FINANCIAL SERVICES REGULATION UNDER THE UK-EU BREXIT DEAL

Executive Summary

The U.K.-EU Brexit deal provides no new transition period for financial services, nor any new arrangements to replace the existing “passport.” This leaves both the U.K. and EU to address matters of access in financial services through unilateral declarations of equivalence under existing equivalence regimes contained in U.K. and EU law (as well as any new ones that might be introduced) and through domestic laws. It does however address certain matters ancillary to equivalence, for instance on combatting money laundering and the application of global standards such as the Basel Rules. Unless there is a raft of unilateral equivalence declarations made by the EU before year end (to match those already made in the U.K.), it looks likely that for financial services 1 January will prove to be a “hard” Brexit, requiring implementation of most aspects of firms’ contingency plans.

Background

The long-awaited treaty between the U.K. and EU which will govern their relationship after the completion of the U.K.’s exit from the European Union was agreed on 24 December 2020 and published by the U.K. government on 26 December 2020. The main document is a “Trade and Cooperation Agreement”, 1246 pages in length, together with 26 pages of declarations, and texts on nuclear cooperation and exchanging classified information.

Financial services, despite being one of the U.K.’s most significant industries, is covered only briefly, on pages 107-111 of the Trade and Cooperation Agreement and page 2 of the Declarations. The more general provisions relating to services, and related areas such as business visas, will also be relevant to financial institutions.

What Is Not Included for Financial Services

It is perhaps easiest to explain the new U.K.-EU regime by reference to what it does not do:

• The current passporting arrangements, which allow U.K. firms access to EU markets, and vice versa, will end.
• There is no extension of the current “transitional period” for financial services.
• There will be no new mutual recognition regime. Indeed, a carve-out for financial services equivalence determinations is introduced from the obligation to provide mutual recognition on a most favoured nation basis.^[1]
•  The obligations on the parties to review their legal framework and work together on non-conforming measures do not apply to financial services.^[2]
•  The obligations on both parties for service industries, for example to facilitate licensing processes and provide a single regulatory interface for U.K. to EU access, do not apply to financial services.^[3]

 As a result, unless there is an (as yet undeclared) issuance of a swathe of new equivalence determinations, most U.K. and EU firms would be well advised to press ahead with their contingency plans for 1 January.

What Is Included for Financial Services

The new U.K.-EU deal is very much “Canada-style.” It does not contain any special privileges for either party as a result of the similarity of U.K. and EU financial regulations at the point of Brexit. The treaty includes:

• A “best endeavors” commitment to implement international standards, naming the Financial Stability Board; the Basel Committee on Banking Supervision, in particular its “Core Principle for Effective Banking Supervision;” the International Association of Insurance Supervisors, in particular its “Insurance Core Principles;” the International Organisation of Securities Commissions, in particular its “Objectives and Principles of Securities Regulation;” the Financial Action Task Force; and the Global Forum on Transparency and Exchange of Information for Tax Purposes of the Organisation for Economic Cooperation and Development.^[4]
•  A commitment to allow newly established or expanded financial services from the U.K. into the EU (or vice versa) to take place subject to the same local licensing regime as local players. This comes alongside a commitment for authorisation to be provided within a reasonable time, subject only to the prudential carve-out.^[5] It is far from clear how useful this will be in practice and it is, in any event, much less extensive than the obligations in relation to general services industries.^[6]
•  U.K. and EU self-regulatory organisations, which are defined to include exchanges and clearing houses, are required to admit financial services suppliers from the U.K. and EU on a non-discriminatory and “most favoured nation” basis.^[7]
•  Access to U.K. and EU payment and clearing systems operated by public entities is required.
• A standard “prudential carve out,” allowing both sides to impose financial regulations in the area of regulatory capital and related prudential areas with only a limited curtailment of this carve-out, where its usage would violate other provisions of the treaty.^[8]
•  The ability of member states to regulate EU27 branches of U.K. firms on a national basis is reserved.^[9] A host of other EU27 national and U.K. law sector-by-sector peculiarities in their financial services laws or residency requirements are preserved.^[10]
• Transfers of data from the EU (and the three EEA member states, upon their express acceptance) to the U.K. shall not be treated as a transfer of data outside of the EU. This arrangement will exist for four months, extendable by a further two months unless either party objects to such extension. This treatment may be ceased if the U.K. substantively amends its data protection legislation without the agreement of the EU. This interim provision has been included, presumably, to give the EU enough time to adopt an adequacy decision in respect of the U.K.—the adoption of an adequacy decision specifically brings to an end this bridge period.^[11]

What Are In-Scope Financial Services?

The question of which institutions will be in or out of scope of the financial services definition^[12] may be important for some sectors. Life and non-life insurance, insurance mediation, deposit-taking, brokerage, investment advice, clearing, settlement and asset management are all clearly in scope of the definition. The definition of banking and investment services is essentially an embellished version of that in the Annex to the fourth Capital Requirements Directive (CRD4).^[13] However, no investment instruments are prescribed and there is noteworthy “underlap” between the CRD4 regime and activities defined under other EU regulatory regimes, such as MiFID II^[14] and the Payment Services Directive.^[15]

There are attempted catch-all provisions for “services auxiliary to insurance, such as consultancy, actuarial, risk assessment and claim settlement services” and also for “advisory, intermediation and other auxiliary financial services on all the activities listed in points (A) to (K), including credit reference and analysis, investment and portfolio research and advice, advice on acquisitions and on corporate restructuring and strategy”. However, exchanges, multilateral trading facilities and specialist payment services firms (other than account information providers, which may fall into a financial data category) would not appear likely to fall under any such auxiliary definition. Moreover, it is unclear whether activities relating to instruments at the edge of financial regulation, such as emission allowances or shorter-dated or physically-settled derivatives, which are or may be regulated under MiFID II or other regimes, are in-scope. Doubtless, opportunities may present themselves over the coming years for payment services firms, emissions dealers, exchanges and MTFs to take the position that they are not in the financial services sector for these purposes and should benefit from the more extensive protections and access rights applicable to other services sectors.

What Is Yet to Come—Enhanced Equivalence?

Perhaps the more important measures are described only in high-level in the Declaration and left for the future. This reads as follows (with no more):

“1. The Union and United Kingdom agree to establish structured regulatory cooperation on financial services, with the aim of establishing a durable and stable relationship between autonomous jurisdictions. Based on a shared commitment to preserve financial stability, market integrity, and the protection of investors and consumers, these arrangements will allow for:

- bilateral exchanges of views and analysis relating to regulatory initiatives and other issues of interest;

- transparency and appropriate dialogue in the process of adoption, suspension and withdrawal of equivalence decisions; and

- enhanced cooperation and coordination including in international bodies as appropriate.

2. Both Parties will, by March 2021, agree a Memorandum of Understanding establishing the framework for this cooperation. The Parties will discuss, inter alia, how to move forward on both sides with equivalence determinations between the Union and United Kingdom, without prejudice to the unilateral and autonomous decision-making process of each side.”

As explained in some of our previous client notes, and publications by a partner of this firm,^[16] so-called “enhanced equivalence” would provide a sounder basis for the EU and U.K. to work together. This involves essentially: (i) both the U.K. and EU granting “equivalence” to each other under existing regulatory frameworks, recognising the (at present) identical nature of financial services laws in the EU and U.K.; (ii) introducing greater levels of cooperation and coordination around the development of new laws and processes for possible withdrawal of equivalence; and (iii) “filling the gaps” in the equivalence framework, such as for commercial banking and primary insurance.

This commitment in the Declaration could presage such a model (though it does not require such an outcome), but as of now there are no details or timetable for any agreement.

The announced equivalency and temporary recognition framework for market and customer access has been extensive (although some gaps remain) on the U.K. side for EU firm access. However, equivalency determinations have been close-to-non-existent on the EU side for access by U.K. firms, not providing any express cross-border coverage for even major sectors as banking, asset management or investment services. EU equivalence determinations to date cover only a handful of sectors necessary for systemic reasons, such as clearing and depositories.^[17] Most of the larger U.K. firms will have established EU subsidiaries to provide service continuity, but other U.K. firms will have to rely on other options, such as the “characteristic performance” test or use of “reverse solicitation” in order to continue to provide services to EU clients. These will be of particular relevance to firms with a smaller customer base, or which will not be ready in their licensing or customer transition plans for 1 January 2021. It remains to be seen whether, in the final days of 2020, there is time for any last-minute equivalency decisions or other temporary relief to be published on the EU side to prevent the need for customer terminations by U.K. firms.