Are You Ready for Brexit?
It’s more than four years since the Brexit referendum, but still there remain unresolved operational issues and significant political uncertainty for fund managers and investment firms operating in and marketing services into the European Union (“EU”).
With the end of the Brexit transitional period on December 31, 2020 approaching fast, and slow progress being made on the proposed future trading relationship between the UK and EU, the hopes for a deal on financial services to include some form of cross-border access are fading.
On November 9, 2020 the Treasury issued a number of equivalence decisions which will allow UK firms to continue accessing EU-based exchanges, clearing houses and financial benchmarks. The Financial Conduct Authority (FCA) has also made use of the Temporary Transitional Power (“TTP”) which was given to it by the Treasury to allow firms until March 31, 2022 to make necessary changes to their compliance arrangements. This should smooth the transition to the new post-Brexit UK regulatory framework.
However, there have not yet been signs of allowing the same level of equivalence from the EU, apart from equivalence being allowed to UK clearing houses until mid-2022. Responses to minimize the impact of a hard-Brexit on firms have been mainly adopted at a national level by EU Member States, without a coordinated response within European Supervisory Authorities.
As negotiations continue, what options should investment firms consider if they wish to continue to operate on a cross-border basis after the end of the year?
UK firms providing services and marketing in the EU
UK firms currently relying on EU financial services passports and wishing to continue to provide services and to market into the EU, will have to ensure compliance with the applicable local requirements in each EU Member State. Below are some of the options available to them:
- Appointment of EU-based distributors or placement agents: By appointing one or more appropriately licensed fund distributors or placement agents in the EU, UK firms can continue to gain access to EU investors. Paying for such third-party services may not be palatable to all firms, especially where they already have well-established and experienced in-house marketing and business development teams. However, some of these distributors may be able to provide secondments or chaperoning arrangements for employees of UK firms.
- National Private Placement Regimes (“NPPR”): As the UK will be treated as a third country going forward and UCITS and AIFMD passports will no longer be available to firms, UK AIFMs marketing non-EU funds into the EU will no longer do so under Art.36 of the AIFMD. Instead they will have to seek registration under Art.42 in each of the countries where they are marketing their funds. Similarly, UK AIFMs marketing EU AIFs and UK UCITS into the EU will also be required to register for marketing under Art.42. Some EU Member States, e.g. Finland, are already allowing UK firms to submit their Art.42 notifications, even though the transitional period has not ended yet. Nevertheless, firms should note that even if they have registered in each relevant Member State under the local NPPR, different stages of the marketing process (e.g. meeting prospective investors to market the fund, issuing subscription documents or the reception and submission of subscription requests) may still amount to the performance of a regulated activity and require appropriate licensing in the local jurisdiction.
- Reliance on reverse solicitation: The provision of investment services or the offering of funds as a result of the sole initiative of the client or a reverse enquiry generally falls outside the scope of local requirements across EU Member States. This can be a viable option for UK firms but only to the extent that the initiative of the client can be appropriately evidenced and documented. Reliance on reverse solicitation may also be restricted on a product by product basis, so that it may not be possible for UK firms to offer follow on funds or services to existing clients or investors, even when the initial approach was at their sole initiative;
- Appointment of a third-party EU Management Company / AIFM: With appropriate Memoranda of Understanding (“MoUs”) now in place between the UK Financial Conduct Authority (“FCA”) and the European Securities and Markets Authority (“ESMA”) and EU National Competent Authorities (“NCAs”), the delegation of portfolio management activities to UK managers will still be allowed. This can be an option for UK firms looking to manage and market EU UCITS and AIFs into the EU. By appointing an EU entity authorized under the UCITS Directive and/or the AIFMD, UK-based portfolio managers will be able to rely on the appointed EU firm’s product marketing passports. Some, but not all, third-party EU Management Companies and AIFMs also offer distribution services, allowing chaperoning or secondment arrangements for marketing personnel of the delegated portfolio manager.
- Reliance on national transitional reliefs: In the absence of an EU-wide solution similar to the UK’s Temporary Permissions Regime (“TPR”), discussed in more detail below, certain EU Member States have adopted their own national transitional reliefs. Other Member States allow the provision of cross-border services to professional and eligible counterparties, often subject to notification or authorization from the local regulator. The table below provides an overview of some of these relevant transitional reliefs and third-country license regimes.Firms will have to look at each relevant country on a case by case basis going forward to ensure local compliance.
- Obtaining an EU license: UK firms may decide to obtain a license in an EU Member State to continue servicing and approaching EU clients and maintain access to passporting arrangements. This is not an easy process as it will require complex considerations, for example around which Member States would offer the optimal solution taking into account its regulatory and legal framework, tax regime, reputation as a financial services center, availability of expertise and professional services providers, etc. Important considerations also include the time required to obtain the required license, the local regulator’s expectations around substance, regulatory capital and financial and non-financial resources required to become fully operational. For the reasons above, this option may not be easily viable for smaller firms which may decide to adopt one or more of the above options before committing to such a significant investment of time and resources.
EU firms providing services and marketing in the UK
The UK TPR will allow EU firms operating in the UK, either via a service or a branch passport, to continue operating in the UK within the scope of their current permissions after the end of the Brexit transition. Fund managers marketing funds in the UK via a passport will also be allowed to continue to temporarily market in the UK after the transition period.
EU firms and fund managers wishing to use the TPR must notify the FCA by December 30, 2020. Fund managers which have notified the FCA previously and need to update their notification, for example to add new sub-funds, must inform the FCA by December 9, 2020.
Once in the TPR, firms will be allocated slots for submitting formal authorization applications, and fund managers to submit recognition or NPPR notifications as appropriate, to formalize their regulatory position at the end of the TPR. The FCA has set out the specific rules which will apply to these firms during the TPR.
Those EU firms which decide not to enter the TPR will benefit from the Financial Services Contracts Regime (“FSCR”) which will allow them to wind down their UK business in an orderly fashion.
What should your firm do to prepare?
There is no one-size-fits-all solution for firms impacted by the end of the transition period. The answer will depend on each firm’s specific circumstances and to what extent it relies on customers and investors based in the EU.
Firms should consider carefully what impact Brexit will have on their business models and activities and, once this is clear, consider what option, or mix of options, described above would offer the best solution for ensuring continuity of their cross-border operations.
Temporary relief and cross-border regimes available in the EU
Below is a non-exhaustive list of temporary relief regimes available across EU Member States. The situation is continuously evolving so firms are encouraged to seek local advice where necessary.
|Belgium||UK firms wishing to continue providing investment services to per se professional clients, eligible counterparties and expatriates will be able to do so subject to previous notification to the Belgian Financial Services and Markets Authority (“FSMA”) to demonstrate that relevant conditions are met. The notification must be submitted before the end of the Brexit transition.|
||UK firms wishing to continue providing investment services to per se professional clients and eligible counterparties will be able to do so for an 18-month transitional period subject to previous notification to the Danish Financial Supervisory Authority (“DFSA”).
|Finland||UK firms can apply for authorization from the Finnish Financial Services Authority (“FIN-FSA”) as third country firms to provide services to per se professional clients and eligible counterparties on a cross-border basis. UK firms which have submitted an application for authorization to FIN-FSA can continue providing services to professional clients and eligible counterparties in accordance with their EU passports while their application is being assessed.
|France||No transitional relief available at the time of writing this article.
|Germany||No transitional relief available at the time of writing this article.|
||UK firms can benefit from the existing provisions in domestic legislation implementing MiFID which allow firms with a head office outside of the EU to service Irish per se professional clients and eligible counterparties as long as they do not do so from an establishment in Ireland.
UK AIFMs will also remain able to manage Irish Qualified Investor Alternative Investment Funds (“QIAIFs”) on a cross-border basis without the need for an AIFMD management passport.
||UK firms can apply for authorization from Banca d’Italia and Consob as third country firms to provide services to per se professional clients and eligible counterparties on a cross-border basis.|
UK firms can apply for authorization from the Commission de Surveillance du Secteur Financier (“CSSF”) as third country firms to provide services to per se professional clients and eligible counterparties on a cross-border basis.
The CSSF has also now formally clarified that Luxembourg AIFs will be allowed to continue to be managed by their current UK managers subject to notification to the CSSF providing evidence that certain conditions are met (e.g. only professional investors are invested in the AIFs and investor consent has been obtained).
|Norway||Under current proposals of the Norwegian Ministry of Finance, it is expected that UK firms permitted to carry out investment services in Norway under EU passports will continue to provide such investment services to professional clients and eligible counterparties until December 31, 2022.
Chancellor Outlines Plans for the Future of UK Financial Services
On November 9, the Chancellor Rishi Sunak outlined his plans for the UK financial services industry to remain an open and attractive financial center by leading on green finance.
To help the UK meet its environmental targets, the Government will issue its first Sovereign Green Bond in 2021, with the intention to follow up with further green bonds to meet growing investor demand. These bonds will help fund projects that will tackle climate change, finance investment in infrastructure and create green jobs across the UK.
The Chancellor also announced the introduction of more robust environmental disclosure standards in the UK. This will help investors and businesses to better understand the impact of their exposure to climate change. It will also help them to set the price for climate related risks more accurately and support the move to a greener economy in the UK.
Given the urgency of the climate threat, a voluntary approach to climate related financial disclosure is not considered to be sufficient. The UK will therefore become the first country in the world to make disclosures that are aligned with Task Force on Climate-related Financial Disclosures (TCFD) fully mandatory by 2025, going beyond the “comply or explain” approach.
The UK will also implement a green taxonomy, which will be a common framework for assessing which activities can be defined as environmentally sustainable. To this end, a UK advisory group has been set up to review the EU metrics to assess whether they are appropriate for the UK market.
The Government published a roadmap report, setting out an indicative path for the introduction of new rules and legislative requirements over the next 5 years, with most action occurring over the first 3 years. Most of the mandatory requirements will be in place by 2023, with further refinements by 2025. This is seen as an important part of the work to strengthen the UK’s position as a global leader on green finance.
The FCA will develop proposals for client focused disclosures by asset managers, life insurers and FCA regulated pensions schemes. The FCA is currently developing the policy proposals, intends to publish a consultation paper in the first half of 2021 and aims to finalize the rules by the end of 2021. The Regulator will consider phasing in the obligations, starting first with the largest or most interconnected firms in 2022 and introducing requirements for smaller firms in 2023.
The Chancellor’s announcement on the UK regime appears to concentrate on the environmental aspects of sustainable finance, rather than social and governance considerations.
There is now a question over how the EU Sustainable Finance Disclosure Regulation (SFDR) will apply to UK firms in 2021. Whist it appears that SFDR may not be adopted in the UK as it prepares to implement its own regime, if UK firms are seeking to market their products into the EEA from March 2021, SFDR remains highly relevant for firms wishing to use the national private placement regimes. There is also likely to be increasing investor demand to comply with SFDR disclosure obligations.
We welcome the Government’s announcement and the FCA’s planned work on sustainable finance. We continue for the moment to work on SFDR, will address the FCA consultation once published and will be happy to assist firms through these changes.
UK Defers CRR2 and IFPR Implementation to January 2022
The UK Treasury, Financial Conduct Authority and Prudential Regulation Authority have announced a revised timetable for the implementation date for both Capital Requirements Regulation 2 (CRR2) and Investment Firms Prudential Regime (IFPR). The UK’s target implementation date is now January 1, 2022.
- IFPR was previously deemed likely to apply from June 26, 2021, in line with the implementation date of the EU’s Investment Firms Directive and Regulation (IFD/IFR)
- CRDV and CRR2 were previously due to be implemented in the UK from December this year and May 2021, respectively.
This gives UK Firms; credit institutions and large systemic bank-like MiFID investment firms subject to CRDV and CRR2, and other MiFID investment firms subject to IFPR, a little longer to implement the new regimes, which will be welcomed by all parties.
The relevant UK authorities also now have a more practical period over which to consult and implement final provisions, permitting those Firms in scope to be more actively involved in that process.
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