On 23 June 2016, UK voters decided to leave the European Union ("EU"). While implementation of this decision will take years, financial institutions doing business in the UK and the rest of the EU, especially those that rely on the EU "passport" for financial services, must begin to assess now the impact of Brexit on their business models. There are a number of issues that financial institutions will face, but amongst the most important are the extent to which firms (i) based in the UK (including the UK subsidiaries of non-UK banks) will be able to access EU markets and (ii) based in the EU (outside the UK) will be able to access UK markets.
After a summary of the steps financial institutions should be taking now, this Brexit report provides an update on the Article 50 Treaty on European Union ("TEU") notification process, the main models that could replace membership of the EU, and the principal options currently available to the financial services industry if, as could well be the case, the EU passport is phased out.
What steps should financial institutions be taking now?
Brexit creates uncertainty concerning how financial institutions may do business in the UK and the EU which is unlikely to be clarified for many years. In the meantime, financial institutions doing business in the UK and the EU, or planning to do so, must consider the potential impact of Brexit on their business models. In this regard, the Financial Conduct Authority ("FCA") has specifically reminded financial institutions of their risk-based obligations to have contingency plans to deal with such a significant change in the financial market place.
Many firms will not be able to wait until the Conservative Party appoints a new Prime Minister, Article 50 is triggered, withdrawal is negotiated and a new relationship between the UK and EU is agreed, before planning, and even implementing, their response to Brexit. Firms faced with the prospect of setting up and authorising a new entity in the EU and then novating contracts and moving staff, a process that could take well over a year for some firms, will need to act more quickly. Accordingly, and depending upon the time their contingency plans will take to implement, some firms may need to act before the outcome of negotiations is known.
In assessing their business goals and meeting their regulatory obligations, financial institutions should consider the following, given the real risk that a full EU passport will not be available in the future (see below – What are the principal models of relationships with the EU post-Brexit?):
They should identify the activities for which they rely on the passport either to provide services or products from the UK into other European Economic Area ("EEA")1 jurisdictions, or from other EEA jurisdictions into the UK. Since the passport may be phased out as part of the implementation of Brexit, financial institutions may need to restructure their operations, including obtaining licences in new jurisdictions, to service their customers. In addition, to the extent they are planning to expand their business or attract new customers, they may conclude they need to act quickly to adjust to Brexit.2
To the extent that financial institutions already have licensed subsidiaries in other EEA jurisdictions, they may consider whether those subsidiaries could become vehicles for exercising the passport. For example, a US bank that has subsidiaries in the UK and in Germany may want to consider whether "passport" activities throughout the EEA should begin to be conducted from the German subsidiary rather than the UK subsidiary. By the same token, a French bank that has subsidiaries in both France and the UK may want to think about whether certain passporting services conducted from the UK should be transferred to France. Finally, non-EEA banks that have set up branch networks in the EEA based on a subsidiary in the UK should consider the likelihood that the passport may cease to be available for those branch networks and thus may need to consider establishing a presence in another EEA jurisdiction.
Depending on the nature of their business activities, some institutions may conclude that they will have a reasonable chance to continue to provide services from the UK even if the passport ceases to be available. This is because some EU legislative initiatives, such as Solvency II, Markets in Financial Instruments Directive II ("MiFID II")/Markets in Financial Instruments Regulation ("MiFIR") and the Alternative Investment Fund Managers Directive ("AIFMD"), contemplate permitting third country financial institutions (i.e., institutions that are not located in the EEA) to provide some cross-border services to some customers without local licences if the third country jurisdiction has laws that are "equivalent" to those of the EU. At this time, the UK has fully implemented the required EU legislation, including Solvency II and AIFMD, and is on course to fully implement MiFID II, so the UK's laws will not only be equivalent but identical to those of the EU. It is possible that the EU will recognise that certain activities conducted from the UK pursuant to these legislative frameworks (assuming the UK does not modify them) will continue to have access to EEA markets, even in the absence of the passport. However, as discussed below the EU must decide whether or not to deem a third country's laws equivalent and therefore, in the UK's case, there is a risk that it may choose not to do so or may delay a decision, so this option is subject to uncertainty. In addition, not all EU legislation includes the concept of equivalence and, where it does, equivalence does not give the same access to the single market as the UK currently enjoys.
Some firms may be able to have a separate legal entity act as a booking centre in an EEA Member State which then enters into back-to-back transactions on a riskless principal basis with a UK entity that has the staff, capitalisation, and systems to hold the risk. It may also be possible for EEA entities to outsource certain activities to UK entities. These operational models, however, may not be welcomed by all EEA regulators.
Employment issues will also be a concern for firms. A large percentage of the City's approximately three hundred and sixty thousand workers come from other EEA countries, and Ireland, France and Italy between them account for almost half of the City's EEA-originated work force. EEA nationals seeking to live and work in the UK could face new rules incorporating a traditional visa/entry clearance as well as formal requests for work authorisation. UK workers in the EEA would be likely to face reciprocal requirements. The specific terms of any immigration requirements will be subject to the negotiated terms for withdrawal and any domestic arrangements with other EU member states. At a minimum, the current free movement terms are expected to remain in place for the two years the Article 50 process is anticipated to last. Those workers who are legacy beneficiaries of the free movement of workers should consider whether to exercise the right to obtain permanent residency to protect against any future change.
Firms will need to give consideration to how they handle data within the EEA, and in particular, where customer data is located. Currently firms are free to transfer data within a firm in the EEA with little restriction. Depending upon whether the UK adopts the General Data Protection Regulation (due to come into force in May 2018) and the terms of any exit, firms may face restrictions on the transfer of customer data between the UK and the rest of the EEA and should consider whether steps need to be taken to obtain appropriate consents from customers or relocate the hosting of data.
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1 The EEA consists of the EU Member States plus Iceland, Liechtenstein and Norway.
2 Some financial firms, such as insurers and reinsurers, may conclude they are not reliant on the passport to any significant degree for access to the EU market. See our Legal Update dated 7 July 2016 "Brexit: What does it mean for the insurance industry?" on the impact of Brexit on (re)insurers at https://www.mayerbrown.com/Brexit-What-does-it-mean-for-the-insurance-industry-07-07-2016/.
Originally published 8July 2016
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