4.01  The 2016 Brexit Referendum raised immediate concerns for UK financial institutions as to how they would be able to maintain access to the European Union (EU) and European Economic Area (EEA) markets. Firms authorised in the UK by either the Prudential Regulation Authority (PRA) or the Financial Conduct Authority (FCA) are entitled to ‘passport’ that authorisation into other EEA States to carry on business there either on a cross-border services or branch establishment basis. In many cases, UK firms are also able to appoint local agents in European markets based on their UK authorisation. This framework applies in the banking, investment services, insurance, payments, and funds sectors, among others.

4.02  Clearly, the ability to carry on business across the EEA based on a single licence granted in a firm’s home state, is key to the development of a single market in financial services. UK authorisation also carries with it other important advantages. For example, the European Market Infrastructure Regulation (648/2012) (EMIR) requires certain derivative transactions to be cleared through European authorised central counterparties (CCPs). EEA institutions are precluded from using third country CCPs (unless formally recognised by the European Commission under Article 25 of EMIR). This could preclude UK CCPs providing clearing services to EU firms in a hard-Brexit scenario, when they lose their status as European authorised CCPs. Given the potential impact of this on financial stability issues, in the lead-up to the initial Brexit deadline of 29 March 2019 the European Securities and Markets Authority granted temporary recognition to three CCPs established in the UK to provide services in the EU on a no-deal Brexit scenario for a twelve-month period.

4.03  Put shortly, therefore, operating as a licensed entity in an EU jurisdiction confers substantial benefits which are at risk in a post-Brexit world. Given that passporting rights are derived from EU directives, these rights will terminate upon the UK leaving the EU when EU laws will cease to apply in the UK, assuming a ‘hard-Brexit’ scenario in which there is no agreement reached between the UK and the EU as to the terms of the UK’s withdrawal from the EU. UK licensed firms will become third country firms, that is firms who are established and licensed in a non-EEA jurisdiction and will need to access the EU markets on this much more restrictive basis. UK firms will also lose their status as EU entities. Therefore, roles reserved under EU directives for EU licensed entities, such as EU authorised CCPs under EMIR or as EU credit institutions under the Capital Requirements Directive are at risk.

(p. 76) 4.04  While there has been considerable focus on the ability of UK firms to access EU markets, it is important not to lose sight of the implications of Brexit on EU and EEA firms who either have branches in the UK or provide cross-border services into the UK. Such firms also presently rely on European passports to access or carry on business in the UK without the need to obtain separate authorisation in the UK from either the FCA or PRA. The rights of EU firms to do business in the UK will equally be removed upon the UK leaving the EU and EU laws ceasing to apply. In order to address this issue the UK has introduced its Temporary Permissions Regime (TPR), which permits EEA firms who presently rely on a passport to carry on doing so following Brexit, on the basis that such firms will in due course apply for full UK authorisation. However, EU firms who do not avail themselves of the benefit of the TPR will in the future either need to obtain UK authorisation before commencing business or ensure that they are not contravening UK law in transacting with persons in the UK, for example, because they only carry on limited activities which come within an exemption from licensing.

4.05  In the aftermath of the referendum, ‘equivalence’ was seen by many as a panacea for these problems. Equivalence is based on the notion that UK laws and regulations in the financial services area will be fully aligned with EU laws on the date on which the UK exits the EU. The concept of equivalence is expressly set out in certain EU legislation and firms from jurisdictions determined by the European Commission to be equivalent for those purposes are granted market access rights, albeit in certain specified circumstances.

4.06  EU legislation has tended to focus on activities carried on within the territory of the EU. However, in recent years, reflecting the internationalisation of financial services and the expanding competencies of the EU, EU laws have increasingly come to set out the terms on which firms operating from outside the EU can transact with and provide services to parties in the EU. This has resulted in equivalence regimes being written into EU laws. The Commission has stated that ‘Equivalence is not a vehicle for liberalising international trade in financial services, but a key instrument to effectively manage cross-border activity of market players in a sound and secure prudential environment with third-country jurisdictions that adhere to, implement and enforce rigorously the same high standards of prudential rules as the EU.¹ It therefore involves a form of regulatory deference to the standards of the EU.

4.07  Following the referendum result, commentators suggested that such equivalence regimes could provide a composite basis for UK-based firms to continue to provide services into the EU, on a similar basis to how firms use their existing passports. In reality, however, the equivalence framework under EU law is fragmented and does not support such a composite approach to market access. The Capital Requirements Directive (2013/36/EU) (CRD IV), for example, does not contain any equivalence regime that allows a third (p. 77) country firm access to European markets. Given that the CRD IV covers the banking industry, this is a major lacuna. Other directives such as the Markets in Financial Instruments Directive (2014/65/EU) (MiFID II) do provide for access rights for firms from equivalent jurisdictions. However, these are limited in scope. Moreover, the European Commission’s Communication² in July 2019 highlights some of the complexities and considerations that would arise in the Commission granting any equivalence decision. For example, in this communication, the Commission attaches utmost importance to taking a proportionate view on the risks posed by third country frameworks. Therefore, third countries for which equivalence is likely to be significantly used may be viewed by the Commission as presenting additional risks, which may in turn result in the Commission expecting additional assurances.

4.08  In its White Paper The Future Relationship between the United Kingdom and the European Union the UK government suggested that post-Brexit market access to the EU could be governed by an enhanced equivalence regime, recognising that a material upgrade to the existing regimes is required. In fact, the White Paper expressly stated that: These regimes are not sufficient to deal with a third country whose financial markets are as deeply interconnected with the EU’s as those of the UK are … the existing autonomous frameworks for equivalence would need to be expanded, to reflect the fact that equivalence as it exists today is not sufficient in scope for the breadth of the interconnectedness of UKEU financial services provision. A new arrangement would need to encompass a broader range of cross-border activities that reflect global financial business models and the high degree of economic integration. The UK recognises, however, that this arrangement cannot replicate the EU’s passporting regime.

The White Paper was published in July 2018 and the UK government’s position evolved to adopt the concept of ‘mutual recognition’, the key difference being that mutual recognition provides a comprehensive framework which would allow all firms meeting UK requirements to provide services to the EEA. The EU has thus far not accepted either a modified equivalence regime or a mutual recognition regime as a basis for UK firms accessing EU markets in a hard-Brexit scenario.

4.09  Following Brexit, it is very likely that the UK will remain subject to the same standards as the EU (some would say higher given the UK’s tendency to gold-plate European laws) so that UK firms will, in practice, be subject to equivalent rules to their European peers. Arguably, therefore, there is no reason in principle why UK regulated firms should be prevented from accessing the European markets on the same basis as before Brexit. For example, investor protection and transparency standards would be the same mitigating the risk of investor detriment. Of course, this would mean that the UK would maintain a level playing field with the EU and UK laws and regulations would remain closely aligned to the EU’s Single Market.

4.10  While this position makes logical sense, market access has become a political football in the post-referendum world.

4.11  The UK submitted its notification of its intention to withdraw from the EU pursuant to Article 50 of the Treaty on European Union on 29 March 2017. Originally this meant that the UK would have left the EU at midnight on 29 March 2019. All EU law would have ceased to apply in the UK from that date and the UK would have become a ‘third country’. This deadline has now been extended to 31 January 2020.

4.12  The UK government had agreed the terms of a Withdrawal Agreement. This provided for a transitional period to apply. Article 126 of the draft Transitional Agreement provided that a transition period would apply (up to 31 December 2020). EU law would be applicable to and in the UK during the transition period. This transition period would have permitted UK firms to have continued access to the EU markets pursuant to their existing passports. In this time a new relationship between the UK and the EU could have been negotiated establishing, for example, the enhanced equivalence regime advocated in the UK government’s White Paper.

4.13  However, since the Withdrawal Agreement has not been ratified by the UK Parliament, as matters presently stand, the UK will leave the EU on 31 January 2020 and become a third country to be treated on the same basis as other non-EEA jurisdictions in relation to market access.

4.14  Of course, for equivalence to be relevant, the UK will need to ensure that the process of its withdrawal from the EU does not result in the UK operating to lower standards.

4.15  As already noted, technically, the UK’s withdrawal from the EU will mean that EU laws will cease to apply, which could potentially mean that the UK no longer maintains equivalence to the EU. The UK government has, however, been committed to ensuring ‘that the UK will have a functioning legislative and regulatory framework’ on the basis that ‘the same laws and rules that are currently in place in the UK would continue to apply at the point of exit, providing continuity and certainty as [the UK] leaves the EU’ (HM Treasury’s approach to financial services legislation under the European Union (Withdrawal) Act 2018).

4.16  In the run-up to the original exit date provided for under the European Union (Withdrawal) Act 2018, which was 29 March 2019, the UK had been engaged in the process of ‘onshoring’ EU legislation, that is incorporating EU laws into UK domestic legislation to ensure continuity following Brexit. The effect of this would be to create a body of retained EU law in UK domestic law following Brexit. This would be achieved by preserving UK law provisions which implement EU requirements (referred to as EU-derived legislation) and converting into UK domestic law directly applicable EU legislation such as EU regulations.

4.17  The UK government also committed to implementing various ‘in flight’ EU provisions which would come into force after exit day pursuant to the Financial Services (Implementation of (p. 79) Legislation) Bill³. Powers have also been granted to the UK government and regulators to make necessary adjustments or corrections to laws for the purpose of ensuring that the UK has a properly functioning body of laws in the financial services sector following Brexit. The combination of the above means that following Brexit the UK should maintain a body of laws that are consistent with EU law in the banking, insurance, and financial services sectors.

4.18  Traditionally, EU-level laws have focused on the carrying on of business within the EU’s Single Market. The focus of such laws has therefore been trade between Member States, as opposed to trade into the EEA from third countries. This is because European legislation has focused on the four freedoms under the European Treaty: the freedom of movement of goods, capital, services, and persons within the EU.

4.19  Individual Member States have until recently been left to legislate for market access into their states from third countries. For example, the UK has permitted non-EEA firms to provide services into the UK on the basis of the overseas persons’ exclusion (OPE) contained in Article 72 of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (the RAO). Overseas firms have been permitted under the OPE to provide services to persons in the UK provided that they do not do so from a permanent place of business in the UK and that they comply with UK marketing or financial promotion rules.

4.20  Other European jurisdictions have also operated similar regimes, which have allowed third country firms to do business in their respective jurisdictions without triggering local licence requirements. These include the following:

1. (a)  Ireland provides a ‘safe harbour’ for investment firms which are authorised in third countries. Such firms do not require an Irish licence in order to provide investment services under MiFID II to per se professional clients or eligible counterparties, as defined under the directive. For this to apply the third country in which the firm is established must not be designated as non-cooperative by the Financial Action Task Force (‘FATF’) and must be a signatory to IOSCO’s multilateral MOU on cooperation and the exchange of information. Additionally, the firm must not have a branch in Ireland.

2. (b)  Luxembourg law permits a third country firm to provide investment services to Luxembourg-based per se professional clients. This is subject to the third country firm being licensed in its ‘home state’ and being subject to prudential requirements that the Luxembourg regulator, the Commission de Surveillance du Secteur Financier (CSSF), considers to be ‘equivalent’ to Luxembourg’s. This exemption was restated recently in CSSF Circular 19/716 which sets out the regimes (p. 80) applicable to third country firms who wish to provide investment services into Luxembourg.

3. (c)  Under the Dutch act on financial supervision (Wet op het financieel toezicht (AFS)) third country firms which carry on activities in the Netherlands on a cross-border basis or through a branch are required to obtain a licence from the Dutch authority for the financial markets (Autoriteit Financiële Markten (AFM)), unless an exemption applies. Dutch law does in fact contain an exemption which is referred to as the ‘Section 10 Exemption’. This exemption is contained in the Exemption Regulation AFS (Vrijstellingsregeling Wft). The Section 10 Exemption was formerly only available to third country firms with their registered seat in Switzerland, the United States of America, and Australia, provided they were subject to supervision in their home country in respect of the relevant investment services they intend to provide or in respect of dealing on own account. In light of Brexit the Exemption Regulation has been extended to cover firms established in the UK.

4. (d)  Other possibilities have existed for third country firms to do business with European clients and counterparties. For example, firms have relied on reverse solicitation, on the basis that the European client has taken the initiative and contacted the firm and not vice versa. Alternatively, some firms have taken the approach that the ‘characteristic performance’ of the service is carried on from outside the EU so that no licensable activities are being carried on within the EU’s territory.

4.21  Closer examination of EU legislation reveals that equivalence under the relevant EU directives is very much a patch work rather than a composite and consistent approach to setting out a code for non-EEA firms to access the EU markets.

4.22  A number of EU financial services regulatory provisions do not contain any express provision for access by third country firms at all. As noted above, CRD IV does not contain any third country regime for banking. Although CRD IV does refer to equivalent jurisdictions, this is in the context of matters such as the prudential treatment of certain types of exposures to entities located in non-EU jurisdictions. There is also no regime covering the marketing and sale to retail investors of units issued by third country mutual funds or regulated collective investment schemes, which are regulated in Europe under the Directive on Undertakings for Collective Investment in Transferable Securities (Directive 2009/64/EC) (‘UCITS’). Moreover, there is no legislative provision for access to EU markets by third country firms in the case of insurance mediation and distribution nor does an equivalence regime exist for the payments industry.

4.23  Certain other activities offer a more restrictive third country regime by which firms may obtain access not to the Single Market as a whole, but to EU Member States on a country-by-country basis. Solvency II, for example, requires that an insurer must seek authorisation from a competent authority in a Member State in order to carry on insurance business there, and in order to apply for authorisation it must establish a branch in the territory of the Member State.

4.24  The EU has stated that⁴ equivalence refers to a process whereby the Commission assesses and determines that a third country’s regulatory, supervisory, and enforcement regime is equivalent to the corresponding EU framework.

4.25  The recognition provided by the Commission makes it possible for EU regulators to rely on a third country firm’s compliance with the third country framework which has been deemed ‘equivalent’ by the Commission.

4.26  A third country must request recognition of equivalence from the EU. Such a request can only be made where it is expressly provided for in EU legislation. In other words, it is not available with respect to the provision of all services or to the provision of services to all client categories.

4.27  Regard must therefore be had to the relevant EU legal provisions to understand the availability and scope of any third country equivalence regime. The Commission is not bound to act on a request for an equivalence assessment. The EU has full discretion and acts unilaterally in deciding whether to perform an equivalence assessment and, thereafter, as to its determination and outcome. The Commission is also not under any specific deadline to complete an assessment once it is commenced. For example, EMIR came into force in August 2012. It took up to four years for the Commission to assess the equivalence regime of CCPs located in the US before making its decision in March 2016.

4.28  Equivalence assessments are in all cases performed by the Commission. This is often based on advice from one of the European Supervisory Authorities (ESAs) (who are the European Banking Authority (EBA), the European Securities and Markets Authority (ESMA), and the European Insurance and Occupational Pensions Authority (EIOPA)) depending on the relevant sector. This is provided for under Article 33 of the Regulations establishing the ESAs. Equivalence decisions can include conditions or limitations, to better cater for the objectives of granting equivalence. The assessments typically involve an intensive dialogue with the competent authorities of the third country whose framework is being assessed.

4.29  A Commission Staff Working Paper entitled ‘EU Equivalence Decisions in Financial Services Policy: An Assessment’ from February 2017 referred to two general objectives of equivalence decisions. These were:

1. (a)  balancing the need for financial stability and investor protection in the EU with the benefits of maintaining open and globally integrated EU financial markets; and

2. (b)  promoting regulatory convergence around international standards and upgrading supervisory cooperation.

4.30  The Commission working paper stresses that those objectives, including promoting the internal market, financial stability, and market integrity, are ‘considered in view of the factual and legal circumstances of each case’. As the Commission also points out, it needs ‘to factor in wider external policy priorities and concerns in particular with respect to the promotion (p. 82) of common values and shared regulatory objectives at international level’ in each particular assessment. Equivalence is also often conditional on the reciprocity of the third country concerned.

4.31  These matters demonstrate that equivalence assessments involve more than an objective assessment of specified criteria but also intentionally embrace policy considerations. Ultimately, the decision to recognise another jurisdiction as equivalent is a political one and this has proved to be controversial, for example, in the context of the assessment of equivalence for Swiss trading venues under the trading obligation for shares set out in Article 23 of the Markets in Financial Instruments Regulation (600/2014/EU) (MiFIR). According to this, EU investment firms are required to trade equity securities on a trading venue in the EU or on an equivalent third country trading venue. The Commission’s approach to equivalence in relation to Swiss trading venues was explicitly tied to the establishment of a broader institutional agreement between the EU and Switzerland and earlier conclusions of the European Council to the effect that no further market access should be granted to Switzerland until a broader institutional agreement is in place. It was on this basis that equivalence was granted only on a temporary basis, which the Commission permitted to lapse in a spat that is still ongoing at the time of writing.

4.32  Another controversial aspect of the equivalence regime is that a recognition of equivalence can be revoked at any time. For example, in July 2019, the Commission repealed existing equivalence decisions in the field of Credit Rating Agencies for certain countries, including Australia and Singapore. However, the ability to withdraw an equivalence assessment confers power on the Commission where a third country is seeking to implement new laws or supervisory practices.

4.33  Decisions of the Commission in relation to equivalence are usually in the form of Implementing Acts made under powers conferred by the European legislation to which the equivalence decision relates. The Commission can adopt such acts only after confirmation by representatives of Member States in a vote of a regulatory committee. The European Parliament does not have any formal role in making equivalence assessments. However, its observers are invited to meetings of the regulatory committee.

4.34  The legality of a decision of the Commission in relation to equivalence could in theory, at least, be challenged before the Court of Justice of the European Union (CJEU). This is on the basis that decisions of the Commission can be challenged before the CJEU pursuant to Article 263 of the Treaty on the Functioning of the European Union (TFEU).

4.35  The Commission has summarised the process as follows:

1. (a)  Process—

   1. (i)  involvement/role of the ESAs in the equivalence assessment; and

   2. (ii)  in a few cases, involvement of Member State authorities in the equivalence assessment.

2. (b)  Criteria for assessing equivalence—

   1. (i)  types of criteria used (equivalent legal framework, effective supervision and enforcement, supervisory co-operation arrangements in place, other specific equivalence conditions etc.);

   2. (p. 83) (ii)  reference to international standards;

   3. (iii)  requirement for corresponding recognition/equivalence possibilities in a third country;

   4. (iv)  principle of proportionality; and

   5. (v)  tax and anti-money laundering considerations as part of the assessment.

3. (c)  Follow-up/implementation—

   1. (i)  possibility to grant less advanced/transitional equivalence status;

   2. (ii)  supervisory action necessary to enable the use of equivalence benefits;

   3. (iii)  monitoring/review process envisaged after a decision has been taken;

   4. (iv)  possibility to withdraw, as necessary, at any moment the equivalence decisions.

4.36  We consider below the different European legislative frameworks and their approach to the concept of ‘equivalence’.

4.37  The ‘CRD IV Package’ comprises EU legislation establishing prudential rules for banks, building societies, and investment firms, most of which have applied since 1 January 2014. The two primary measures in the CRD IV Package are the CRD IV Directive and the Capital Requirements Regulation (575/2013/EU) (CRR).

4.38  Title V of CRD IV legislates for the CRD IV Single Market passport for banking services in the EU. Article 33 of this provides that a Member State must allow banks established in other Member States to set up a branch and/or provide services directly into their jurisdiction. CRD IV does not provide any passporting or equivalence regime for third country banks.

4.39  Article 47 of CRD IV does cover ‘Relations with Third Countries’. This addresses the position of third country banks which have a licensed branch in the EU. A branch of a third country bank which is licensed in an EEA state cannot passport that licence across the EEA. Article 47(3) of CRD IV provides that the EU may negotiate an agreement with a third country, which would ensure that branches of banks from that third country are treated in the same manner in different Member States across the EU.

4.40  Concluding, in relation to CRD IV, the directive does not contain any equivalence regime that would be relevant in the context of Brexit. This means that UK licensed banks will need to establish licensed entities in the EU following Brexit subject to any applicable domestic laws that allow third country banks to access local markets.

4.41  Investment services are regulated across the EEA under MiFID II. Like the CRD IV regime for banks, the investment services regime is in fact a package of provisions which include the MiFID II and MiFIR and certain other provisions. MiFID II and MiFIR set out two (p. 84) distinct regimes for the provision of services by third country firms. These are the regime under Article 46 of MiFIR for the provision of services to wholesale clients and the regime under Article 39 of MiFID II relating to retail clients or elective professional clients.

4.42  Article 46 of MiFIR provides a gateway mechanism for third country access whereby third country firms can register with ESMA in order to provide services to eligible counterparties and per se professional clients throughout the EU on a cross-border basis. This provision is dependent on the adoption by the Commission of an equivalence decision, in accordance with Article 47(1) of MiFIR, which states that the relevant third country’s legal and supervisory arrangements align with those of the EU.

4.43  For the three years that follow the adoption of an equivalence decision under Article 47(1), third country firms may either register with ESMA or, in the alternative, continue to carry on investment services with eligible counterparties or per se professional clients in compliance with the relevant Member States’ national regimes, by virtue of transitional provisions set out in Article 54 of MiFIR.

4.44  Under Article 39 of MiFID II, Member States may require that third country firms intending to provide investment services to retail and elective per se professional clients within their territory establish a branch within the jurisdiction. This provision is not mandatory so that Member States have a choice as to whether to require the establishment of a branch or to regulate the provision of services by the third country firm to retail clients in some other way. Where a Member State requires a third country firm to establish a local branch, this will only permit access to the market of the Member State concerned and will not confer any passporting or similar rights of market access across the EU. This may be contrasted with the position described above in relation to Article 46 of MiFIR where once registered with ESMA, third country firms can provide services across the EEA.

4.45  Where a Member State implements MiFID II to require the establishment of branches, a third country firm that has not established a branch in that Member State will not be able to provide investment services to retail clients or elective professional clients in that state. Where a Member State does not implement the requirement to establish a branch, the provision of services to retail clients and elective professional clients will be subject to existing national law and regulation, such as the OPE in the UK.

4.46  Under Article 39 of MiFID II, where a Member State requires third country firms to provide services from a branch in that Member State, the Member State concerned must determine that: (1) the relevant firm is subject to authorisation and supervision in its home country; (2) the third country pays due regard to any FATF recommendations on anti-money laundering and countering terrorist financing; (3) there are appropriate cooperation agreements in place between the competent authorities of the Member State and the relevant third country; and (4) the relevant third country has signed an tax exchange agreement, which is compliant with standards set by the Organisation for Economic Co-operation and Development (OECD), with the relevant Member State. The decision on whether the third country framework meets these requirements is, therefore, taken by each relevant Member State under MiFID II. This is because the Article 39 regime is not a pan-European equivalence regime.

(p. 85) 4.47  Under Article 46 of MiFIR, third country firms can seek to be registered with ESMA where the Commission has adopted an equivalence decision. This requires the Commission to determine that the legal and supervisory arrangements of the relevant third country ensure that firms comply with legally binding prudential and conduct of business arrangements equivalent to the requirements of MiFIR and MiFID II. ESMA is required to establish cooperation agreements with the competent authorities of third countries judged by the Commission to be equivalent.

4.48  Under Article 46(6) of MiFIR, third country firms must, before providing any service or performing any activity in relation to a client established in the EU, ‘offer to submit any disputes relating to those services or activities to the jurisdiction of a court or arbitral tribunal in a Member State’.

4.49  MiFID II also regulates the activity of operating certain trading venues described in MiFID II as a multilateral trading facility (MTF) or an organised trading facility (OTF). Providers of such services are subject to licensing requirements under MiFID II, as well as ongoing supervisory requirements. For third country providers of MTF and OTF services, the services are subject to the same regime for third country providers as other MiFID II investment services as described in the section above.

4.50  An MTF or OTF operator in a third country will also be able to request access to EU CCPs, provided that the Commission has adopted a decision stating that the legal and supervisory framework for trading venues in that third country is equivalent to the requirements for trading venues under MiFIR.

4.51  There is no third country regime for the provision into the EU markets of trading platform services other than by means of an MTF or OTF.

4.52  Third country CCPs can potentially provide services to EU-based parties pursuant to market access provisions contained in EMIR and MIFIR.

4.53  Article 25 of EMIR provides for access to EU markets if the third country CCP meets a number of requirements. These include an equivalence determination by the Commission as to the regulatory and prudential framework for CCPs in the third country.

4.54  Third country CCPs will obtain access to the EU as a result of being ‘recognised’ under Article 25(2) of EMIR by ESMA. This is dependent on its ‘home’ jurisdiction having been determined to be equivalent as described above. Therefore, there must be both an equivalence determination and specific recognition of the CCP by ESMA. There have been so far several equivalence decisions in respect of third countries regarding their CCP supervision regime. Where such an equivalence decision is made, a CCP in the relevant third country can aply to ESMA for recognition under EMIR.

4.55  A CCP recognised in this way will be a ‘qualifying central counterparty’. This means that clearing participants will be able to benefit from favourable treatment of their own funds requirements for CCP exposures under the CRR.

(p. 86) 4.56  In addition to the provisions for CCPs under EMIR, third country CCPs may also benefit the following provisions under MiFIR.

1. (a)  Access to trading venues: under Article 38(1) of MiFIR, a CCP established in a third country may request access to a trading venue in the EU subject to that CCP being recognised under Article 25 of EMIR. In addition, it is required that the Commission adopt a decision with regard to the legal and supervisory framework of the third country in accordance with Article 38(3) of MiFIR, confirming that it provides an effective equivalent system for permitting CCPs and trading venues authorised under foreign regimes access to CCPs and trading venues established in that third country.

2. (b)  Access to trade feeds: third country CCPs which have been recognised by ESMA under EMIR will also be granted the non-discriminatory access to trade feeds from trading venues as guaranteed to EU CCPs by Article 36 of MiFIR.

3. (c)  Access to EU benchmarks: similarly, third country CCPs which have been recognised by ESMA under EMIR will be granted non-discriminatory access to EU benchmarks as guaranteed to EU CCPs by Article 37 of MiFIR. The third country CCP is required to apply to the benchmark administrator itself for a licence to use the benchmark.

4.57  As already mentioned in the introduction to this chapter, in advance of the original exit date of 29 March 2019, in order to minimise financial stability risks, the EU conferred temporary recognition on UK CCPs and central securities depositaries (‘CSDs’). This was effected through the following measures:

1. (a)  Commission Implementing Decision (EU) 2019/544 of 3 April 2019 amending Implementing Decision (EU) 2018/2031 determining, for a limited period of time, that the regulatory framework applicable to CCPs in the United Kingdom of Great Britain and Northern Ireland is equivalent, in accordance with EMIR.

2. (b)  Commission Implementing Decision (EU) 2019/545 of 3 April 2019 amending Implementing Decision (EU) 2018/2030 determining, for a limited period of time, that the regulatory framework applicable to CSDs of the United Kingdom of Great Britain and Northern Ireland is equivalent in accordance with the Central Securities Depositories Regulation.

4.58  Both of the above provisions will only apply in the event of a ‘no-deal’ Brexit scenario.

4.59  On 1 March 2019, ESMA announced that, in the event of a no-deal Brexit, the CSD established in the UK—Euroclear UK and Ireland Limited—will be recognised as a third country CSD to provide its services in the EU. The recognition decision would take effect on the date following the UK’s withdrawal from the EU, under a no-deal scenario.

4.60  On 5 April 2019, following the adoption of Commission Implementing Decision (EU) 2019/544 of 3 April 2019, ESMA issued a new recognition decision to make sure that the UK CCPs (LCH Limited, ICE Clear Europe Limited, and LME Clear Limited) are recognised in (p. 87) the event of a no-deal Brexit. The Commission has granted UK clearing houses temporary equivalence until 30 March 2020.

4.61  EMIR imposes clearing and reporting obligations on investment firms and credit institutions entering into certain over-the-counter (‘OTC’) derivative contracts. In particular, EMIR requires market counterparties to centrally clear certain types of OTC derivative contracts and to apply certain prescribed risk mitigation techniques as specified under Article 11 of EMIR.

4.62  While EMIR is principally directed at activities within the EU, its requirements can also apply extraterritorially. For example, if a counterparty to a transaction involving an EU counterparty is located in a third country or where the relevant OTC derivative contract has a ‘direct, substantial and foreseeable effect’ within the EU.

4.63  The extraterritorial application of EMIR’s requirements gives rise to potential issues for parties located in third countries.

4.64  Section 4.10 above on market infrastructure addresses the mechanism by which third country CCPs obtain recognition for the purpose of clearing OTC derivative trades. Once recognised, EU and non-EU counterparties may use a non-EU-based CCP to meet their clearing obligations. A similar position applies with regard to the use of a non-EU-based trade repository to report transactions to.

4.65  In addition to this EMIR addresses the potential overlap of regulations that might apply in relation to a single transaction which might be subject both to EU and third country laws. Pursuant to Article 13 of EMIR where at least one of the parties to an OTC derivatives contract is located in a jurisdiction that has been determined to be equivalent, the requirements of EMIR can be disapplied and the relevant third country’s requirements applied instead.

4.66  Activities carried on in relation to the investment funds are regulated in the EU under the Alternative Investment Fund Managers Directive (2010/76/EU) (AIFMD) and the UCITS Directive. Put shortly, the UCITS regime covers regulated funds whereas the AIFMD covers unregulated or alternative investment funds. The UCITS Directive does not contain any provision allowing for access by third country providers. This is understandable on the basis that a UCITS is a particular category of regulated European investment fund which can be distributed to retail investors. Third country UCITS or regulated funds cannot be marketed in the EU as retail funds. They may however be marketed to professional investors as alternative investment funds under the AIFMD.

4.67  The AIFMD sets out licensing and ongoing obligations in relation to persons involved in the management and distribution of alternative investment funds (AIFs). The AIFMD (p. 88) established passports for both the marketing of particular funds across the EU (the Marketing Passport) and the management of funds across the EU (the Management Passport). The AIFMD can apply extraterritorially, including in relation to the marketing of third country AIFs to investors in the EU and the management of AIFs, where either the manager or the AIF is located in a third country. In contrast to the position with the Recast UCITS Directive, the AIFMD does contain express provision dealing with the position of third country managers and funds. Presently many UK firms rely either on their ability to manage AIFs established elsewhere in the EU under the Management Passport or to provide portfolio management services to alternative investment fund managers (‘AIFM’) established in other EU jurisdictions under delegation. Both of these structures are under threat from a hard Brexit, although the steps that have been taken by ESMA and the FCA, mentioned below, to agree a memorandum of understanding relating to the fund management industry, should permit UK firms to continue to manage the assets of EU AIFs from the UK pursuant to delegation. The loss of the Management Passport will be ameliorated in this way. In relation to the Marketing Passport, UK firms may in the future be able to rely on local national private placement regimes (‘NPPR’) or reverse solicitation.

4.68  The AIFMD provides two regimes for access to EU markets by third country AIFMs. These are:

1. (a)  Article 42 of AIFMD, which sets out the minimum conditions which Member States must apply in order to allow a third country AIFM to carry on marketing activities in respect of any AIF without an AIFMD ‘passport’; and

2. (b)  Articles 37 and 39 to 41 of AIFMD, which provide for the authorisation of third country AIFMs intending to market and manage EU or third country AIFs with an AIFMD ‘passport’. It should also be noted that Articles 35 and 36 govern the situation in which an EU AIFM wishes to carry on marketing activities in respect of a third country AIF and apply to situations in which the AIFMD ‘passport’ is either available (Article 36) or unavailable (Article 35).

4.69  Article 42 of the AIFMD provides for NPPRs, by which individual Member States may allow third country AIFMs to market AIFs to professional investors subject to certain conditions. The marketing to professional investors in the EU of third country AIFs by third country AIFMs is also governed by Article 42 of the AIFMD. Third country AIFMs must comply with each Member State’s individual NPPR regime when they market AIFs in that country.

4.70  The AIFMD provides for a second and separate regime under which, after a transitional period and the entry into force of a delegated act by the Commission, a harmonised firm-specific ‘passport’ regime is to become applicable to:

1. (a)  third country AIFMs performing management and/or marketing activities within the EU; and

2. (b)  EU AIFMs managing third country AIFs.

4.71  The requirements of this regime are set out in Article 37 and Articles 39 to 41 of the AIFMD. In this context, the term ‘passport’ refers not to Member States’ access to the Single Market but rather to the stringent regulatory framework for the activities of third country AIFMs (p. 89) which establishes the conditions subject to which a third country AIFM can obtain an authorisation to manage EU AIFs and/or to market AIFs to professional investors in the EU. In other words, rather than a liberalising measure for international trade in fund management services, it is a licensing measure which requires third country AIFMs to submit an application for authorisation in the EU. This regime is, however, not yet in force.

4.72  In order to use the NPPR regime under Article 42 appropriate cooperation arrangements must be in place between the competent authorities of the Member States where the AIFs are marketed and the supervisory authorities of the third country where the non-EU AIF is established in order to ensure an efficient exchange of information that allows competent authorities of the relevant Member States to carry out their duties in accordance with the AIFMD.

4.73  It is an obvious point but worth stating that the UK has not needed to enter into supervisory cooperation arrangements with competent authorities in Member States given its membership of the EU. Given the inter-connectedness of the UK and EU funds industry and particularly the links between London on the one hand and Dublin and Luxembourg on the other, agreement was reached between the UK and ESMA in February 2019 on a memorandum of understanding which will take effect in the event of a non-deal Brexit. A copy of the memorandum has not been published so it is not clear what the scope of this will be.

4.74  In relation to this, in a statement issued on 1 February 2019, ESMA stated that the memorandum agreed with the FCA was similar to the memorandum agreed with other third country supervision authorities. According to ESMA, the memorandum agreed with the FCA covers supervisory co-operation, enforcement and the exchange of information between individual regulators and the FCA. The memorandum allows these supervisory authorities to share information relating to market surveillance, investment services and asset management activities. This in turn allows matters such as fund manager outsourcing and delegation to continue.

4.75  Another requirement set out in Article 42 is that the AIFM must comply with the transparency requirements laid down in Articles 22 to 24 of the AIFMD. Even so, Member States are permitted, under Article 42(2) to impose stricter rules on third country AIFMs than are applicable under the AIFMD.

4.76  Similar requirements must be satisfied under Article 36 in respect of an EU AIFM marketing a third country AIF, including the requirement for appropriate cooperation arrangements. In addition, the AIFM must comply with all the requirements of the AIFMD, excepting only the rules on the appointment of depositories.

4.77  The alternative access provisions ‘with a passport’ set out in Article 37 and Articles 39 to 41 of the AIFMD do not yet apply. In order for the regime provided under these Articles to be brought into application, the requirements of Article 67 of the AIFMD must be satisfied. These include, sequentially: (1) positive advice to the Commission by ESMA on the application of the passport to third country AIFMs and AIFs—which advice is to be based on the existing marketing and management of those entities in Member States under the NPPRs—and (2) a delegated act by the Commission under Article 67(6).

(p. 90) 4.78  Under Article 67(4), ESMA’s positive advice to the Commission must include advice to the effect that ‘there are no significant obstacles regarding investor protection, market disruption, competition and the monitoring of systemic risk’ which would impede the application of the ‘passport’ to third country AIFMs and AIFs. Similar issues must be taken into account under Article 67(6) by the Commission before it can adopt a delegated act. The natural inference is that ESMA will, in examining the existing use of the NPPRs by third country AIFMs and AIFs, consider whether the legal and regulatory frameworks in place in their home jurisdiction establish adequate standards on investor protection, market conduct, competition and systemic risk.

4.79  Although Article 67 the AIFMD only refers in general terms to a single positive advice from ESMA (to be issued by 22 July 2015) and a single delegated act required to bring Articles 37 to 41 into application, ESMA has, in fact, taken a country-by-country approach, releasing advice in relation to specific third countries on separate occasions. A first set of advice on the application of the passport to six countries (Guernsey, Hong Kong, Jersey, Singapore, Switzerland, and the United States) was published in July 2015 and a second, on the application of the passport to twelve countries (Australia, Bermuda, Canada, Cayman Islands, Guernsey, Hong Kong, Isle of Man, Japan, Jersey, Singapore, Switzerland, and the United States) was published in September 2016.ESMA has suggested that the Commission may wish to wait until ESMA has delivered positive advice on a sufficient number of third countries before triggering the legislative procedures foreseen by Articles 67(5) and (6).⁵

4.80  Once the UK has withdrawn from the EU and is considered a third country, its regulatory and oversight framework will presumably also be assessed by ESMA. The FCA rules which apply to the authorisation of EU AIFMs in the UK and to the marketing to professional investors in the UK of EU AIFs could influence ESMA in its assessment of the UK.

4.81  Since the UK has implemented the AIFMD in full, it could be expected that ESMA would find no significant obstacles to competition. It is worth noting, however, that in its advice on AIFMs and AIFs based in Hong Kong, Singapore, and Australia, ESMA noted, in considering whether a level playing field existed under the heading ‘obstacles to competition’, that the local regimes facilitated market access by retail funds (including UCITS) from only certain Member States.

4.82  It is therefore possible that, in assessing whether to give positive advice in relation to the UK on AIFMs and AIFs, the basis on which UCITS from Member States are granted access to investors in the UK may be a consideration

4.83  With regard to obstacles to the monitoring of systemic risk, ESMA is required to base its advice on the existence and effectiveness of cooperation arrangements for the purpose of systemic risk oversight between the competent and supervisory authorities of the Member State and the third country. Although ESMA has agreed a memorandum of understanding with the FCA it is uncertain how ESMA would carry out this part of its (p. 91) assessment, particularly as ESMA’s assessment for the purposes of its advice requires a consideration of how well the cooperation arrangements in question are working and, in the absence of evidence in relation to the working of an existing cooperation agreement, whether previous supervisory engagement provides support for the expectation of good supervisory cooperation.

4.84  Other issues which ESMA has indicated the Commission may also wish to consider alongside its advice, which are not expressly referred to in the AIFMD, include: (1) fiscal matters in the third country; and (2) the anti-money laundering and counter-terrorism financing regime in the third country. If the Commission determines to adopt these criteria, it is uncertain how it will apply them in relation to the UK.

4.85  If and when the ‘passporting’ regime comes into application, by virtue of the delegated act specified in Article 67(6), third country AIFMs and EU AIFMs managing third country AIFs will be subject to an authorisation and licensing regime. The authorisation of third country AIFMs is provided for in Article 37 AIFMD, which requires a third country AIFM to become authorised in a Member State of reference and thus to comply with the provisions of the AIFMD as implemented in that Member State. Consequently, in the absence of transitional arrangements or an agreement or withdrawal terms, a UK AIFM, which intended either to manage an EU AIF or market a third country AIF in the EU, would have to comply both with the AIFMD as implemented in its Member State of reference and also with the rules applied to it by the FCA in the UK This could result in concerns where FCA rules diverge from those in the Member State of reference.

4.86  Article 37(7) AIFMD provides that no authorisation shall be granted to a third country AIFM unless specified requirements, including but not limited to, are met:

1. (a)  appropriate cooperation arrangements are in place between the competent authorities of the Member State of reference, the competent authorities of the home Member State of the EU AIFs concerned and the supervisory authorities of the third country where the non-EU AIFM is established, in order to ensure an efficient exchange of information that allows the competent authorities to carry out their duties in accordance with the AIFMD; and

2. (b)  the third country where the AIFM is established has signed an agreement with the Member State of reference, which fully complies with the standards laid down in Article 26 of the OECD Model Tax Convention on Income and on Capital and ensures an effective exchange of information in tax matters, including any multilateral tax agreements.

4.87  In addition, Article 37(8) provides that the authorisation of third country AIFMs shall be subject not only to the criteria laid down for EU AIFMs by Chapter II of the AIFMD but also to additional criteria which include the provision of supplementary information, including a requirement to show that, where compliance with an EU rule is impossible the relevant third country law provides for an equivalent rule, which has the same regulatory purpose and offers the same level of protection to investors of the relevant AIFs and that the AIFM complies with that equivalent rule.

(p. 92) 4.88  ESMA is mandated under Article 37(23) to develop regulatory technical standards (‘RTS’) specifying the conditions under which a third country rule can be considered equivalent and to have the same regulatory purpose while offering the same level of investor protection. No draft RTS have been published so far.

4.89  Solvency II implements the main framework for insurance and reinsurance regulation throughout the EU.

4.90  While Solvency II contains the concept of equivalence, it does not provide for cross-border access in a uniform manner. Article 162 specifically states that the provision of direct insurance within the EU by a third country insurer must be subject to local authorisation through a branch in each Member State in which it wishes to write business. There is no consistent approach relating to the treatment of cross-border services business (often referred to as ‘non-admitted’ insurance) from outside the EU. In some Member States, the prudential regime may be triggered when a third country firm covers risks located in the State in question but has no other presence there; in others, an ongoing presence is required before any regulatory authorisation becomes necessary.

4.91  The equivalence provisions in Solvency II only apply in the following three contexts, none of which relate to mutual access.

1. (a)  Reinsurance provided by a third country reinsurer: under Article 172 of Solvency II, reinsurance contracts between an EU cedant and a third country reinsurer which is located in a jurisdiction whose solvency regime is assessed to be equivalent for the purposes of Article 172 must be treated in the same manner as if the contract were concluded with an EU reinsurer.

2. (b)  Group solvency: Article 227 provides that where a Solvency II group contains a third country (re)insurer which is located in a jurisdiction whose solvency regime is assessed to be equivalent for the purposes of Article 227, the group may apply to use local rules for the third country (re)insurer in their group capital calculations carried out under the deduction and aggregation method rather than having to apply Solvency II rules to the third country (re)insurer.

3. (c)  Group supervision: under Article 260, where a Solvency II group is headquartered in a third country which is assessed as having a system of group supervision that is ‘equivalent’ to that operated under Solvency II, EU supervisors must rely on the supervision of that group at a worldwide level by the national supervisor in that jurisdiction. This does not, however, prevent EU regulation at a European subgroup level.

4.92  The Solvency II regime sets out a list of the conditions which must be fulfilled by a third country for an equivalence determination in each of the three cases mentioned previously. The criteria include: (1) a provision for the existence of a risk-based supervisory system; (2) sufficiently resourced and empowered supervisory authorities which are able to protect policyholders and beneficiaries; (3) adequate capital requirements imposed on (re)insurers; and (4) effective governance systems. On the day that the UK separates from the EU, the UK will have implemented all of Solvency II as required, which in theory implies that UK (p. 93) regulators and insurance providers could be considered eligible to meet the criteria for third country equivalence.

4.93  In practice, however, these conditions have proved difficult to satisfy and are entirely within the control of the Commission. Only two countries currently have full equivalence in all three areas: Switzerland and Bermuda. In the case of Bermuda, the Commission’s decision was the result of an iterative process where only provisional equivalence for group solvency was granted on the first assessment. The UK has been at the forefront of prudential regulation for insurance and in some areas, is super equivalent (e.g. the senior insurance managers regime) so it should be in a position to achieve equivalence.

4.94  Insurance intermediation is currently subject to a Single Market ‘passport’ throughout the EU under Directive (EU) 2016/97 on insurance distribution (recast) (the Insurance Distribution Directive, or IDD). There is no third country regime under either measure that provides a means of access for third country insurance intermediaries.

4.95  The Benchmarks Regulation applied from January 2018. As a result, financial institutions in the EU are only be able to use benchmarks registered with ESMA.

4.96  For third country administrators, registration is only possible on the basis of: (1) a positive equivalence decision; (2) recognition by the competent authority in the administrator’s ‘Member State of Reference’; or (3) endorsement by an EU administrator, with full authorisation, of the benchmark(s) which it provides. The Benchmarks Regulation lays down, in Articles 32 and 33, specific requirements which must be fulfilled for either recognition or endorsement to occur and which may, in part, be satisfied by demonstrating compliance with certain international standards.

4.97  Although the Benchmarks Regulation offers access to third countries by way of equivalence, recognition, or endorsement, there continues to be ambiguity about the standards that apply to each threshold test for access. The availability of a positive equivalence determination in favour of the UK will depend on the application of the requirements set out in Article 30(2) and 30(3) of the regulation. Those paragraphs require that the framework must be equivalent taking account of whether the legal framework and supervisory practice of the third country ensures compliance with the IOSCO principles for financial benchmarks.

4.98  In addition, a positive equivalence decision will only be granted where benchmark administrators are subject to effective supervision and enforcement on an ongoing basis in the third country in question.

4.99  The Prospectus Regulation (Regulation 2017/1129) sets out common standards for the issue of securities within the EU and also permits the ‘passporting’ of a prospectus which (p. 94) has been approved by a Member State’s competent authority across the EU. The position of third country issuers is addressed in Articles 28 to 30, which allow third country issuers either to drawer up a prospectus under the Prospectus Regulation or use a prospectus that the issuer has prepared under the laws of a third country. Subject to certain requirements, such a prospectus may also be approved by the competent authority of a Member State and then ‘passported’ into other Member States.

4.100  Specific provisions for issuers registered in a third country are established by Article 29 of the Prospectus Regulation. These provide that the competent authority of the ‘home Member State’ of the issuer in question can approve a prospectus for an offer to the public or for admission to trading on a regulated market in the EU, subject to certain additional requirements relating to disclosure and information. The concept of a ‘home Member State’ is not entirely dissimilar to that of ‘Member State of Reference’ in other EU provisions and, means, very broadly, the Member State where the securities are intended to be offered to the public by the issuer for the first time or where the first application for admission to trading on a regulated market is made, subject to an element of election on the part of the third country issuer.

4.101  Currently, the UK Listing Authority (UKLA), which is part of the FCA, is the competent authority in the UK and can approve Prospectus Regulation-compliant prospectuses for third country issuers whose ‘home Member State’ is the UK. Once the UK leaves the EU, approval granted by the UKLA will no longer enable the provision of such prospectuses in the EU.

4.102  There are, however, a number of exemptions in the Prospectus Regulation from the requirement to prepare a Prospectus Regulation-compliant approved prospectus in order to make an offer of securities or otherwise market the securities. Where an offer of securities falls within an exemption, it may be possible to use a third country prospectus or similar offering document within the EU on the basis, that the offer is exempted from the requirements of the Prospectus Regulation so that a compliant prospectus does not need to be prepared and approved. One exemption is available where the offer is made solely to ‘qualified investors’.

4.103  The Prospectus Regulation entered into force on 20 July 2017 and applied from July 2019. It repealed the earlier Prospectus Directive.

4.104  Chapter VI of the Prospectus Regulation establishes specific rules in relation to issuers established in third countries and provides two means by which a prospectus drawn up by an issuer established in a third country may form the basis of an offer of securities in the EU.

1. (a)  by virtue of Article 28, a third country issuer intending to offer securities to the public in the EU and to seek admission to trading on an EU regulated market may draw a prospectus up in accordance with the Prospectus Regulation and seek approval of its prospectus from the competent authority of its ‘home Member State’. Once such approval is received, the prospectus will entail all the rights and obligations provided for a prospectus under the Prospectus Regulation; and

2. (b)  under Article 29—which is set out in terms very similar to those in Article 20 of the Prospectus Directive—the competent authority of a third country issuer’s ‘home Member State’ can also approve a prospectus drawn up under the laws of the third country. In these circumstances it must apply requirements similar to those laid down in Article 20 of the Prospectus Directive and also satisfy itself that it has (p. 95) concluded adequate cooperation arrangements with the relevant supervisory authorities of the third country in question.

4.105  If a Prospectus Regulation-compliant approved prospectus is required, for example, where a UK issuer that intends to list on a UK trading venue wants to extend a retail offer to EU investors then, following Brexit, the issuer would need to have its prospectus approved by a Member State competent authority, namely the competent authority of its ‘home Member State’. Approval by the UKLA would not be sufficient in the circumstances of the UK’s withdrawal without a bespoke agreement or transitional arrangements. If the UK retains rules post-Brexit which require UK prospectuses to meet the same standards as a Prospectus Regulation-compliant prospectus, then it may be the case that (subject to any translation required) essentially the same document can be submitted to a competent authority for approval for use in the EU.

4.106  A prospectus can only be approved by a competent authority in the EU under Article 29 of the Prospectus Regulation if it has been drawn up in accordance with international standards on disclosure. The issuer is also required to show that the information requirements laid down by legislation in the country where it has its registered office are ‘equivalent’ to requirements under the Prospectus Regulation. Under Article 29(3), the Commission is empowered to determine that the information requirements imposed by the national law of the third country are equivalent to the requirements of the Prospectus Regulation.

4.107  In addition to the requirement of an equivalence assessment, Article 29(3) of the Prospectus Regulation requires that cooperation arrangements on supervision are in place between the ‘home’ competent authority and authorities in the third country.

4.108  Under Article 29(3), the Commission is empowered to adopt delegated acts establishing general equivalence criteria as well as to take an implementing decision on whether the particular information requirements imposed in a third country jurisdiction meet the equivalence requirement. Alternatively, a third country issuer can seek approval for a prospectus under Article 28 from the same competent authority on the basis that the prospectus itself has been drawn up in accordance, not with the laws of the third country in question, but in accordance with the Prospectus Regulation.(p. 96)