission is whether to keep the City of London at arm’s length while pursuing an inward-looking CMU or instead opening up the CMU to London and the rest of the world (particularly New York).
To be transformative, the CMU must support globally interconnected markets and be able to unlock investment both from within the EU and the rest of the world. However, whether this will actually happen remains to be seen. Deeper global integration might result in the loss of EU regulatory control given the relatively small size of EU markets compared to London and New York. Also, European corporates could seek finance outside the EU as a result.
At present it seems increasingly unlikely that the Commission will be open to the idea of giving up regulatory control. In the last ten or so years commentators have noted that a side-effect of increased pan-European financial services regulation has been a so-called soft closing of the EU market, forcing non-EU participants to submit to EU rules and, where a positive equivalence determination is not possible, getting authorisation to operate within the Union. The Commission’s recent communication on its equivalence regime and its reference to equivalence assessments and looking more closely at requests from high impact third countries, which we assume to include the UK, suggest that this policy will not be changing in the immediate term. In addition, the Commission documents discussing its approach to future EU relationship with the UK, and in particular the cooperation and equivalence in financial services, highlight the intention to maintain the principle of its regulatory and decision-making autonomy. This is to be reflected in, among other, adherence to the principle that European equivalence decisions are “unilateral and discretionary” and that the block’s autonomy on equivalence should not be restricted by any possible free trade agreement. The UK therefore will have a dilemma in the sense that if access to EU markets is to be based on equivalence (where available in EU legislation) it will be constrained as to how far it can diverge from EU rules and mechanisms.
There are other opportunities and challenges facing the CMU initiative that will require careful consideration. These are in the form of rapid technological change and disruption, as well as climate change. This will mean that the Commission will have to think carefully as to how it can adopt its policymaking to support investment, research and innovation in these areas. Brexit and the future relationship with the UK may add a further layer of complexity.