Following the Brexit vote, the Bank of England, PRA and FCA have stressed to firms that their obligations under UK law that derive from EU law continue to apply until British businesses are told otherwise.
Until the result of the vote, UK firms active in the investment services market were focusing their resources on implementing the revised Markets in Financial Instruments Directive (MiFID) and Regulation (MiFIR) package – known as MiFID 2. One of its key benefits for many financial market institutions is to allow firms to provide a variety of investment services in a wide range of products throughout the European Economic Area (EEA) on the basis of one "home state" authorisation and minimal regulatory interference from "host state" authorities using the "passporting" mechanism.
Since the vote, there has been much political and academic speculation over the future of UK financial services regulation, none of which has yet resulted in any certainty. However, it seems inevitable that, given the UK has still not made the "Article 50" notification that would formally start the Brexit clock ticking, the current implementation timeline for MiFID 2 means it will need to be implemented before the UK leaves the EU – so the UK will need to be fully compliant with its requirements (and, until the UK does leave the EU, the MiFID 2 passporting mechanism will apply to allow UK firms to provide services and activities in or into other Member States). The UK government and regulators should continue to work on implementing MiFID 2 in line with the current time frame. This means they must adopt and publish the measures transposing the Directive into national law by 3 July 2017, and apply (with minimal exceptions) the provisions under the Directive and MiFIR from 3 January 2018.
In principle, leaving the EU would mean loss of the MiFID passport (as well as the loss of passports available under other pieces of single market legislation relevant to financial institutions, which are outside the scope of this briefing). Until the terms of Brexit are clear, however, we do not know the extent to which some rights may remain, whether for example because the UK leaves the EU but remains in the EEA, or by bilateral agreement. But, in any event, the so-called third-country provisions under MiFID 2 may provide some firms with an alternative means of access to the single market.
This note looks briefly at the key provisions of MiFID 2 that affect firms from third-countries.
For further information generally on the possible legal implications of Brexit, see our Brexit hub.
The third country regime under MIFID 2
MiFID 2 contains provisions, under Article 39 of the Directive (Article 39) and Article 46 of MiFIR (Article 46), whereby third-country firms can access the single market. These provisions have been designed to provide some uniformity to the provision of investment services by a third-country firm (under the current MiFID, the ability of third-country firms to provide services in or into EU countries is largely a matter of the domestic law of the relevant "host").
Establishing a branch under the MiFID 2 provisions
Under Article 39, Member States have the option (but no obligation) to require third-country firms wanting to provide investment services to retail or elective professional clients in that member state to establish a branch there. If a firm does have to establish a branch, this triggers an authorisation requirement and imposes significant conditions on a firm such as the need for sufficiently freely available capital, the implementation of co-operation and tax agreements, the appointment of appropriate managers who must ensure the firm complies with the same overarching governance requirements as any other MiFID firm, and membership of an investor compensation scheme authorised or recognised under the Investor Compensation Schemes Directive.
As stated above, Member States have the option to impose this requirement on third-country firms. The UK's initial view was that it would not impose this requirement, but it has traditionally been one of the EU members with the most friendly regulatory environment for third-country firms. Currently, many third-country firms can, for example, do business in the UK without a full MiFID authorisation, whereas they can do little or nothing in several other Member States.
Right to provide investment services on a cross-border basis
Alternatively, third-country firms wanting to provide investment services or perform investment activities only to or with per se professional clients and eligible counterparties within the EU, with or without setting up a branch, could do so under Article 46.
For Article 46 to apply, third-country firms must be registered on a register maintained by the European Securities and Markets Authority (ESMA). But before they can apply to be on the register, the following conditions must be met:
- the EU Commission must adopt an "equivalence" in relation to the relevant third country;
- the firm must be authorised in the jurisdiction in which its head office is established to provide the relevant investment services or activities, and must be subject to effective supervision and enforcement ensuring full compliance with the requirements applicable to that third country; and
- co-operation arrangements must be established between ESMA and the third-country regulator.
The equivalence requirement means that the third country will need to have in place regulatory rules that are equivalent to key regulations applicable in the EU and an equivalent recognition system for third-country firms wishing to provide investment services in its jurisdiction.
Article 47(1) provides that a third country's prudential and business conduct framework will be considered to have equivalent effect if:
- The firm is subject to authorisation, effective supervision and enforcement on an ongoing basis
- The firms is subject to sufficient capital requirements and appropriate requirements applicable to shareholders and members of their management body
- The firm is subject to adequate organisational requirements in the area of internal control functions
- The firm is subject to appropriate conduct of business rules
- The third country's framework ensures market transparency and integrity by preventing market abuse in the form of insider dealing and market manipulation.
It is worth noting in this context that the Commission does not take equivalence decisions lightly. There is precedent under other single market directives, which indicates the process is often long drawn out and the outcome far from a mere procedural matter.
Member States also have the option to permit third-country firms to offer services to professional clients and eligible counterparties in their own jurisdiction without ESMA registration. This is again a matter for the individual Member State. Also, registration with ESMA brings with it the ability to provide the relevant services to these clients without the need for further applications or analysis of any other domestic laws.
The position of UK investment firms under MiFID 2 post Brexit
So where does this leave UK firms? As noted above, it seems inevitable that the UK will fully implement and apply MiFID 2. In principle, this should mean the Commission has no reason not to deem the UK "equivalent" for the purposes of Article 46 and 47. Of course if the UK's implementation does not follow all MiFID 2's requirements, the Commission may find reasons not to make the determination.
Firms should note:
- if there is a successful equivalence decision and an ESMA registration follows, this will not permit firms to provide services using the ESMA "passport" to retail clients EU wide;
- if firms wish to provide services to retail clients, they will still need to consider the requirements of each relevant Member State;
- MiFID 2 does not oblige Member States to allow third-country firms to provide services to any client unless it is done under the ESMA passport and to wholesale customers only; and
- the ESMA passport will also, in any event, cover only MiFID 2 services and activities. Firms that derive their authorisation (currently) from other EU legislation will need to consider their position under that legislation, and whether a similar third-country regime may be possible for these areas of business.
On the other hand, MiFID 2 introduces also the concept of "reverse solicitation" – which means that, provided a client has genuinely pro-actively requested services or products from a third-country firm, that firm can provide them without the need for any registration or authorisation. However, firms wishing to rely on this must take great care to ensure both that the initial request genuinely comes from the client, and that the firm does not breach MiFID 2 once the client relationship is set up.
For the moment, UK firms should just continue as instructed by the regulators, and prepare to implement MiFID 2 in line with its requirements. It is likely to be some significant time before there will be a clear enough picture of the terms of exit for any firm to take a final decision on its position.
Andrew Barber (Partner) and Emma Radmore (Legal Director) are members of Bond Dickinson's financial services team.