For many years, the European Union’s single market directives have allowed City of London firms to ‘passport’ their services across the European Economic Area (‘EEA’) and operate out of other member states without the need to obtain additional authorisation l to the one which they had obtained in a particular member state. Firms from overseas, including many of the large US credit institutions, have chosen London as their financial centre partly because these directives have provided unfettered access to the other European markets with only a single authorisation issued by the relevant UK regulator.
The UK’s decision on 23 June 2016 to leave the European Union (commonly referred to as ‘Brexit’) has naturally caused high levels of uncertainty about how easy it will be for UK-based / authorised institutions to carry on business in the remaining member states. Several firms have already announced that they are putting measures in place to transfer to nearby financial centres, such as Paris and Frankfurt which have, in turn, been taking steps to ensure that they are attractive venues for these types of firms. While it is unknown at the current time whether the UK will remain a member of the EEA and the precise nature of the UK’s arrangement with the EU (at this stage, the UK has not formally notified the EU that it wishes to withdraw from the EU), this blog post will look at the UK’s potential future passporting rights from a non-EEA status.
So, as a non-EEA member, would the UK be able to indirectly benefit from any upcoming EU legislation on the single market directives, and if so, to what extent would any restrictions or limitations be placed on the City of London?
The position under the current EU legislation
The Markets in Financial Instruments Directive (2004/39/EC) (“MiFID”) was introduced over a decade ago by the EU to strengthen the single market for investment purposes and to increase competition in the EU financial markets. In the UK, much of this legislation was introduced through the Financial Services and Markets Act 2000 (“FSMA”), with Schedule 3 of FSMA permitting the ‘passporting’ of UK-based investment services and activities to other Member States. Under the MiFID provisions, there were no harmonised rights in relation to non-EEA firms (commonly referred to as third country firms): this effectively meant that a non-EEA firm that wished to set up business in the EEA was subject to the broad discretion of each Member State and faced the prospect of meeting each nation’s specific requirements.
The impact of future EU legislation
In response to the ever-increasing complexity of financial products and services, as well as the speed of globalisation, the European Council on 13 May 2014 approved further legislation which will amend the former MiFID provisions: the Markets in Financial Instruments Directive (2014/65/EU) (“MiFID II”) and the Markets in Financial Instruments Regulation (Regulation 600/2014)(“MiFIR”). This legislation is scheduled to take effect before the UK is likely to be out of the EU, and it could therefore play a major role in the UK’s access to the single market.
Following Brexit, there is a great deal of uncertainty over the effectiveness of MiFIR because not all UK businesses that currently benefit from passporting rights will be able to rely on its provisions. For example, while UK securities trading and ancillary services (e.g. margin loans) might in theory be covered, it seems insurers and cross-border private banks would not.
Under articles 46 & 47 of MiFIR, many of the rights enjoyed by EU passport holders can be extended to non-EEA countries, provided the ‘equivalence’ criteria are met by the non-EEA country. It is clear from this legislation that the European Commission has absolute discretion with regard to any application made by a non-EEA country. The criteria range from ensuring that non-EEA firms are subject to “effective supervision” (article 47(a)) through to behaving with the “appropriate conduct of business rules”(article 47(d)). In addition, under article 47 (2), the relevant competent authorities from the non-EEA country must report regularly to ESMA (the European Securities and Markets Authority). There is no reason at the moment to suggest why the UK should not meet these equivalence criteria, but any future decision made by Westminster (such as revoking the controversial cap on bankers’ bonuses) could result in City of London firms losing their passporting rights under the single market.
MiFID II directly affects business conducted with retail and elective professional clients. Under this provision, non-EEA firms are likely to have significantly fewer rights than EEA firms. Member States are still entitled to impose specific requirements (as under the MiFID) or alternatively adopt Article 39 of MiFID II:
“a Member State may require that a third country firm [that is, a non-EEA firm] intending to provide investment services or perform investment activities with or without any ancillary services to retail clients or to professional clients within the meaning of Section II of Annex 2 in its territory establish a branch in that Member State”.
This provision would therefore require non-EEA firms to establish a branch in the jurisdiction of each member state and comply with further criteria as established under Article 39 (2), such as initial capital requirements and the willingness to abide with each member state’s anti-money laundering regulations. In short, this would add an additional layer of compliance to firms established in the UK.
While it has been suggested that the legislation noted above could play a role in negotiating a post-Brexit passporting movement around the EEA, this is unlikely to happen unless the UK government is willing to make a number of concessions to the remaining EU member states. Jonathan Hill, the recent former EU commissioner for financial services, has suggested that UK-based firms may lose all passporting rights unless the UK backtracks on the planned restrictions over the free movement of people. Many months of negotiation are now set to take place on the UK’s future relationship with the EU; however, rather like the boy with his finger in the dam wall, financial services firms established in the UK seek a far more immediate reassurance.