The consequence of this is that key pieces of upcoming EU financial services legislation will have to be implemented before the UK formally leaves the EU.
On 29 March 2017, the UK Government invoked Article 50, and therefore began the formal two-year negotiation period with the EU, at the end of which the UK’s membership of the EU will cease. As a result, the UK will cease to be a member of the EU on 29 March 2019. The UK Parliament has also passed the European Withdrawal Act, which repeals the European Communities Act 1972 with the purposes of ending the supremacy of EU law in the UK, and converts existing EU law into UK domestic law to preserve a working Statutory Framework (which the Government is then empowered to amend by Statutory Instrument to correct any deficiencies).
Presently, a two-year transition period has been agreed to as part of withdrawal negotiations between the EU and the UK, during which EU law would continue to apply and firms can continue to rely upon existing passporting rights while the details of the future relationship between the EU and the UK are agreed. While the EU has stated that the transition period will only take effect if a full withdrawal agreement is ratified by the relevant EU and UK bodies (which has yet to occur), the FCA and PRA have stated that financial services institutions can incorporate a two-year transition period into their Brexit planning.
The UK’s post-Brexit relationship with the EU
Since the invocation of Article 50, there has been considerable uncertainty concerning the future relationship between the EU and the UK, the extent to which the EU and UK regulatory regimes will be aligned following the UK’s withdrawal from the EU and the resultant level of access the UK will have to the EU single market. While a number of details are still to be negotiated and agreed with the EU and the ultimate outcome of negotiations remains subject to change, the UK Government has now agreed to a proposed model for its post-Brexit relationship with the EU, published in a white paper on 12 July 2018, with the following key features:
- that the UK will "maintain a common rulebook for all goods" with the EU, maintained by a treaty and overseen by Parliament. The common rulebook would (amongst other things) cover agricultural products and environmental, employment and consumer protections;
- a ‘facilitated customs arrangement’ between the UK and the EU to minimise border friction and allow for a ‘combined customers territory’ in which domestic policies may be applied to goods intended for the UK, but EU equivalents would be applied to goods to be exported into the EU. The intention is stated to be that the UK controls its tariffs with respect to trade with the rest of the world, but applies EU trade policy to trade with the EU;
- a "joint institutional framework" to interpret agreements between the UK and the EU, with disputes to be resolved by joint committees and by independent arbitration with a joint reference procedure to the European Court of Justice for the interpretation of EU rules;
- "regulatory flexibility" in the services sector, with arrangements on financial services, but which do not replicate the EU’s existing passporting regime. It is proposed that these arrangements will include the mutual recognition of professional qualifications, reciprocal recognition of equivalence under existing third-country regimes, a bilateral framework of treaty-based commitments facilitating market access and reciprocal supervisory cooperation; and
- the end to free movement, but "reciprocal mobility arrangements" with the EU in a number of defined areas in the interest of economic, cultural and scientific cooperation, including: visa-free travel for short-term business reasons, students and tourism, participation in cultural exchanges such as Erasmus+ and streamlined border arrangements.
This model for future relations is without precedent; it would entail less than the full single market access engendered by the "Norway Model" (by which the UK would join the European Economic Area (EEA) and the European Free Trade Association (EFTA) and be subject to EU standards and regulations in most areas). However, in some areas (in particular, the market for goods) it would entail greater access to the single market and regulatory alignment than a "no deal" Brexit and a reversion to World Trade Organisation (WTO) rules.
The proposal has yet to be agreed with the EU and as such, may be subject to change in the course of continuing negotiations. However, the proposal to maintain "regulatory flexibility" in the services sector would, if agreed to by the EU without amendment, mean that the UK will have reduced access to the EU single market and lose the benefit of the EU passporting regime. This analysis proceeds on the basis that the UK will, accordingly, be treated as a "third country" post-Brexit.
Regulatory flexibility would also mean that the UK regulatory regime is not required to be aligned with the EU regulatory regime after the UK withdraws from the EU and any transition period expires, and that their respective regulatory regimes may diverge over time. Nevertheless, three factors suggest that the UK is likely to retain a robust regulatory regime following Brexit:
- UK thought-leadership - the UK has been at the forefront of the development of modern financial services regulation;
- the international nature of regulatory developments - the UK has adhered to a number of international commitments beyond its membership of the EU, including (by way of example) the commitments on financial services regulation made at the G20 meeting in Pittsburgh in 2009; and
- equivalency decision - should the UK wish to be deemed “equivalent” under European financial services legislation (to allow some level of access to the EU financial services markets post-Brexit), it will be necessary to maintain robust regulatory standards.
Family Offices
- Family offices provide a wide range of both regulated and unregulated services to their clients.
- From a financial services regulatory perspective, Brexit is most likely to impact those family offices that are regulated and which rely on European “passport” rights to provide regulated services from the UK to the EU (including via a physical branch in one or more EU member states) and vice versa. These firms are principally larger single family offices that have chosen to become regulated for structural or other reasons and multi-family offices that need to be regulated in order to service multiple clients.
- The primary concern for family offices providing investment services to EU clients from the UK or UK clients from elsewhere in the EU, is the ability to maintain access via the passporting regimes in the European Single Market Directives.
- The impact of Brexit on family offices will ultimately depend upon the nature of the Brexit model adopted. The following analysis assumes that after leaving the EU the UK will not be a member of the European single market.
Passporting
- Certain regulated family offices rely on the ability to provide services throughout the EU under the MiFID II “passporting” system.
- In the context of EU financial services legislation, passporting is the exercise of the right by a firm, authorised within one EU member state (its home member state), to carry on activities in another EU member state (a host member state) on the basis of its authorisation in its home member state, without the need to obtain additional authorisation from the host member state.
- Post-Brexit, the treatment of UK-based family offices will depend on the Brexit model adopted. If the UK does not maintain access to the single market, the UK would become a third country for passporting purposes and UK family offices will be treated as third country firms.
- The position under MiFID was that third-country passporting is not permitted and instead each member state’s national regime must be complied with, for example, requiring firms to establish an authorised entity in that member state. MiFID II - comprising the Markets in Financial Instruments II Directive (MiFID II Directive) and the Markets in Financial Instruments Regulation (MiFIR) - has applied from 3 January 2018. MiFID II introduces two new passports for “third country firms” which could mitigate the position for UK firms post-Brexit.
- Under Article 39 MiFID II Directive, the “branch passport” may permit firms to establish a branch in an EU member state to provide services to all clients (including retail and elective professional clients) in that member state, provided that certain conditions are met. Individual member states have to “opt-in” for this passport to be available to firms.
- Alternatively, the Article 46 MiFIR “cross-border passport” does not require a branch to be established but does require an assessment of equivalency by the European Commission with respect to the third country. Firms would also need to register with ESMA and comply with certain conditions. Importantly, this passport can only be used by firms to provide cross-border services to per-se professional clients and eligible counterparties.
- In addition to the two new passports, MiFID II provides for the possibility of EU clients accessing services from third country firms at the exclusive initiation of the client (the so-called “reverse-solicitation” exemption). However, this is not seen as a practical solution for providing services into the EU as there will be significant regulatory focus when operating under such provisions.
Market Abuse Regulations (MAR)
- MAR came into effect on 3 July 2016 and repeals and replaces the previous civil market abuse regime in the UK. The FCA is unlikely to relax regulation in this area when the UK leaves the EU, and it is likely that the UK will be required to maintain compliance with MAR for equivalence purposes under other regimes.
- Regardless of whether the UK maintains compliance with MAR, the regulations themselves have extra-territorial effect as they apply to all actions and omissions relating to financial instruments admitted to trading on an EU trading venue (and other financial instruments whose price or value depends on or impacts a financial instrument traded on an EU trading venue). However, financial instruments admitted to trading on a UK trading venue will no longer fall within the scope of MAR once the UK leaves the EU.
Fourth Money Laundering Directive (MLD4)
- MLD4 replaced MLD3 and was implemented on 26 June 2017. Even when the UK leaves the EU it is unlikely to make major changes to the MLD4 legislation as it is committed to compliance with the Financial Action Task Force Recommendations.
- On leaving the EU, the UK will become a third country under MLD4 and will no longer be in scope. However, it may still impact UK firms to the extent that they deal with entities based in the EU, particularly in relation to due diligence requirements. In addition, given the UK’s commitments as a member of the Financial Action Task Force, it would be required to implement a broadly equivalent domestic anti-money laundering regime in any event.
Tax
- Post-Brexit, the UK may be in a position to simplify its current VAT regime and reduce the VAT applicable to certain products. However, whether it would do this given the revenue VAT generates is a different matter. The UK’s double tax treaty will be largely unaffected by Brexit, however, provisions which assume the UK’s membership of the EU may require amendment.
- Without the benefits of EU directives, tax leakages in cross-border transactions and payments may occur. Consideration should be given to implementing any cross-border mergers before the UK leaves the EU. Additionally, without a requirement to comply with EU case law, the UK Government could reverse legislative changes made to accommodate EU treaty principles.