Brexit – Preparing for the period after the transitional period

Since 29 March 2017 it has been clear that Great Britain will leave the EU. After long negotiations, UK and the EU finally agreed on a withdrawal on 31 January 2020 on the basis of a withdrawal agreement. The withdrawal agreement also includes a transitional period until 31 December 2020. During this period, the conditions for the future relations between the EU and UK are to be negotiated and defined. However, no substantial progress in the negotiations has been announced to date.

Legal situation during the transitional period

Under the withdrawal agreement, EU law continues to apply to the United Kingdom during the transitional period. The withdrawal agreement does not contain any specific provisions regarding the cross-border provision of financial services.

However, as the UK is essentially treated as if it were still a member state of the EU, the rules on cross-border provision of financial services within the EU (resp. the EEA) continue to apply. UK firms providing financial services under Annex I of the CRD IV or Annex I of MiFID II (including deposit business, lending business, or financial leasing) may continue to use the European single market. European financial service providers can still provide their cross-border financial services in the UK without having to apply for a further licence.

This is based in particular on the possibility of using the so-called European passport, where a licence in the home country and notification of the supervisory authorities are basically sufficient to be able to provide financial services in other European countries. Compared to third countries, the conditions for outsourcing activities have been made less stringent. In addition, with regard to the capital market, for example, securities prospectuses can be used throughout the EU and there are simplified rules for the distribution of UK funds in the EEA compared to the requirements for the distribution of funds from third countries.

Alongside these advantages, UK financial service providers must of course also fulfil the obligations (such as reporting requirements) of European financial regulatory law during the transitional period. ESMA clarified this once again in a statement on UK withdrawal on 31 January 2020.

And after the transitional period?

This question is not a new one; it was already widely and intensely discussed in the run-up to the withdrawal agreement.

At that time, it had not been clear for a long time whether a withdrawal agreement could be concluded. The national legislators and supervisory authorities had therefore already taken some measures to mitigate possible negative consequences of a “no-deal Brexit”. This situation seems to be becoming increasingly urgent again.

Further transition period?

For financial service providers, the German legislator had created a provision for the case of a no-deal Brexit (i.e. without any agreement) in section 53b para 12 German Banking Act (Kreditwesengesetz, “KWG”) KWG. This enabled the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, “BaFin”) to continue to apply the regulations regarding the European passport for a maximum of 21 months (as we reported here). However, this option is explicitly tailored to the case that the UK leaves the EU without a withdrawal agreement.

Since the UK finally left the EU with a withdrawal agreement at the end of January, the explicit wording of the regulation is likely to be invalid at present. Considering its clearly defined scope of application, it is extremely doubtful whether an analogous application would be possible in the event that the EU and the UK are unable to agree on the future relationship in the financial services sector. It would rather be up to the German legislator to determine a (further) transition period for the period after 31 December 2020.

No publications or statements by BaFin on this issue are known at present.

The UK Financial Conduct Authority (FCA), on the other hand, announced on 1 July 2020 that it intends to re-establish the “temporary permissions regime” (TPR) at the end of the transition period. From 30 September 2020, EEA financial services providers and EEA fund managers who have not done so in the past will be able to notify the FCA of their intention to use the TPR. For a certain period after the end of the transition period, they will then be able to continue to use their European passport from the EEA to the UK, for example, or to distribute funds in the UK as they did before. The background is that the UK wants to prevent EEA financial service providers from no longer being able to operate in the UK after the end of the transitional period. During the TPR, EEA financial service providers can then apply for a licence.

The FCA is therefore already making preparations for the period after the transition period.

Legal situation without further transition period

If no further (national) transitional periods come into force and the UK and the EU are unable to agree on specific provisions regarding the financial services sector, the third country regime will probably apply to the UK without restriction from 1 January 2021. In this case, the more detailed statements of the (European) supervisory authorities ESMA, EBA and BaFin on Brexit, for example with regard to the outsourcing of processes to third country firms, should also apply. The European passport could then no longer be used by UK financial service providers operating within the EU.

In other words, branches of UK financial service providers would become branches of companies domiciled in a third country. That would mean that these branches would have to apply for a separate KWG licence. Alternatively, it would be possible to set up a legally independent subsidiary and apply for a licence for it. The second alternative has the advantage that this subsidiary would then be considered a European financial services provider and could use the European passport in other European countries. This is not possible for branches of third country firms (for example, UK firms). These options apply accordingly to payment service providers.

UK fund managers will also become third country fund managers at the end of the transition period. They will no longer be able to offer their services on the basis of the European passport, but will then have to apply for their own licence. According to section 58 German Capital Investment Code (Kapitalanlagegesetzbuch, “KAGB”), this licence is subject to additional requirements compared to a “normal” licence of domestic (German) fund managers. Special conditions are also attached to the distribution of funds by a third country fund manager.

With regard to outsourcing in the fund sector (such as risk and portfolio management) BaFin had already concluded a Memorandum of Understanding with the FCA in preparation for a possible no-deal Brexit (as we reported here). This would be a prerequisite pursuant to § 36 (1) no. 4 KAGB to allow outsourcing to UK managers. Although this agreement was concluded primarily due to a possible no-deal Brexit, it should also be applicable for the period after 31 December 2020.

Comment

The end of the transition period on 31 December 2020 is fast approaching, without any signs of an agreement between the EU and the UK on future relations in the financial sector.

Financial service providers intending to provide cross-border services in Germany (or the EU) should therefore ensure they are prepared the UK becoming a third country from 1 January 2021.

In contrast to UK, no further transitional period is currently in place in Germany. As a result, numerous benefits such as the European passport will no longer be available and more stringent regulatory requirements will often have to be met, which may also require an adjustment of the business model.