Brexit – impact on the Financial Services sector – 15 months on

Brexit – impact on the Financial Services sector – 15 months on

Notwithstanding the constant barrage of Brexit-related news, much of the uncertainty I described in my article last July remains. See Brexit | Financial sector | Michelmores

An air of mystery continues to shroud the Brexit process, yet major developments in the interim have shed some light on what the future might hold for the financial services sector and the viability of firms’ contingency plans.


One of the most important developments in the last year has been the Prime Minister’s declaration in January 2017 that the UK would seek a “Hard Brexit”. This would mean not opting for Single Market membership, but instead seeking to agree a bespoke trade agreement, or failing that, to trade under World Trade Organisation rules. Whilst this announcement ended speculation that UK firms’ all-important passporting rights might be retained through Single Market membership, it opened up speculation as to what a bespoke deal might look like, including whether this might involve the retention of passporting rights.

Another important development was the much-debated triggering of Article 50 in March 2017. This set the clock ticking on the two-year negotiation period. The date that the UK will officially leave the EU is now all but set in stone, although talk of transition suggests that March 2019 may not be the date on which the effects of Brexit begin to be felt. The Prime Minister suggested in her Florence speech that a transition period would be sought and could last for around two years beyond Britain’s exit date.

The April 2017 release of the EU’s negotiations resolution gave UK-based firms some cause for concern. The resolution stated that the EU was opposed to any piecemeal or sectoral provisions, including in relation to financial services, which provided UK-based undertakings with preferential access to the internal market or customs union. The resolution also stated that following Brexit, the UK would be considered a “third country” for the purposes of access to the Single Market.



The main question on the lips of many boards is what models will be available to UK authorised firms seeking to retain cross-border access to EU markets. Access is currently provided by passporting rights contained in EU Directives. Passporting rights allow a business authorised in one EEA state access to the Single Market, whilst obviating the need to go through authorisation processes, establish physical presences or hold separate pools of capital in each jurisdiction.

Preservation of Passporting?

As it appears that the UK will not seek membership of the Single Market, passporting rights will not apply to UK firms, except where they are provided for by any bespoke trade agreement between the EU and the UK. However, it is still far from clear if such a deal to retain access can be agreed.

Third-Country Regimes

The EU operates third-country regimes (TCRs) which allow firms from outside the EU to export their services into EU states without the need for a licence. TCRs are generally conditional on a determination that the legal and regulatory system in the relevant country is “equivalent” to that in the EU.

Whilst equivalence is not clearly defined, the UK would likely be in a strong position to demonstrate equivalence, as the current UK regulatory framework is derived from EU legislation. However, due to the need to show on-going equivalence, reliance on TCRs would ultimately result in the direction of UK financial regulation being bound to that of EU policy. Given the controversy regarding the continuing influence of European Court of Justice decisions on domestic law, it is unclear whether binding UK Financial Regulation to the EU in this way would be politically acceptable.

There are other limitations to reliance on TCRs, including the fact that only a small proportion of financial services covered by the passporting regime are subject to TCRs. There is a degree of access in relation to central clearing services and TCRs are due to be introduced shortly in relation to wholesale investment services and certain activities relating to alternative investment funds.

However, TCRs would not allow access for deposit taking, lending, payment services, mortgage lending, insurance activities and activities relating to retail investment funds. Furthermore, the rights and protections offered under TCRs are less extensive and less reliable than passporting, sometimes only applying to specific types of customers or specific member states. Some TCRs are also subject to general restrictions or have local restrictions imposed in specific member states. TCRs can also provide only limited certainty as they may be withdrawn or varied with little or no notice.

Local Exemptions

It has been suggested that the importance of TCRs and passporting have been over-emphasised on the basis that, for many activities, licences may not be needed under local law. Under this rationale, passporting merely provides a protective measure to ensure that businesses exporting services do not need to consider whether a licence is needed on a case-by-case basis.

The problem with this approach is it assumes knowledge of the laws of each member state. Exemptions exist on a state-by-state basis. Which firms and services are exempted from the need to obtain a licence will differ depending on the state in which the activity takes place, the type of firm, the type of activity, the type of customer, and whether or not the business intentionally solicited the customer.

Alternatively, member states may permit third country firms to gain authorisation from the local regulator. However, many member states are unwilling to take this approach and in some instances the relevant directives expressly prohibit it.

Establishing an EU presence

A possible solution for UK businesses seeking to retain passporting rights would be to establish an EU subsidiary. Whilst the subsidiary would be able to passport services as an EU-based firm, this would require the UK firm to transfer all or part of its business to the subsidiary. This is likely to entail significant practical and timing difficulties. Such a structure is also likely to entail operational inefficiency, as well as extra requirements in terms of capital adequacy and regulatory compliance.

In the asset management sector, there is the possibility of providing services through EU-based funds which delegate investment management to UK-based fund managers. This approach has previously been employed by US managers who have benefitted from the use of Irish or Luxembourg-domiciled funds with passporting rights throughout the EU. However, this has its own limitations and additional overheads for asset managers.

A further caveat in relation to the above was contained in the European Securities and Markets Authority (ESMA)’s Opinion of May 2017. ESMA noted the risks of UK-based firms using “letter box” entities in the EU where the aim is to perform all substantial activities or functions outside the EU. The Authority recommended that outsourcing and delegation to third countries should only be possible under strict conditions. However, it is difficult to see how the EU could legislate specifically to exclude UK-based firms from using this practice without also excluding other third countries, thus damaging the prospects of EU investment.

It is clear that UK-based firms’ ability to export their services to the EU following Brexit should by no means be taken for granted, and each possible workaround comes with its own complications.

If you would like more information on this topic, please contact Jonathan Kitchin, Partner in Michelmores’ Finance & Investment team.

This article is for general information only and does not, and is not intended to, amount to legal advice and should not be relied upon as such. If you have any questions relating to your particular circumstances, you should seek independent legal advice.