Compliance and Regulation Readiness: Planning for the Unknown
June 23, 2016 will go down as a red letter day in the history of the UK. It will undoubtedly be several years before we can judge properly whether it was the genesis of new opportunities or a serious misstep. A second referendum has been ruled out and the idea of somehow legally blocking the British people’s decision to leave the EU is probably just a distraction.
Despite the protest marches and legal challenges, it now seems almost inevitable that the UK will leave the EU, although the timing of that is still mired in uncertainty. Certainly, the two years allowed for negotiation once Article 50 has been triggered does not seem long to decouple the UK from the plethora of EU legislation and rules across numerous different industries and sectors, let alone renegotiate a new relationship with the EU. Some commentators take the view that we are better using the two years to focus exclusively on managing our exit, and then to negotiate separately from outside. Whatever form the negotiation takes, it is going to be a highly challenging exercise with unmatched levels of complexity. To say it will be a distraction for the government from business as usual is a massive understatement.
There are however, some things we can be reasonably certain about:
- The current in-flight EU financial services legislation, such as Markets in Financial Instruments Directives (MiFID) II, will be adopted by the UK. Not only will MiFID II be implemented ahead of the UK actually leaving the EU, but the UK will almost certainly retain MiFID II and most of the rest of EU financial services legislation after it has left, at least for a while.
- A European Economic Area (EEA) model, whereby the UK retains access to the single market but without accepting the ‘four freedoms’ of the EU (in particular the free movement of people), looks unrealistic. Not only are other EU leaders giving a strong steer that free market access is inextricably bound up with the free movement of people, but it is hard to envision the UK being happy to be a passive recipient of EU legislation as an indefinite arrangement. Hence this model does not appear to be an attractive long-term solution.
- London’s long-standing status as Europe’s financial services capital will not change, at least not for a generation. In Zyen’s 2016 Global Financial Centers Index, London was the top financial center in the World. The highest EU city in the rankings was Luxembourg at number 14.
The UK being a ‘third country’ for the purposes of EU financial services legislation will not be a disaster, particularly in the wholesale markets. Although being outside the EU would limit the ability of UK firms to access some EU market participants, particularly retail investors, this does not represent a body blow to London. Some firms will have to establish themselves in the EU as a result, but that does not mean having to move all of their business operations to another country. As UK asset managers re-evaluate their operating model in a post-Brexit environment, third party management companies based in the EU will undoubtedly play a prominent role and become a consideration of choice. Duff & Phelps’ authorized “Super ManCo” entity based in Luxembourg, one of the first to obtain a third party Alternative Investment Fund Manager (AIFM) license, provides an umbrella solution for Alternative Investment Funds (AIF) and Undertakings for Collective Investment in Transferable Securities (UCITS) companies across all asset classes and jurisdictions to access European investors while mitigating against political and legal uncertainty. This includes regulatory substance, hosting services and fund engineering, combined with risk and independent valuation services.
Before we all relax too much, it’s worth reflecting on a few things:
- Non-European firms who are thinking about setting up in the EU in order to access the single market may now decide not to set up in the UK. On the other hand, firms that want access to the UK market will almost certainly set up there rather than elsewhere in Europe.
- Although the wholesale adoption by the UK of current EU regulation should ensure the UK’s regime could be deemed ‘equivalent’ to EU rules and therefore allow third country access, this is not automatic and an equivalence assessment by the EU authorities may take some time to complete.
- The EU may decide to ‘pull up the drawbridge’. Without the tempering influence of the UK in the EU’s development of financial services legislation, EU Member States may take their financial services markets in a more protectionist direction. One consequence of this could be to restrict further access of third country firms to EU investors.
This fast-moving and constantly evolving situation makes it hard for market participants and investors to plan with any certainty. Everyone in cross border financial services, regardless of their current business model, should understand the potential impact of Brexit on their business. Clarity will emerge eventually, but in the meantime, it is sensible to explore the options that may be open to firms. Contingency planning, albeit at a fairly high level, will serve to calm stakeholders.