It seems as though it has been a long, long time since the referendum on membership of the European Union: an interminable period of speculation, rumour, threats, dire forebodings. And somehow very little certainty at all about what life will look like after March 2019, ie the date specified in the UK’s notification of triggering Article 50. After March 2019, the UK will (in all likelihood) exit the European Union. We are still in the dark about much of what will result from Brexit for many areas of life. For the financial services and insurance sectors, an optimist might say the picture is becoming slightly clearer. In this article, Roseyna Jahangir, looks at where we are as of 18 November 2018.
Of course, the terms of the UK’s withdrawal from the EU withdrawal have still not yet been finalised. Earlier this year, given the lack of progress, the EU and the UK announced that they had agreed a transition period to extend the time for finalising the terms of the withdrawal. During this transitional period, the UK would retain access to the EU on the same basis as present. This transition period is conditional upon the two sides agreeing the key terms of the withdrawal before March 2019.
In November 2018 – ie just over four months before the March 2019 deadline - a draft proposal of the key terms of the withdrawal has only now been published. The 585 page draft agreement on the withdrawal of the United Kingdom of the Great Britain and Northern Ireland from the European Union and the European Atomic Energy Community (Draft Withdrawal Agreement), is supported by an ‘Outline of the Political Declaration Setting out the Framework for the Future Relationship between the European Union and the United Kingdom’ (Outline). If passed by the respective governments of the UK and the EU, it will set out the basis for the UK’s future relations with the EU.
Effect of withdrawal on domestic legislation
After March 2019, unless a transitional agreement has been agreed, the regulatory framework that underpinned a significant proportion of the UK’s body of legislation will be abruptly removed, undermined or will make no sense.
It has been reported that implementation of EU obligations accounted for 62% of laws that came into force in the UK between 1993 and 2014  . Many of these EU-derived measures are of minimal (or even no) effect on life in the UK: for example, they may be technical enabling measures or affect non-UK industries. But for other UK sectors, including the financial services and insurance sectors, the EU is embedded into the fabric of legislation.
There are two main ways that EU legislation has become embedded in that of the UK. As part of the development of a single market for goods and services, the rules and regulations that underpin key activities are set at the highest level of policy and principle by EU legislation. This European legislation has become effective in the UK either directly, in the case of Regulations such as the General Data Protection Regulation, or Directives that have been transposed into Acts of Parliament, such as the Consumer Credit Directive, implemented primarily through amendments to the UK’s Consumer Credit Act 1974, and statutory instruments made under the Consumer Credit Act. The regulation of the financial services and insurance sectors has received particular focus from the legislators of Europe, especially in the light of the financial crash of 2008. In recent years, legislators sought to ensure that the weaknesses that had been starkly exposed by the crash would be bolstered by a stronger, more comprehensive legislative system. On the whole, this has led to more Regulations and fewer Directives. Many more recent pieces of legislation – such as the revised Markets in Financial Instruments legislation and the laws for alternative investment fund managers – have combined Directives and Regulations, so that some parts are fully reflected in UK laws and others merely referenced.
Even where EU-derived legislation has been implemented in the UK through domestic legislation, much of this legislation is intrinsically interspersed with references to the European legislative framework, such as European legislation and bodies. For example the Capital Requirements Regulations 2013, contains over 80 references to the European Banking Authority (EBA), in provisions ranging from a requirement to notify the EBA (among other bodies) if an emergency situation arises in relation to a relevant institution to the ability for the EBA to break deadlock on a disputed decision regarding capital adequacy of a multi-jurisdiction group, where the relevant supervisors are unable to agree. And, increasingly the European Securities and Markets Authority (ESMA) is taking direct responsibility for authorising and supervising certain providers, who are then able to do business across the EU. This also would have to change.
Accordingly, if the United Kingdom is no longer to be part of the European Union, not only will the European laws that have direct effect in the UK need to be replicated in UK, but all domestic instruments containing references to European legislation and bodies, such as the examples above, will need to be revised and redrafted so that the UK legislation continue to ‘work’.
To prepare for this removal (which may need to take effect as soon as next March, in the event of exit from the EU without a transition agreement), the UK Government passed the European Union (Withdrawal) Act 2018, and has been preparing draft Statutory Instruments under it which, when passed, will give effect to the replication and reworking of this European fabric of law into UK legislation. To date over 25 draft statutory instruments have been published for the financial services and insurance sectors alone, amending more than 11 Acts and 44 statutory instruments.
On the other hand, the freedom of services principle that is part of the foundations of the single market of the European Union is put in practice through the passporting regime. This provides that certain regulated activities can be carried out by UK firms into Europe.
Currently, firms doing business with the EU rely one or more of eight different types of passport, based on eight Single Market directives:
- Capital Requirements Directive (CRD), which enables the provision of advisory, credit, custody or deposit services, and includes passports under the former Banking Consolidation Directive and the Capital Adequacy Directive
- Markets in Financial Instruments Directive, letting firms buy and sell shares, bonds or other financial instruments on own account or for clients, and provide investment management, advisory and related services, and to trade on exchanges and trading venues around the EU
- Solvency II Directive, which lets insurance firms sell insurance to and from other European countries
- Payment Services Directive which facilitates the provision of payment services
- Mortgage Credit Directive which regulates loans made to consumers for the purpose of buying residential property
- Alternative Investment Funds Management Directive regulates the management of hedge funds, private equity funds and other ‘alternative investment funds’
- Undertakings for Collective Investment in Transferable Securities (UCITS) Directive governs the management and sale of regulated, retail, fund products
- Insurance Distribution Directive regulates the marketing and distribution of insurance products
- Electronic Money Directive applies to the operation and use of electronic payment systems.
The FCA reported in 2016  that there was a total of 336, 421 passports being used by 5,476 UK firms to access the various European markets, and 8,008 European firms to access the UK.
Firms from non-EU countries that want to provide financial services in European countries without having to establish an authorised entity can, in general, only do so on the basis of an equivalence assessment. This is a determination by the relevant EU body that their country's regulatory regime is "equivalent" to that of the European Union for the particular services that wish to be provided.
Equivalence is assessed on a case by case basis, against applicable corresponding EU legislation. For example, in relation to article 172 of Solvency II Directive, only Bermuda, Japan and Switzerland have been assessed equivalent. An equivalence assessment can be time consuming to be undertaken and can be withdrawn at any time by the European Union if deemed appropriate. The areas in which there is provision for equivalence assessments is limited: at present, third country insurance entities can only obtain equivalence assessments in relation to reinsurance (based on article 172 of Solvency II). Furthermore even once a successful equivalence assessment has been made, there may be restrictions about the type of clients to whom relevant services may be marketed and provided; in particular when it comes to ‘retail’ clients. Even worse, certain directives (like the Capital Requirements Directive) do not cater for equivalence at all, while the AIFMD has now been in force for over 4 years without a proper, fully-working, equivalent status being awarded. So equivalence was never going to be a good outcome – even though the UK, as possibly the most compliant jurisdiction in the entire EU in terms of implementing measures, would have identical rules to those measures on Brexit day, and therefore could hardly be argued not to be equivalent.
Lack of equivalence presents a number of issues, including the need to take a step back on what it means to be carrying on business in or into another jurisdiction. Many firms have just used a passport for ease, without considering whether they truly need one. The determination of whether cross-border business is carried on "in" the host country is not set at EU level, so there is a painful process of determining each country's position in cases where it is not clear that the business will require some form of licence, in the absence of a passport or an equivalence determination.
Draft Withdrawal Agreement
For financial services, the effect of the transition agreement is that things will continue (largely) as normal until the end of the transition period.
Thereafter, the ‘Outline’ document indicates that for financial services, the UK will do business with the EU on an equivalence basis: “Commitment of equivalences assessments by both Parties as soon as possible after the United Kingdom’s withdrawal from the Union, endeavouring to conclude these assessments before the end of June 2020”. It therefore appears to be confirmed that there will not be a special arrangement for the UK’s financial services and insurance firms, and that we will potentially access European markets in much the same way that firms from countries such as Japan and the United States do today in insurance. If this is so, the shortcomings of the equivalence measures in the various sectoral directives will become rapidly and readily apparent – and if the EU is not prepared to give the UK some bespoke concessions based on its total equivalence, and persists in its previous stance that the UK must be treated like any other third country, then, if UK firms are to be able to operate under an effective replacement to the current passport, the EU would need to amend most if not all of the key single market directives to enable this to happen. The glimmer of hope is that hitherto, the pragmatic approach to dealing with firms that operate under passports which they will no longer be able to use has seemed to be a one-way street – all being led from the UK. The Outline, while falling short of any indication that any form of passporting regime, or "equivalence-plus" will be put in place, at least articulates willingness on both sides to progress.
The way ahead?
While it is possible that there would be a second vote, or that the Draft Withdrawal Agreement will be renegotiated, it looks as though when the UK leaves the EU, the financial services and insurance sectors will do business with the EU as a third country.
The other option to equivalence for doing business in the European Union is to open a branch or subsidiary in a member state and use passports from that country to access the rest of the Union. This is the way in which many if not most of the non-European firms have done most of their business with Europe to date: ironically, often by opening a branch or subsidiary in the UK and using that as their ‘gateway’ to Europe. Accordingly, many firms in the UK have already started to transfer their European operations to business-friendly countries such as Luxembourg, Germany and Ireland.
However there are helpful indicators in the Draft Withdrawal Act and the Outline. It had been speculated that applications for equivalence assessments could only start after the end of the transition period; however the Outline confirms that the process of assessment would start during this period. And given the fact that the UK’s legislation is, and for the duration of the transition period, will continue to be based on EU laws and standards, one would hope that the assessments would be relatively straightforward. But, on the minus side, there are still concerns over the ability of certain sectoral EU measures to be able to deliver the equivalence assessment required without amendment. There is of course precedent for bespoke arrangements with third countries, such as the arrangements between the EU and Switzerland in general insurance, but there is no real indication that any similar "special" status is contemplated at the moment.
Furthermore, financial services and insurance firms do not exist in a vacuum: there are indications of agreements that will be supportive of the financial services and insurance sectors as a whole: getting data protection recognition in place will overcome what could otherwise be an overpowering block to doing business, as will the recognition of the rights of EU workers already in the UK and visa-free travel going forward.
But overall, it does appear that for the financial services and insurance sectors, while there is a clearer picture of what trade with the European Union is likely to look like, that picture is, on the whole, executed in the brute realism style rather than a Romanticised pastoral scene.