The impact of Brexit on the passporting rights of banks, investment firms and other financial institutions

Close to five-and-a-half thousand British firms currently hold ‘passporting’ rights provided under various of the Single Market directives, which allow a financial services firm authorised in one European Economic Area (EEA) member state to provide certain regulated services (eg deposit-taking, lending, payment services, investment services) across the EEA without requiring separate authorisation in the other EEA member states in which it operates. For EEA firms holding passports into the UK, the figure is just over eight thousand.

It is no surprise, therefore, that since the UK’s Brexit vote in June, there has been considerable attention on the question: ‘How will Brexit impact on passporting rights?’. In practice, the answer to that question will turn on the terms of the UK’s post-exit relationship with the EU.

UK joins the EEA – full EEA-wide market access

As an EEA member state, financial institutions established in the UK and in other EEA member states would continue to enjoy full passporting rights and to be able to establish a branch and/or conduct business on a cross-border basis in all EEA member states. However, the relationship between membership of the Single Market and free movement of workers may render that option politically unachievable.

UK is determined to be an ‘equivalent’ third country – conditional partial EEA-wide access

If UK institutions lose their passporting rights on the UK’s exit from the EEA, certain of the Single Market regimes would nevertheless provide these firms with a degree of access to EEA markets. This access is conditional on a determination by the European Commission that the UK has an equivalent financial regulatory and supervisory regime, and subject in most cases to the UK granting reciprocal access for EEA firms. On the date that the UK leaves the EU, assuming that it maintains substantially the UK implementation of EU financial services legislation, the UK would be in a strong position to be assessed as an equivalent jurisdiction, although concerns regarding reciprocity and competitiveness could prevent or delay recognition. The more UK regulations depart from the current regime, the longer the assessment process is likely to take, and the greater the risk that those regulations will not ultimately be determined to be equivalent.
As an ‘equivalent’ third-country, the UK could benefit from access under several of the more important pieces of financial services regulation, including the forthcoming MiFID II Directive and the Markets in Financial Instruments Regulation (together, MiFID II) for to investment services and trading venues (including regulated markets, multilateral trading facilities and organised trading facilities), the European Market Infrastructure Regulation for derivative clearing and reporting requirements, and the Alternative Investment Fund Managers Directive (the AIFMD) for alternative investment funds. While each of these regimes provides for access on the basis of equivalence, the manner in which the equivalence mechanisms operate, and the nature and extent of the access that is provided, varies between regimes.

UK is not determined to be ‘equivalent’ and so is treated as a standard third country – no EEA-wide access

It is possible that UK legislation will not be determined to be equivalent under the EU regimes discussed above. For some types of business, such as banking services, payment services and the management of undertakings for the collective investments of transferable securities (UCITS) funds, the governing EU legislation provides no ‘equivalence’ mechanism at all.
Where the ‘equivalence’ route is not available, the ability of UK firms to provide services and sell products to clients in the EEA, cross-border from the UK, will be significantly curtailed or more difficult. For example, a firm in the UK that provides investment services governed by MiFID II or which markets funds subject to the AIFMD would be permitted to do so cross-border, at the ‘exclusive initiative of the client’: ie without active solicitation. However, that carve-out is interpreted restrictively in some member states and is of limited practical value. Managers will, in theory, be able to market fund interests governed by the AIFMD under each member state’s unharmonised national regimes, but will need to apply for permission to do so on a country-by-country basis, and will be required to comply with varying local disclosure, transparency and other regulatory obligations.
In order to replicate the market access that they currently enjoy, firms will need to establish locally-authorised EEA branches or subsidiaries. EEA authorised subsidiaries will benefit from EEA passporting rights, but branches will not. Groups that follow this strategy may be subject to a resultant increase in regulatory capital requirements and other business costs. Unless new subsidiaries are established and authorisations obtained, UK firms will, on exit from the EEA, be at a significant competitive disadvantage. They will not be able to compete for business in the EEA with firms from the EEA or existing third-country jurisdictions which have already established locally authorised EEA entities.