Brexit and Financial Services: deal or no deal?

Insight

22.11.2018

Ahead of Sunday’s summit of European leaders, we consider recent Brexit developments affecting financial services in the United Kingdom (UK) and the European Union (EU) including the draft withdrawal agreement and a long-awaited publication on Brexit contingency planning from the European Commission. This is an update to an article circulated earlier this month entitled “Brexit and Financial Services: The Final Countdown” which provided an in depth analysis of the state of Brexit in the context of financial services including the UK’s “onshoring regime” as set out in secondary legislation in respect of AIFMD, MiFID and UCITS.

1. Are we close to agreeing a deal?

Since the publication this month of our article “Brexit and Financial Services: The Final Countdown” there have been a number of developments.

First, and most importantly, the draft text of the Brexit withdrawal agreement (the Draft Withdrawal Agreement) has been provisionally agreed between the UK Government and EU officials. As anticipated, this includes a transition period (or to use the UK government’s phraseology the “implementation period”) beginning on 29 March 2019 lasting until 31 December 2020. The Draft Withdrawal Agreement provides that the transition period can be extended but only for a limited period and such extension would need to be agreed between the EU and the UK before 1 July 2020.

As described in our previous article, during the transition period, the UK would be treated, for most purposes, as if it were still an EU Member State, with access to EU markets on current terms, and importantly maintaining current passporting rights. The advantage of a transition period is that it buys time for financial services firms to prepare before the UK’s new on-shoring regimes relating to MiFID, AIFMD and UCITS come into effect. Should there be no deal, those regimes will take effect upon Brexit on the evening of 29 March 2019.

The Draft Withdrawal Agreement has raised concerns across Parliamentary parties and although it has received support from those favouring certainty, the question is whether Parliament will approve the Draft Withdrawal Agreement in its current form. There remain a number of contentious issues including the so-called “backstop” which seeks to maintain an open border between the UK and Ireland but which, as drafted, effectively keeps the UK in the customs union until both the UK and the EU agree it is no longer necessary. The potential result being the UK will need to follow EU rules for an indefinite period of time without having any say over them. Further, Spain has warned it will reject the Draft Withdrawal Agreement without clarifications in the withdrawal agreement and the political declaration concerning the future of Gibraltar.

The UK and the EU are now scrambling to finalise the text in time for Sunday’s summit of European leaders and it waits to be seen whether such a revised text will be agreed addressing some of the concerns raised across Parliamentary parties and other Member States. Of course, even if a revised text is agreed, the final text of the withdrawal agreement will still need to be ratified by the UK’s Parliament ahead of 29 March 2019.

2. What are the developments in the UK?

The UK continues to plan for both a scenario where a deal is finalised and ratified by the UK Parliament (deal scenario) and one where a withdrawal agreement is not ratified by Parliament (no deal scenario).

In our previous article we considered, amongst other things, draft statutory instruments concerning the on-shoring of the AIFMD, UCITS and MiFID regimes. These continue to be laid before Parliament and will come into effect on the evening of 29 March 2019 in a no deal scenario. In a deal scenario, it is our view that this onshoring legislation is still likely to be relevant albeit after the transition period and perhaps in an amended form.

To prepare for a no deal scenario, the Financial Conduct Authority (FCA) has published a direction stating that EEA firms carrying on regulated activity in the UK under the on-shored passporting arrangement need to submit a Temporary Permission Notification Form through the FCA’s Connect system between 7 January 2019 and 28 March 2019 if they intend to obtain a deemed permission or variation under the temporary permissions regime.

In a speech delivered on 5 November at the City and Financial: 3rd UK Financial Services Brexit Summit, the FCA’s Executive Director Nausicaa Delfas noted that over 1,300 firms and funds had expressed an interest in joining the temporary permissions regime to date and highlighted that should there be a no-deal scenario, the FCA is working with financial services firms to ensure that a robust regulatory framework is in place and that there is a smooth transition for firms and their customers.

Ms Delfas considered the expectations of firms preparing for a no-deal scenario, noting that the FCA expects firms to:

take their own legal advice on what a no-deal Brexit might mean for them and their customers, and steps needed to manage this;
understand the impact of Brexit on their customers and continue to service customers fully and fairly and communicate with them in a timely fashion, including letting customers know if there will be changes to a firm’s ability to provide services to them after Brexit, and if any changes will affect customers’ products or contracts (including in relation to customers’ rights and protections under the Financial Services Compensation Scheme and the Financial Ombudsman Service); and
continue to meet the FCA’s rules as they implement their Brexit plans.

Finally, the FCA has published the following consultations in respect of Brexit, encouraging firms to respond by 7 December:

CP 18/28: proposed changes to the Handbook and Binding Technical Standards – first consultation; and
CP 18/29 temporary permissions regime for inbound firms and funds.

More consultations are anticipated alongside the publication of further draft statutory instruments concerning Brexit by HM Treasury.

3. What are the developments in the European Union?

Save for its “Notice to Stakeholders: Withdrawal of the United Kingdom and EU Rules in the Field of Asset Management” (Notice) published on 8 February 2018 available here, the European Commission has remained mostly silent on financial firms’ contingency planning. However, last week it published a contingency action plan (Contingency Action Plan) to prepare for a no deal scenario. This publication is available here and summarised below.

Within the Contingency Action Plan, the European Commission emphasises that Member States will play a key role in implementing and enforcing EU law vis-à-vis the UK as a third country and as such must intensify their efforts and prioritise implementing administrative and practical measures and adaptations of their legislation required ahead of Brexit.

The European Commission emphasises that Member States should refrain from bilateral discussions and agreements with the United Kingdom noting that these would either be incompatible with the division of competences within the European Union or, even where compatible with the division of competences, would in the end jeopardise the integrity of the European Union. This may dampen the likelihood of any bilateral agreements favouring financial services being put in place between the UK and other key players such as Luxembourg and Ireland ahead of Brexit.

While it discourages bilateral agreements, the European Commission encourages European Supervisory Authorities to start preparing cooperation agreements with UK supervisors to ensure that exchange of information relating to financial firms is possible immediately after the withdrawal date in the case of a no deal scenario. As discussed in our previous article, these agreements are required to be put in place in case of a no deal scenario so that UK firms can access Members States’ National Private Placement Regimes and are also required for EEA firms to delegate certain operations to the UK, such as portfolio management.

Recognising that significant disruptions may materialise from the abruptness of a no deal scenario, the European Commission is exceptionally envisaging a limited number of contingency measures to mitigate those. The European Commission stressed that contingency measures would apply to a limited number of cases and only be taken where strictly necessary and in the interest of the European Union and its citizens. It listed a number of general principles relating to the implementation of such measures, including that they would be temporary in nature, they would not in principle go beyond the end of 2019 and since they are adopted unilaterally by the European Union so too can they be revoked unilaterally.

With respect to Financial Services, the European Commission acknowledged that a no deal scenario would result in the loss of the right for financial operators established in the United Kingdom to provide their services to the Member States under current financial services passports, and that the activities of EEA operators in the UK will be subject to UK law. However, it harked back to its Notice which underlined the salience of preparing for all possible scenarios, including a no-deal scenario.

The Contingency Action Plan acknowledged that many financial services firms have prepared or are preparing for a no-deal scenario by adjusting contracts and / or relocating capacities to Member States and calls on financial firms to accelerate these efforts. The European Commission recognises that it will not be possible to complete all capacity-building necessary in time by March 2019 and as such there is a risk to financial stability. However, save in respect of cleared derivatives, it considers that the risks to financial stability in respect of the financial services sector have diminished significantly and therefore does not suggest contingency measures in its Contingency Action Plan.

With respect to cleared derivatives, should there be a no deal Brexit scenario, the European Commission will adopt temporary and conditional equivalence decisions to ensure that there will be no disruption vis-à-vis clearing. The European Commission encourages UK-based infrastructures to pre-apply to the European Securities Markets Authority for recognition under the equivalence regime. Otherwise, the European Commission considers that there would be a disorderly close out of derivative positions of EEA clearing members involving UK central parties as well as risks in relation to services provided to EEA operators by UK central security depositaries which cannot be replaced in the short-term.

4. What should firms be doing?

Firms should continue to plan for both a deal scenario and no deal scenario and EEA firms wishing to rely on the UK’s temporary permissions regime in case of a no deal scenario should start preparing their Temporary Permission Notification Forms to submit through the FCA’s Connect system in a timely manner between 7 January 2019 and 28 March 2019.

If you require further information on anything covered in this briefing please contact Grania Baird or Kya Fear, or your usual contact at the firm on +44 (0)20 3375 7000.

This publication is a general summary. It should not replace legal advice tailored to your specific circumstances.