With less than two months to Brexit, it is important to understand post-Brexit arrangements for both EEA firms and funds currently passporting into the U.K. as well as U.K. fund managers who are relying on a cross-border passport to market and manage their funds in other EU Member States.
For inbound EEA passporting firms and funds, the U.K. government has established the “Temporary Permissions Regime” and the “Financial Services Contracts Regime”. These will apply in a “No Deal” Brexit scenario, where the U.K. and European Union fail to conclude a Withdrawal Agreement. In such circumstances, passporting rights would cease at 11 pm on 29 March 2019.
If, on the other hand, the U.K. and EU reach an agreement on withdrawal terms, a two-year transitional regime will apply. During this period, the U.K. would be committed to complying with EU laws and passporting arrangements would carry on throughout this time.
At this time, the outcome of the ongoing political discussions is unclear. While there is cause for some optimism, U.K. and EEA firms need to plan around the worst case scenario of a “No Deal” Brexit.
II. What is the Temporary Permissions Regime (“TPR”)?
When the U.K. leaves the EU, European firms passporting into the U.K. will no longer be able to rely on their existing rights to provide services in the U.K. under a Single Market Passport. Absent the Temporary Permissions Regime, such firms would need to obtain full FCA authorisation in order to carry on their activities.
The intention of the TPR is to allow passporting firms to continue their current activities and to provide them with time (up to three years) to submit an application for full authorisation. The TPR will apply from when the U.K. leaves the EU on 29 March 2019. Formally, the FCA will temporarily authorise firms in the regime to undertake regulated activities covered by their passports on the same basis as if the firm concerned had been authorised in the U.K. by the FCA.
III. Who is eligible to enter the regime?
Clients will fall under either of the following two categories:
A. Firms passporting into the U.K. on a services or branch basis.
Firms which have passports in place before Exit Day (e.g., under MiFID II or AIFMD) will be able to carry on business under the TPR after Brexit. Firms will be able to carry across any “top-up” permissions that they have from the FCA.
B. Funds that use a marketing passport. This would include:
- EEA UCITS schemes; and
- EEA Alternative Investment Funds (including EuVECAs, EuSEFs, ELTIFs and AIFs authorised as MMFs).
Other types of eligible entities include certain EEA credit institutions and insurers, as well as payment and electronic money institutions.
IV. How to enter the regime?
Firms and funds who would like to enter the TPR will need to notify the FCA during the notification window from 7 January 2019 through 28 March 2019. It is important to understand that firms that have not submitted a notification during the notification window will not be able to use the TPR and as a consequence will not be able to carry on their activities or continue marketing in the U.K. after the Exit Day other than under the Financial Services Contracts Regime (see below) or in reliance on an exemption. The only exception to this is for new sub-funds of EEA UCITS that are in the temporary marketing permission regime on exit day.
Firms within the Temporary Permissions Regime will in due course need to apply for full FCA authorisation. A “landing slot” (i.e., a certain period of time) will be allocated to firms, during which time they will need to submit their licensing applications. It is expected that the first landing slot will be October to December 2019 and the last will be January to March 2021, but details are to be confirmed after the Exit Day. Firms in the Temporary Permission Regime who either do not subsequently apply for full authorisation or whose applications are rejected, will need to rely on the Financial Services Contracts Regime or an exemption from U.K. licensing or else cease their U.K. activities.
V. How to notify the FCA?
Firms and funds will need to notify the FCA via the Connect system. There will be no fee for firms or funds notifying the FCA that they wish to use the regime, and they should not wait for confirmation of whether there will be an implementation period before they submit their notifications.
Before initiating the notification process, firms should ensure they are registered for the Connect system (https://www.fca.org.uk/firms/connect). Firms should check their passports on the FS Register and notify the FCA through their national competent authorities as soon as possible should there be any changes. Fund managers should check which funds and/or sub-funds they are actively marketing in the U.K. and notify the FCA through their national competent authorities as soon as possible should there be any changes.
Firms and funds should follow the step-by-step guidance published by the FCA on how to use the Connect system to complete the notification process:
It is expected that firms and funds in the TPR will pay periodic fees from the 2019/20 fee year. The draft 2019/20 fee rates will be consulted in the FCA April 2019 fee rates Consultation Paper. The FCA will provide feedback on responses to that consultation and publish the final fee rates in July 2019, following which invoices will be issued.
VII. Application of U.K. Rules
The FCA’s powers over firms doing business in the U.K. will continue to apply. Under the current passporting arrangements, supervising responsibilities are allocated between Home and Host State Competent Authorities. This formal allocation of responsibility will no longer apply. There will be some expansion in the scope of FCA powers as the FCA will take over responsibility for some (but not all) matters that were previously the responsibility of the firm’s Home State.
VIII. The alternative – Financial Services Contracts Regime (“FSCR”)
The Financial Services Contracts Regime is an alternative regime for inbound EEA passporting firms who wish to continue to run off existing U.K. business following Exit Day but do not wish to obtain U.K. authorisation to carry on post-Brexit U.K. business. This would be attractive to firms who have limited U.K. business that does not justify obtaining a full U.K. licence. The FSCR will apply automatically to EEA passporting firms who do not enter the TPR.
Firms will be able to conduct U.K. activities only where this is necessary for the performance of a pre-existing contract. This will apply for a period of five years. The FSCR will not provide any relief for the marketing of EEA funds, which will either need to be in the TPR or else avail themselves of the U.K. National Private Placement Regime or obtain recognition under s.272 FSMA (the regime for individually recognised overseas schemes). It is worth noting that EEA firms managing U.K. authorised funds will not be able to continue managing those funds under the FSCR; therefore, such firms should be sure to notify the FCA to enter the TPR in order to benefit from such regime.
The FSCR provides for two forms of U.K. run-off: firstly, Supervised Run-Off for branches in the U.K. and secondly, Contractual Run-Off for cross-border services.
IX. Contingency planning for outbound U.K. fund managers
In the event of a “No Deal” Brexit, U.K. firms will become Third-Country Firms and will not have passporting rights to access the EU market. In such circumstances, they might nevertheless be able to continue marketing their funds and providing services in the EEA, including as follows:
A. Rely on the NPPR regime as Third-Country Firms
U.K. Managers will be able to continue to market their funds in the EU under the applicable national private placement regime (“NPPR”), which requires making notifications. The NPPR route will also trigger ongoing reporting obligations in the relevant EU Member States, as long as the following conditions are fulfilled: (i) the target EU Member State’s domestic law allows for the making of NPPR notifications, i.e., being a feasible NPPR Member State, (ii) a so-called “cooperation agreement” between the FCA and the competent authority of the target EU Member State is in place (the FCA and ESMA announced on 1 February 2019 that they had agreed a Memorandum of Understanding to this effect), and (iii) if the fund being marketed is established in a different country to that of its AIFM, then cooperation agreements also need to be agreed between the Competent Authority in the fund’s establishment country and the targeting EU Member State where marketing is to be directed.
B. Establish an EU AIFM
A U.K. AIFM could establish an EU AIFM as a full-scope AIFM in its country of establishment which will then be able to market an EU AIF to EU Member States under the AIFMD cross-border passport. There are two options as to how the relationship between the U.K. AIFM and the new AIFM can be structured:
- 1. The EU AIFM will carry out the risk management function in relation to an EU AIF and delegate portfolio management back to the U.K. AIFM.
- Pros: fewer personnel and less resource will be required at the EU AIFM since it is only carrying out risk management function.
- Cons: the delegation of portfolio management back to the U.K. AIFM will only be permitted under the AIFMD if the FCA enters into a Cooperation Agreement with the Competent Authority of the jurisdiction in which the AIFM is established. The FCA and ESMA have now announced that appropriate agreements will be in place for Exit Day. The firms will need to ensure that proper substance is established on the ground in Europe so that the new EU AIFM is not a letter box entity.
- 2. The EU AIFM will maintain both risk and portfolio management for the relevant EU AIF and the U.K. AIFM will only provide investment advice to the EU AIFM in relation to the AIF.
- Pros: since there will be no delegation of portfolio management back to the U.K. AIFM, there will be fewer regulatory requirements.
- Cons: since the EU AIFM will be maintaining both risk and portfolio management functions, more substance would be required at the EU AIFM. The U.K. firm would also need to ensure that there were no local law prohibitions on it providing services to a party located in an EU Member State.
C. Appoint a third-party EU AIFM
The U.K. AIFM could appoint a third-party EU AIFM which will be able to market its EU AIFs to EU member states under the AIFMD cross-border passport. The third-party EU AIFM could either delegate portfolio management back to the U.K. AIFM or maintain both risk and portfolio management while only taking investment advice from the U.K. AIFM.
Pros: as the third-party EU AIFM is already established, the U.K. AIFM does not need to wait an extensive period of time (which is normally 6 to 9 months) for its own EU AIFM to be established and authorised before carrying out its business in the EU.
Cons: the overall management of the EU AIF will be carried out by a third-party EU AIFM, which is disadvantageous to U.K. fund sponsors.
D. Rely on reverse solicitation or the initiative test to interact with investors
Article 42 of MiFID II, Article 46(5) MiFIR, and Recital 70 AIFMD all recognise the ability of firms to provide services to clients who have approached the firm at the client’s exclusive initiative.
Pros: firms should be able to respond to RFPs and similar approaches from EEA clients.
Cons: the test can be interpreted in a restrictive way. Firms need to consider the availability of this exemption on a case-by-case basis and not as an alternative business model for the post-Brexit environment.
E. National Exemptions
Many jurisdictions have local exemptions for Third-Country Firm access. Moreover, certain jurisdictions around the EU are taking steps to establish transitional arrangements that will permit U.K. firms to continue to have market access post-Brexit. For example, the Netherlands has legislated to allow U.K. MiFID firms to continue to provide services, including portfolio management, to professional clients and eligible counterparties in the Netherlands for a period of two years. Other jurisdictions such as Italy are also passing similar legislation.
Pros: national law exceptions and transitional arrangements might enable U.K. firms to carry on cross-border businesses without establishing a local licensed entity.
Cons: the availability of exemptions will need to be investigated on a country-by-country basis. In some cases these might be hard to comply with or might provide only temporary relief.