Bartlomiej Kulpa,
LLM (Twitter: @KulpaBart)
Introduction
Since Boris Johnson took the helm
as British Prime Minister, a no-deal Brexit has become the most likely
scenario. The UK-based financial services firms are waiting to hear if they
will be able to serve clients in the EU 27, and if so, on what basis. Currently,
the UK-based financial services firms rely on the so-called passporting rights.
According to The Economist, 5,476 financial services firms based in Britain used
336,421 European passports to sell their products in the EU in 2016. By
comparison, approximately 8,000 financial services firms based in the EEA used
23,535 European passports to sell their products in the UK. This proves that
the removal of passporting rights as well as uncertainty over what will replace
them amount to an existential threat.
The Concept of a European Passport
A European passport is a right
granted under the Single Financial Market Directives, such as MiFID II (The
Markets in Financial Instruments Directive 2014/65/EU), to an EEA institution
licenced in an EEA Member State. The European passport enables financial
services firms to act on a cross-border basis within the EEA. If Britain leaves
the EU without a Brexit deal, the UK-based financial services firms will lose
the passporting rights and consequently full access to the single market. In
other words, they will be treated as third country financial services firms.
Articles 34 and 35 of MiFID II form
the legal basis for the passporting rights. Article 34 provides for freedom to
provide investment services and activities in another Member State if such investment
services and activities are authorised by the competent authorities of a home
Member State. As regards Article 35, that allows financial services firms to
provide services in another Member State through the right of establishment of
a branch provided that such services are authorised by the competent
authorities of the home Member State. Pursuant to Articles 34 and 35, a
financial services firm must notify the competent authorities of the home
Member State of its intention to provide services in another Member State. In
other words, the financial services firm must apply for a licence.
Subsequently, the competent authorities of the home Member State inform the
competent authorities of a host Member State of the financial services firm’s
intention to serve clients in the latter.
There is no doubt that the
advantages of the concept of a European passport easily outweigh the
disadvantages. Firstly, one licence enables financial services firms to obtain
access to 31 countries which have a population of over 500 million consumers
(this will be reduced after a Brexit). From a legal point of view, this means
that a financial services firm that has been granted a European passport is not
required to obtain a domestic licence in every Member State. Secondly, the
concept of a European passport helps to keep business costs down. Thirdly, the
concept of a European passport is free from political influence. Fourthly, the
range of clients and investors is not limited in scope. In other words, the
concept of a European passport does not only apply to professional investors
but also to retail investors. Lastly, a home Member State regulator cannot
revoke the European passport and the European passport is granted for a period
of time with no fixed limit.
Further, it should be noted that
the concept of a European passport does not have the qualities to be described
as a single European passport. If it qualified as the single European passport,
then financial services firms would be allowed to undertake cross-border
activities throughout the EEA without taking any further actions. A good
example of a single administrative act with EEA-wide effect is a European
trademark granted by the European Union Intellectual Property Office (EUIPO).
The Equivalence Regimes
The EU has operated the equivalence
regimes (also known as the third country regime or TCR) in relation to
financial services firms based outside of the single market under the relevant
Single Financial Market Directives and Regulations, the USA being the prime
example, for some years. In accordance with Articles 46-49 of MiFIR (The
Markets in Financial Instruments Regulation (EU) No 600/2014), the equivalence
regime is based on an equivalence decision made by the European Commission (EC)
and the register of third country financial services firms kept by the European
Securities and Markets Authority (ESMA). As regards the former, the EC’s
equivalence decision states whether, firstly, the prudential and business
conduct requirements that are legally binding in a third country have
equivalent effect under EU law and whether, secondly, the legal and supervisory
arrangements of the third country ensure that financial services firms
authorised by the competent authorities of that third country comply with the legally
binding prudential and business conduct requirements. Once the EC has made the
equivalence decision in favour of a particular third country, financial
services firms based in that third country need to register, within a
transitional period of three years under Article 54 of MiFIR, with the ESMA. As
a result, third country financial services firms are able to operate as a
European hub. It should be noted that Member States shall not impose any
additional requirements on such firms and shall not treat them more favourably
than firms based in the EU.
Moreover, it should be emphasised
that the equivalence regime enables third country financial services firms to
provide investment services and activities only to eligible counterparties and
professional clients. This means that, unlike the concept of a European
passport, the equivalence regime does not apply to retail clients. What is more,
the EC can revoke an equivalence decision at any time if divergences between a
regulatory framework of a third country and the regulatory framework of the EU
appear.
One could argue that in the event
of a no-deal Brexit the equivalence regime would be more attractive for smaller
financial services firms. As practice proves, multinational financial services behemoths,
which have used Britain as the gateway to the single market, have already
relocated to the EU 27 or are in the process of setting up offices there as
part of their Brexit strategy.
As far as the resolution of
disputes is concerned, third country financial services firms shall, before
providing any services or activities to the EU-based clients, offer to submit
any disputes relating to the aforementioned services or activities to the
jurisdiction of a court or arbitral tribunal in one of the Member States
(Article 46(6) of MiFIR). In other words, such firms shall offer a forum in the
EU where their right to conduct litigation could be exercised. If Britain were
to access the single market via the equivalence regime in the event of a
no-deal Brexit, then the English courts would not have any jurisdiction over disputes
relating to such services or activities. In practice, this would result in
London facing a struggle to retain its position as a global centre for
securities litigation.
Although the equivalence regime
would allow the UK-based financial services firms to access, in the event of a
no-deal Brexit, the single market, the equivalence regime suffers from a few
drawbacks. Firstly, the equivalence regime is a unilateral mechanism. To put it
simply, it only depends on the EU whether it recognises as equivalent the
regulatory standards of a third country. Secondly, since an equivalence
decision is made by a political body, namely the EC, various political factors
can impact the equivalence assessment. Thirdly, the EC’s equivalence decision
cannot be reviewed by a court.
The European Passport Light
The next issue that merits
attention is the so-called ‘European passport light’ as set out in Article
47(3) of MiFIR. A third country financial services firm can rely on the
European passport light if the following conditions have been met: (i) the EC
has made an equivalence decision in favour of a particular third country; and
(ii) the third country financial services firm has been granted the
authorisation to establish a branch in one of the Member States pursuant to
Article 39 of MiFID II. As a result, the third country financial services firm
will be able to provide services and activities to eligible counterparties and
professional clients in other Member States without the requirement to
establish a new branch for each additional Member State. In the same way as the
equivalence regime, the European passport light does not apply to retail
clients. However, unlike the equivalence regime, the European passport light is
not based on the requirement to register with the ESMA.
The MiFID II Own Initiative Principle
Article 42 of MiFID II creates an
exception to a Member State’s imposition of an authorisation requirement, which
is enshrined in Article 39 of MiFID II, for a third country financial services
firm where that firm provides investment services or activities at the
exclusive initiative of a retail or professional client. The MiFID II Own
Initiative Principle is coterminous with the reverse solicitation test. Compared
to the equivalence regime, the MiFID II Own Initiative Principle applies to
retail as well as professional clients. However, from a practical point of
view, the MiFID II Own Initiative Principle does not seem to be useful for big
financial services firms that intend to actively gain a market share.
Furthermore, any marketing to EU-based clients triggers the EU rules for
providing financial services and consequently the need for obtaining an EU
licence.
Conclusion
It seems that the equivalence
regime is the only workable arrangement that could replace the concept of a
European passport in the event of a no-deal Brexit. Unless the UK government
creates ‘Singapore upon Thames’, the process of making a decision whether
post-Brexit Britain’s regulatory regime is deemed to be equivalent should be
relatively straightforward. However, one should remember that the equivalence
regime does not apply to retail clients and the EC can revoke an equivalence
decision at any time. Therefore, the equivalence regime would not fill the gaps
created after the cessation of the application of a European passport to the
UK-based financial services firms.
Further reading:
M Lehmann and D A Zetzsche, Brexit
and the Consequences for Commercial and Financial Relations between the EU and
the UK, 20 September 2016. Available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2841333;
H Nemeczek and S Pitz, The Impact
of Brexit on Cross-Border Business of UK Credit Institutions and Investment
Firms with German Clients, 1 February 2017. Available at: https://ssrn.com/abstract=2948944;
The Economist, London’s reign as
the world’s capital of capital is at risk, 29 June
2019. Available at: https://www.economist.com/finance-and-economics/2019/06/29/londons-reign-as-the-worlds-capital-of-capital-is-at-risk.
Barnard
& Peers: chapter 14, chapter 27
Photo credit: via Wikicommons,
photo taken by Andy F
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