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The financial services industry has been cited as one of the sectors potentially most affected by the consequences of a Brexit. The Bank of England and numerous international bodies such as the IMF have spoken out strongly in favour of remaining in the EU and a survey conducted by the British Banking Association showed that there is almost no appetite from banks for the UK to leave the EU.
A lot of what is being passed off as informed comment and debate in the current campaigns is, at best, prediction and more realistically might be described as conjecture. Long-established legal positions are being presented as new revelations, either for or against a Brexit.
In this briefing, we attempt to set out some of the potential impacts of a Brexit on the financial services industry
Even if the UK votes to leave the EU, each will still have a relationship with the other. It’s just not clear what that relationship will be. A vote to leave would be followed by at least a two year period to negotiate the detail of our ongoing relationship with the EU. Any trade deal would be subject to a veto by any EU State whose interests were not served by its terms. The UK Government has indicated that it could take up to a decade or more to negotiate that agreement and to replace our trade deals with other countries.
The financial services sector is highly regulated. Much of this regulation derives from the EU, and many recent regulatory initiatives such as MIFID II require firms to deploy substantial resources to ensure they have compliance processes in place. Some might say that a Brexit would allow the UK to cut much of the red tape with which firms have to comply. This may however depend upon a firm's strategic footprint and whether distribution in the EU is a significant aspect of the firm’s business going forward. For example, it would still be necessary for UK firms to comply with EU financial services legislation in the event that such firms were to benefit from a third country MIFID or AIFMD passport as discussed below (subject of course to equivalence tests). Such compliance would be in addition to compliance with any separate resulting UK regime. Ultimately, if financial services firms want to continue trading with EU Member States, they would need to comply with EU regulations to do so. Assuming a passport becomes available for non-EU firms, they may also need to (i) make formal applications to regulators in the Members States in which they wish to market funds/services; and (ii) appoint and establish EU legal representatives for contact with the relevant regulator and to perform compliance functions.
The UK will no longer have a seat at the negotiating table in the development of the regulatory framework. As an important player in the financial services sector, the UK has tended to have significant influence over the development of financial services policy. Indeed, the European Commissioner for Financial Stability, Financial Services and Capital Markets Union is none other than the British Commissioner, Jonathan Hill. This may ultimately lead to diverging legislation (or at least legislation which is applied/interpreted inconsistently) over time, meaning that firms with operations in the UK and the EU would have two set of rules with which they would need to comply.
In reality, regulation is unlikely to diminish substantially post-Brexit, and it is possible that it could increase. Further, regulation of financial services firms is not unique to the EU - regulators and regulations are part of the international landscape in which financial services firms operate.
For many, the key issue is whether market access might be affected in the event of a Leave vote. Currently, passporting arrangements mean that a UK authorised firm can distribute certain financial products or provide certain financial services across the EU from its UK base without needing to obtain authorisation from the regulator in each Member State. Importantly, it also means that firms (and large financial sector groups) established outside the EU (such as a US firm) can do the same from a branch or subsidiary authorised in the UK. Conditions of authorisation essentially impose a number of obligations upon the firm, irrespective of the Member State in which it is established (home state). Under some post-Brexit options, passporting rights would still be retained, e.g. the EEA model, like Norway.
However, under other models, passporting into the EU from the UK would not be possible unless a specific agreement could be reached to permit this. Absent such agreement, firms who want to continue to provide services across the EU may have to establish authorised subsidiaries inside the EU and would be required to restructure their businesses accordingly. This may require relocation of staff and operational infrastructure away from the UK which could have a significant impact on financial hubs such as London and Edinburgh.
Some key areas of financial services regulation impacted by potential restrictions on passporting are as follows:
A UCITS fund is, by definition, domiciled within the EEA. In the event of a Leave vote, existing UK UCITS would potentially not qualify to exist as UCITS and would therefore cease to benefit from the EEA-wide passport available in relation to the distribution and marketing of these funds. This would have a significant impact upon managers of UK UCITS, which would (i) become subject to the AIFMD regime (below); and (ii) potentially become subject to national private placement regimes in relation to EU distribution. As AIFs (rather than UCITS), there would be a potential impact upon the investor base at which such funds are targeted (with retail investors being excluded in many cases). However, it should be borne in mind that many UK UCITS managers already operate a duplicate stable of UCITS in both the UK and either Luxembourg or Ireland (and the latter would continue to benefit from the UCITS passport). Nevertheless, UK-based management companies may no longer be entitled to provide services to EEA-based UCITS and an element of corporate/operational restructuring would still likely be required.
In the absence of a MIFID passport, UK authorised firms would no longer be able automatically to undertake MIFID business in the EU and the same restriction would apply to EU firms seeking to conduct MIFID business in the UK. The forthcoming MIFID II regime may dilute the current regime, such that non-EEA firms may be afforded a third country MIFID passport upon registration with ESMA. However this would not be an immediate solution as it would be subject to ESMA making an equivalence determination in relation to the relevant third country regime (i.e. the UK regime equivalent to MIFID). In addition, the delays to MIFID II (currently set for January 2018) are likely to mean that the position will be uncertain for some time and by no means a firm solution.
In the event of a Leave vote, UK AIFMs would potentially be treated as non-EEA AIFMs for the purposes of AIFMD, such that marketing of UK AIFs into the EU would have to be undertaken on the basis of the existing national private placement regimes (NPPs). Additionally, UK AIFMs would no longer be permitted to manage an AIF established in another Member State from its base in the UK. The same is true in respect of EEA AIFMs seeking to market AIFs into the UK or to manage AIFs established in the UK. AIFMD does offer the potential for non-EEA AIFMs to market funds within the EEA on the basis of a third country passport. However, the parameters of this are not yet certain and will depend upon the provision of equivalence determinations by ESMA and decision of the EU Commission, the political aspects of which may prove to be uncertain.
As noted above, even if a third country passport were made available for UK firms under MIFID or AIFMD, the UK firm would then be made subject to certain requirements of the AIFMD regime, despite the UK having departed from the EU.
Whether passporting arrangements can be retained will therefore have a critical impact on the operational structure of a number of UK and international financial services firms who base their European operations out of the UK.
Access to human capital could also be affected. A Norwegian-style relationship with the EU would continue free movement of workers whereas a WTO-based relationship would not.
In any of the potential Leave scenarios, it is unlikely we would see a wholesale reversal of now well-established employment norms which stem from EU law, such as aspects of the Equality Act 2010. It is also important to bear in mind that many of our employment laws do not stem from the EU, such as the laws on unfair dismissal and trade unions and industrial action, or existed prior to the development of EU law in the area, such as equal pay legislation. Certain minimum employment standards would inevitably be required as part of any trade deal and it is unlikely the political will would exist to abolish many of the protections afforded to workers by EU law. It is therefore likely that any changes would be on a fairly minor scale, at least in the short term, with certain Working Time provisions (for example the limit on average weekly hours, which may be of some interest to those in the financial services industry) and the Agency Workers regulations the most likely prospective targets for reform.
A Brexit may allow the UK to take a different stance on remuneration of employees of financial services firms. EU policies to limit bonuses have been controversial within the financial services sector, with firms complaining this impedes their ability to compete globally. However, mirroring EU policy on remuneration may be one of the prices to pay to secure trade deals.
The effect of a Brexit on existing commercial contracts is a potentially very complex issue. Commercial contracts in the UK have been drafted against a backdrop of over 40 years of EU membership and EU law. They will contain references to other legal provisions which may, in the event of a Brexit be repealed or replaced.
For example there are EU directives designed to protect consumers against unfair terms in consumer contracts, implemented in the UK by various pieces of legislation, including the recently implemented Consumer Rights Act 2015 (which consolidates much of the EU law in this area). A Brexit would enable the UK to introduce its own compliance regimes, although again it is likely that the EU would continue to insist that UK products distributed in the EU comply with EU laws and standards (leaving the contractual matrix, at least for many products, unchanged in this area).
However, businesses with contracts that rely on the continuance of existing EU legislation (including in the compliance advisory sector) should consider carefully the potential impact of a Brexit on contractual and business relationships.
Your contractual relationships are one area where it is possible to take concrete, protective action to deal with potential consequences of a Brexit. Existing contracts, particularly long-term ones, could be pulled out of the filing cabinet to see how much flexibility you have. Also trying to build protections into contracts you are entering into between now and 23rd June may help to limit the impact on your business of any ensuing economic turmoil.