Continuity for the City after Brexit
In our article on a post-Brexit
trade deal with the EU, one of the key terms we recommended was
that there should be continued access for goods and services under
existing regulations and directives. The EU currently has
numerous regulations and directives which lay down rules with which
goods and service providers must comply, in return for which the goods
or services may be sold in other member states without further
regulatory restrictions. Unlike a country which might newly approach
the EU for a trade relationship, the UK is currently compliant with
this mass of regulations and directives. So, the basis of a
post-Brexit trade deal should be simple: so long as neither party
changes the relevant rules,
continuity of trade will be preserved and access for compliant businesses will continue
after exit in the same way as before.
Importantly however, this would give both parties (us and the r-EU) the
right to change the rules in a relevant area but bearing in mind that a
rule change might affect the continued access rights of those
businesses who export from the UK to the r-EU or vice versa.
One area where continuity is very important is the field of financial
services. We are delighted to reproduce with permission an article
(first published by Thomson Reuters Accelus on www.complinet.com) by a
real expert in this field, Barnabas Reynolds, who is partner and
head of financial institutions advisory and financial regulation at
Shearman & Sterling LLP:
Brexit: Continuity of current arrangements for banks and
Much of the analysis offered in the media and other publications to
date as to the
implications of Brexit for the bulk of business carried on in the City
has been misleading
and has overlooked or omitted key points.
The vast majority of banking and investment banking activity should be
even in the worst case scenario, and the ultimate situation is likely
to be considerably
better than that.
In other words, by default, institutions conducting wholesale
investment services — that is, broadly, principal and agency
broking/dealing, custody services, fund management outside the scope of
the Alternative Investment Fund Managers
Directive (AIFMD), and investment advice with professional and
sophisticated investors — into EU member states will be
able to do so without the need for regulation other than in the UK.
Any negotiated exit is likely to contain additional facilities for and
recognition of Europe-wide
Current position for Pan-EU
business conducted out of London
Historically, the standard model for institutions headquartered outside
Europe that wish to offer financial services cross-border
within the EU has been by way of an EU incorporated
(normally based in London)
conducting largely investment business cross-border
within the EU and in some instances through a branch located in other
In addition, in the case of larger institutions, groups have often
located a bank branch in one member state (normally the
UK) so as to provide an entity with a strong credit rating to EU
depositors. That entity does not benefit from a passport.
Banks (credit institutions) incorporated in the EU obtain their
passport under the Capital Requirements Directive (CRDIV),
including for investment business activities. Investment firms
currently obtain their passport under the Markets in Financial
Instruments Directive (MiFID). An institution incorporated within an EU
jurisdiction obtains its licence in that member state
and then notifies its regulators of an intention to passport.
The question of when activities (such as short flying visits, phone
calls, emails and so on) are, as a matter of local member
state law and regulation, conducted crossborder
has been scarcely considered by many.
The point is legalistic and subtle. The market and many advisers have
jumped over that question and have made passport
notifications for all activities, on the basis the process is so easy
that the issue need not be examined.
In fact, many key activities do not take place cross-border
at all. For instance, deposit-taking
has been generally regarded
as taking place where the bank's books and records are located. Non-EU
booking vehicles are often used for EU business
without any cross-border
Further, given the location of representatives of EU businesses in
London many of the activities take place between people
located entirely within the City. For those activities which could
genuinely be cross-border
a more rigorous legal analysis
would be advisable going forward in instances where no passport is
available. However, in many instances this will be
unnecessary due to forthcoming changes in EU passporting law which echo
G20 and FSB initiatives to ensure greater
mutual reliance between regulators.
The MiFID II passport extension for UK banks and investment banks
Under the arrangements known as MiFID II (incorporating an updated
MiFID and a newly produced Markets in Financial
Instruments Regulation, MiFIR), which will come into effect from
January 2018 before any Brexit termination notice takes
effect, two new passports are introduced for cross-border
investment business conducted with professional clients and
These passports will be available to banks in their investment business
activities (MiFID2 amends CRDIV), and to
The first passport requires the firm to register with the European
Securities and Markets Authority (ESMA) in its list of
permitted third country firms. The second permits a firm to establish a
retail branch in those EU member states which
require a branch presence for that business (paradoxically, due to the
breadth of the current overseas persons' exclusion,
the UK opted out of implementing this aspect of MiFID II) with the
result that the firm is then granted a passport across
Europe for wholesale investment business.
The term "wholesale" means investment business with, broadly speaking,
corporates (except when below tiny capital
thresholds), financial institutions, insurers, funds (including pension
funds), fund managers and governments.
dealings, including multiple and extensive on-the-ground
visits, can be conducted without a branch being
established. This requires of course a thorough consideration of local
law and regulation including tax laws, in the way that
lawyers assessed the situation under the first incarnation of what is
now MiFID, the Investment Services Directive.
To make use of the new passporting processes outlined above, the
European Commission must make a determination that
the laws of a third country — in this case, the UK — are "broadly
equivalent" to those in the EU in prudential and conduct of
business requirements. It is almost inconceivable that an equivalence
determination will not be automatic given that the
UK's laws will be identical to those of the EU in these respects.
There is also a requirement for those laws to be properly enforced.
Again, it is hard to conceive of any nonautomatic
assessment on that front given that the UK regulators are currently EU
mechanisms will need to be established between the UK regulators and
ESMA or the EU member
state's regulators where the retail branch is established. In the case
of the retail branch there will need to be tax cooperation
There are already other equivalency regimes in place, such as for
central counterparties and other market participants under
EMIR. In this context there have been equivalence determinations for
jurisdictional regimes which are considerably different
from the EU's regime, on the basis that they give rise to similar
Thus, under EMIR, equivalence has been declared for the regimes in the
United States, Hong Kong, Singapore, Canada,
Mexico and others.
There are some limited aspects that are not covered by the MiFID2
passport and other equivalence arrangements, such as
lending by credit institutions under the passport in CRDIV. However,
sophisticated arrangements have been developed for
hedge funds that enable the provision of credit throughout Europe,
which could cover much such activity.
This is, of course, a summary of the situation that presumes the UK
does not negotiate a special deal with the EU, which is
highly unlikely. In particular, banks and investment banks based in the
continuing EU which wish to do business in the UK
or through a branch will need a new relationship with the UK. The
current approach of the Prudential Regulation
Authority to non-EU
institutions operating through a branch in London is to permit this so
long as they are not conducting
significant or systemically risky activities.
Thus U.S. institutions have been required to subsidiarise many of their
UK operations. Banks and investment banks based
in EU member states have not had to subsidiarise to date, due to their
entitlements to passport into the UK without
restriction under CRDIV and MiFID. There are therefore systemically
important branches located in London, established
from bases in other EU member states, primarily operating under the
oversight of regulators based abroad.
In the post credit-crisis
world this brings with it considerable risk that UK and other
regulators have been clamping down on
in order to ensure adequate prudential oversight and satisfactory
recovery and resolution plans.
There will need to be new arrangements put in place to the satisfaction
of UK regulators to deal with these points which
ensure mutually beneficial recognition is in operation between the UK
and continuing EU member states.
The G20 and Financial Stability Board (FSB) have been leading the way
on a global level in working through the detailed
aspects of equivalence regimes and deference to home state regimes and
This work at a global level paves the way for any post-Brexit
arrangement between the UK and the continuing EU.