21 Sep 2020

The last two weeks have been some of the most tumultuous in the Brexit saga. With negotiations nearing their conclusion, the UK threatened to walk away from its international treaty commitments in the Withdrawal Agreement and move to full no-deal preparation mode. While a more diplomatic tone reappeared last week after in-person talks and Tory backbenchers forcing several critical amendments to the Internal Market Bill in the UK, we are now in the 'end game' of the negotiations. With a deal in sight, the whole negotiation could be derailed at a moment's notice. Trust and confidence between the UK and the EU are at a historically low ebb.

Even if a deal can be concluded in the coming weeks, it is unlikely that it will include any substantive concessions on financial services which the EU sees as a strategic sector for its post-COVID recovery. The EU will also not allow such a deal to be ratified through its own Parliament without the removal of the UK's Internal Market Bill. The UK sees this as an essential piece of post-Brexit legislation, and an important signal it means it when it says 'no deal is better than a bad deal'. With so much to play for, the next few weeks are going to be amongst the most important in the story of the UK's departure from the EU, with little to any certainty about the final outcome.

In this note, we update members of several key no-deal Brexit announcements made in recent weeks. These include:

  1. UK Internal Market Bill and next steps
  2. An update on the ESMA letter on delegation and MOUs
  3. The European Commission committing to 18-months’ time limited equivalence for CCPs
  4. The UK TPR reopening at the end of the month, and the TPR now applying for five years
  5. An update on the Overseas Fund Regime and expected timeline for domestic legislation
  6. IA Webinar on onshoring and Brexit preparations for compliance teams

As always, if you have colleagues who would like to be added to these periodic updates, please contact us at brexit@theia.org. In addition, if you have any questions on the below, or Brexit planning in general, please also contact us at brexit@theia.org. To sign up to the IA webinar on the onshoring of the EU rulebook, please click here to register.


UK Internal Market Bill:

 Last week, European Commission Vice President Maroš Šefčovič demanded the UK Government withdraw the controversial Internal Market Bill before the end of the month, or the EU would use the legal remedies contained in the Withdrawal Agreement, and potentially bring the issue to the Court of Justice of the European Union. Not surprisingly, the EU has shown a united front, with several Member States highlighting their support to this approach. Moreover, the European Parliament UK Coordination Group has threatened to veto any future EU-UK trade deal if the UK does not withdraw the bill. The political crisis is also starting to have geopolitical implications for the UK as Nancy Pelosi, Speaker of the US House of Representatives has also warned that Congress would block a potential UK-US trade deal if the UK fails to fulfil its international commitments under the Withdrawal Agreement and the Good Friday Agreement.

While the UK Government has rejected the EU's ultimatum, UK Prime Minister Boris Johnson stated he still believes that negotiations can progress over the next four weeks. On Monday, the bill passed its first vote in Westminster, despite 30 Conservative MPs abstaining and two voting against it. The bill now faces further scrutiny by MPs at committee stage before another vote in the House of Commons this week. Some had hoped this was simply a 'Trumpian' act of defiance designed to jolt the EU out of its current negotiating red lines and win the attention of EU leaders. However, it has become clear that the Government has a fundamental issue with the Withdrawal Agreement itself – and in particular, its provisions which link to level playing field provisions on state aid. The Withdrawal Agreement appears to give the EU backdoor oversight of UK-wide state aid rules by requiring the UK to notify the Commission's DG Competition on any state aid decision in Great Britain affecting Northern Ireland. Reconciling the UK's own red lines with this will prove problematic in the coming weeks.


ESMA letter to the European Commission on AIFMD review and delegation

 On 19 August, the European Securities and Markets Authority (ESMA) in a letter to the European Commission set out 19 recommended actions it believes should be reflected in the forthcoming AIFMD review. The IA is currently working with our European counterparts to advocate any substantive changes to the current delegation model and will be responding to the technical consultation through our International and European Policy Committee and respective policy committees. In summary, the recommendations include:

  1. Harmonisation of AIFMD and UCITS regimes – ESMA states that, in some cases, the newer AIFMD provisions are more granular or specific compared to UCITS Directive requirements, although there might not be any objective justification for such differences. ESMA notes that the European Commission should consider aligning the frameworks where appropriate as applying different requirements to management companies which manage both UCITS and AIFs creates additional burdens for the firms concerned and divergences in supervisory/regulatory outcomes.
  2. Harmonised reporting for UCITS – ESMA suggests that, after improvements to AIFMD Annex IV reporting have been made, harmonised UCITS reporting should generally be aligned with those requirements while allowing for tailoring to the characteristics of UCITS funds. To the extent possible, the reporting should try to exploit the synergies with existing surveys both at EU and national level, and avoid duplications or unnecessary burdens for the supervised entities.
  3. Delegation and substance – ESMA sees merit in providing additional legislative clarifications in the AIFMD and UCITS frameworks with respect to delegation and substance requirements. As an industry, we are strongly opposed to the introduction of any qualitative or quantitative limits on delegation to the UK post-Brexit and have been working closely with EFAMA and HM Treasury to ensure this recommendation does not feature as part of the forthcoming AIFMD review. We will be providing further updates to members in a separate note in due course after discussing these issues with the Commission and other stakeholders this week.
  4. Leverage – AIFMD has two measures of leverage calculation, the gross notional exposure method and the commitment method. Both are used for reporting purposes. In December 2019, IOSCO issued recommendations for a two-step approach for a framework assessing leverage in investment funds. ESMA believes the IOSCO recommendations give rise to a need to amend the current reporting of the gross method calculation in Article 7 of the Commission Delegated Regulation (EU) No 231/2013, to ensure alignment with the IOSCO framework.
  5. Harmonisation of supervision of cross-border entities – ESMA suggests there is a still a lack of clarity in what the precise responsibilities of home and host supervisors are in some cross-border marketing, management and delegation cases. Clarification of the supervisory responsibilities regarding the supervision of cross-border activities of UCITS and AIFs, their managers and their delegates would reduce uncertainty regarding cross-border activities.
  6. Semi-professional investors – currently, there is no definition of “semi-professional” investor in AIFMD. ESMA has already called for greater convergence in the definition of “professional investor” and it sees merit in clarifying the definition of “professional investors” under AIFMD. ESMA is of the view that any possible introduction of any new categories of investors under the AIFMD (such as “semi-professional” investors) should be accompanied by appropriate investor protection rules and that passporting activities should be allowed only in relation to the marketing to professional investors.
  7. Proportionality principle for remuneration requirements – in 2016, ESMA wrote to the European Commission requesting clarification of the application of the proportionality principle in both AIFMD and the UCITS Directive. This clarification would be to make clear that the proportionality principle applies to the full set of remuneration requirements in letters (a) to (r) of paragraph 1 of Annex II of the AIFMD (and Article 14b(1)(a) to (r) of the UCITS Directive).

On the MOUs signed in February 2019, although there may be a slight risk of these being pulled by European authorities in the event of a hard, uncooperative Brexit, we do not believe that these are at risk in the event of a no-deal. Members should rely upon the press statements by both the FCA (here) and ESMA (here) confirming these will apply in any Brexit scenario at the end of the transition period. We also note that the MOUs cover information sharing across all financial services legislation. Given their comprehensive nature, we see it in the interests of both the UK and the EU to remain committed to these documents.


European Commission set to propose 18-months’ time-limited equivalence for UK CCPs:

Members will have no doubt seen commentary in the media signalling a possible delay on the temporary CCP equivalence decision to punish the UK for the current UK Internal Market Bill. However, as we have briefed previously, it is important to recall that this equivalence decision is not intended as a "give" to the UK but as a self-interested act taken to tide the EU over until it develops its own capabilities within its borders. The Commission has now agreed (here) to grant UK-based central clearing counterparties (CCPs) an 18-month temporary financial services equivalence until mid-2022, which would provide EU financial institutions with more time to reduce their exposure to UK market infrastructures.  

We understand that the decision on clearing was deemed necessary in order to avoid the UK forcing its clearing house to ‘off-board’ clients at the end of September, irrespective of the wider Brexit negotiations. However, this new cliff for UK CCP cross-border access coincidentally comes at the end of the EU’s French Presidency in H1 2022 and is preceded by French Presidential elections in April 2022 – the kind of political backdrop which is unlikely to favour extending the deadline further. The expectation is that the SSM and other EU banking supervisors will engage with EU financial institutions in the coming months to draw up specific project plans to demonstrate how they plan to reduce their exposures to UK CCPs for OTC derivative clearing ahead of the mid-2022 deadline.


UK Temporary Permissions Regime to be extended:

On 20 August 2020, the FCA updated and restructured its webpage on the Temporary Permissions Regime (here). As members will recall, the TPR is designed to enable relevant firms and funds which passport into the UK to continue operating in the UK when the passporting regime falls away at the end of the Brexit transition period. The FCA has updated its advice on the operation of the TPR, echoing its July 2020 announcement that the notification window for both inbound firms and funds will reopen on 30 September 2020. This will allow firms and fund managers that have not yet notified the FCA to do so before the end of the transition period. Firms and fund managers that have already submitted a notification can update this with the FCA if new products have since been launched.

Based on information that was previously provided, the FCA has usefully also created a number of webpages covering the following TPR-related topics:

  1. which firms and investment funds can use the TPR;
  2. the rules which will apply to firms and fund operators in the TPR;
  3. the notification process for firms (including information on withdrawing a TPR notification);
  4. considerations for firms leaving the TPR;
  5. the notification process for funds;
  6. TPR fees that your firm or investment fund will need to pay; and
  7. the financial services contracts regime.

The BoE has also published a webpage on the TPR, summarising its approach to the TPR and highlighting the key requirements for UK branches of firms. We recommend members familiarise themselves with these updates as appropriate to their business.


Overseas Fund Regime:

Following its consultation earlier in May on a new Overseas Fund Regime to replace the UCITS passport post-Brexit, we understand HM Treasury is now preparing for the Overseas Fund Regime to be introduced to the UK Parliament via the Financial Services Bill due this Autumn. The bill is expected to take up to twelve months to work through both the House of Commons and House of Lords before finally receiving Royal Assent. The FCA will then need to adapt its rulebook to implement any necessary changes, before concluding any technical equivalence assessments. We, therefore, do not expect for the OFR to operable until at least early 2022. In addition:

  1. HM Treasury has decided at this stage it will not impose FOS or FSCS requirements on Overseas Funds. They have accepted that imposing these two requirements would not bring any additional benefit to investors in Overseas Funds. These two provisions have been removed from HM Treasury's policy proposals, but it is important to note these may resurface again in Parliamentary discussions given MP's focus on investor protection.
  1. When HM Treasury eventually considers equivalence for the EU, it will be doing so at the Directive level, but will be asking the FCA for any additional advice on what additional requirements may be needed for funds domiciled in those jurisdictions where it supervisory approach/implementation 'may not be as robust' as the UK. When operating the regime, HM Treasury will be making equivalence determinations when they are 'broadly satisfied' a regime is equivalent to the UK.
  1. On value assessment, HM Treasury cautioned this is still under review, and its clear their thinking on whether to impose value assessments on overseas funds will be a political one, taking into account the competitiveness of the UK regime and the requirement for a level-playing field for UK funds. In this context, it is important to note that 'additional requirements' in the legislation will sit outside of the 'outcomes-based equivalence' test, but we will continue to monitor this closely. Any discussion on value assessment will come as part of the equivalence debate in due course.
  1. On the need for legal certainty about 'at least' equivalent protections, HM Treasury's view is that they won't be providing any additional criteria. Their argument is this often gets used as an exhaustive list. They want to retain some flexibility in the system and want to be able to grant equivalence by taking into account a wide range of matters, including trade/marketing considerations. This test will 'always include an element of subjectivity'.
  1. On the timing of the FCA registration process, HM Treasury confirmed the two months is a limit, but that the FCA is yet to consider how it will introduce shorter processing times. We again highlighted the 10-day timeline seen in other jurisdictions, and they committed to going back to the FCA for more information.


Onshoring of the EU aqcui now all but complete:

As we have briefed before, HM Treasury has been onshoring all EU law over the course of the past two years to ensure that market participants notice no difference in the rules which apply to them after exit day. Firms should note that any regulation that applies to an EU-based firm up until exit day will equally apply to a UK firm post-Brexit, although the FCA will be exercising special transitional powers to give firms up to 18-months to adapt to the new obligations arising from Brexit. With special thanks to Latham and Watkins, on 6 October the IA will be hosting a member webinar looking at the implications of the onshoring process for member firms, and what steps firms should be taking to ensure they are prepared for the end of the Brexit transition period. To register, and to get more information, please go here. For a full list of the relevant statutory instruments relating to investment management, please see the attached excel document.