Financial services sector implications of ‘Brexit’
June 2016 | SPOTLIGHT | SECTOR ANALYSIS
Financier Worldwide Magazine
Should Britain decide to leave the EU and not to join the European Economic Area (EEA) as a result of a ‘Brexit’ vote on 23 June 2016, the impact on UK and EU financial services firms could be significant.
The City of London is one of the world’s leading financial centres. As such, asset managers, investment banks, retail banks, broker-dealers, corporate finance firms and insurers choose the UK to headquarter their businesses, and access the European and global markets.
A central plank of the European Union’s vision for a single market in financial services is that financial services firms authorised by their local member state regulators may carry on business in any other member state.
UK-based regulated asset managers (e.g., long-only, hedge fund and private equity), banks, broker-dealers, insurers, undertakings for collective investment in transferable securities directive (UCITS) funds, UCITS management companies and investment managers of non-UCITS (alternative investment funds or AIFs) have a passporting right to carry on business in any other state in the EEA in which they establish a branch or into which they provide cross-border services, without the need for further local registration. One potential outcome of a vote to leave the EU in the referendum would be that the UK leaves the EU but decides to join the EEA (with a similar status to, say, Norway) – in which case the impact of a Brexit on the financial sector would likely be minimal.
If the UK leaves the EU and does not join the EEA, however, this would have a significant impact on both UK and EU financial services firms, as described below.
Effect on passporting for UK financial services firms
According to figures released by the European Banking Authority (EBA) in December 2015, more than 2000 UK investment firms carrying on Markets in Financial Instruments Directive (MiFID) business (e.g., portfolio managers, investment advisers and broker dealers) benefit from an outbound MiFID passport, and nearly 75 percent of all MiFID outbound passporting by firms across the EEA is undertaken by UK firms into the EEA.
In the event of a Brexit, and subject to the more detailed comments below, UK firms would cease to be eligible for a passport to provide services cross-border into, or establish branches in, the remaining EEA countries (rEEA) and to market UCITS and AIFs across the rEEA.
Effect on UK financial services regulatory law
The EU is a major source of UK financial services regulatory law. There are more than 12,000 EU regulations which take direct effect in each member country and also EU directives which have been implemented or transposed in local law by each country; EU regulations would cease to apply in the UK post-Brexit. In addition, it would be necessary for the UK to renegotiate or reconfirm a series of EU negotiated free-trade deals that would not automatically be inherited by the UK. It would be open to the UK to leave existing legislation in place for the time being and incorporate directly applicable EU regulations into UK law. Accordingly, in contrast to the impact that the UK leaving the EEA would have on passporting, the UK regulatory environment for financial services firms may not change dramatically in the event of a Brexit. Furthermore, any changes to the UK regime are more likely than not to be deregulatory in nature and therefore favourable to UK firms. In relation to the AIFMD, to take one example, the UK government would have the option to introduce a more tailored and proportionate regime for fund managers managing AIFs with lower risk profiles.
Planning for a Brexit is difficult without knowing what a post-Brexit landscape would look like. However, in the run up to the referendum, it seems prudent for UK financial institutions to consider the impact of Brexit on the terms of any new contracts being entered into. Passporting aside, UK firms will also need to assess the practical issues that would arise in the event of a Brexit. For instance, investment strategies that permit investments in the EEA may need to be amended.
Alternative Investment Fund Managers Directive (AIFMD)
If the UK did not join the EEA following a Brexit, then UK AIFMs would potentially be treated as non-rEEA AIFMs, marketing by UK AIFMs of AIFs to rEEA investors would have to be undertaken on the basis of member state private placement regimes, and UK AIFMs would no longer be able to manage (from the UK) an AIF established in an rEEA member state without being locally authorised in that member state to do so. Further, UK AIFMs that utilise AIFMD passports for MiFID investment services to provide segregated client portfolio management or advisory services on a cross-border basis would cease to be able to use those passports. However, unlike other single-market directives, the AIFMD provides for its regime to be extended to non-EEA managers, and this offers a potential third way should the UK not join the EEA. If the UK were to leave its current AIFMD compliant regime in place, it ought to be technically straightforward (if not politically) following a Brexit, for the AIFMD to be extended to the UK, although this would require a positive opinion from ESMA. In this scenario, UK AIFMs could continue to be authorised under the regime and be entitled to use the AIF marketing and management passports (a non-rEEA manager passport). It is important to note, though, that the use by a UK AIFM of a non-rEEA manager passport would be subject to a number of conditions prescribed by the AIFMD that would have material practical implications.
European Market Infrastructure Regulation (EMIR)
EMIR applies to undertakings established in the EEA (except in the case of AIFs, wherever established, where it is the regulatory status of the manager under AIFMD which is key) that qualify as ‘financial counterparties’ or ‘non-financial counterparties’. Since, post-Brexit, a UK undertaking would no longer be established in the EEA, under EMIR, UK undertakings that are currently financial counterparties or non-financial counterparties would become third-country entities (TCEs) for EMIR purposes.
Post-Brexit, UK undertakings – along with other TCEs – would not be able to avoid EMIR altogether, as a number of its provisions have extraterritorial effect, including in relation to key requirements such as margin for uncleared trades and mandatory clearing.
Markets in Financial Instruments Directive (MiFID)
MiFID gives EEA investment firms authorised in their home EEA country a passport to conduct cross-border business and to establish branches in other EEA countries, free from additional local authorisation requirements.
UK regulated firms that undertake MiFID business would no longer be able to rely on the passport to undertake MiFID business in rEEA and might have to restructure accordingly.
The impact on the provision of cross-border MiFID investment services might be diluted by the regime under MiFID II permitting non-EEA firms to provide investment services to professional clients on a pan-EEA basis upon registration with ESMA.
Undertakings for Collective Investment in Transferable Securities Directive (UCITS)
A UCITS fund must by definition be EEA domiciled, as must its management company. Currently, both UCITS funds and their EEA managers benefit from the passport. UK UCITS funds and management companies established pre-Brexit would no longer qualify as UCITS post-Brexit. UK-based UCITS funds would no longer be automatically marketable to the public in the rEEA and would therefore become subject to local private placement regimes.
Simon Currie and William Yonge are partners at Morgan Lewis. Mr Currie can be contacted on +44 (0)20 3201 5644 or by email: firstname.lastname@example.org. Mr Yonge can be contacted on +44 (0) 20 3201 5646 or by email: email@example.com.
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Simon Currie and William Yonge