19 Oct 2020

The passing of yet another negotiating deadline is nothing new in the story of the UK’s departure from the EU. However, time has all but run out for a deal to be agreed and ratified before 31 December after the failure to meet the UK’s self-imposed 15 October deadline for an outline of a final agreement at this week’s European Council Leaders’ Summit. While both sides have committed to ‘keep talking’, the risk of a no-deal scenario at the end of this year has increased significantly in the past 24 hours. With negotiations at their most tense stage, whoever blinks first will be critical the final outcome in the next few weeks. In this note, we update members on UK and EU responses to the failure to reach an agreement, and provide an update on the EU Share Trading Obligation.

UK statement:

Following the failure to meet his own self-imposed deadline to secure an outline of a final agreement yesterday, in a televised message this afternoon Prime Minister Boris Johnson all but stopped short of walking away from talks. Instead, he lamented the EU’s decision not to engage ‘in the spirit of friendship and partnership’ on its proposals for a ‘Canada-style’ Free Trade Agreement. Citing continued differences in how to handle fishing rights, the Irish Border, and the ability to pass its own laws, Prime Minister Johnson suggested these issues were now ‘almost insurmountable’. Recommending the UK prepare for an ‘Australian-style’ trading relationship with the EU on WTO terms but with a ‘high heart’, Prime Minister Johnson said it was now up to the EU to change its approach to talks for a deal to be reached in time.

Critically, while EU Chief Negotiator Michel Barnier is expected to be in London next week for new talks, whether David Frost will be permitted to meet with him is yet to be seen. Prime Minister Johnson was clear that unless Barnier is able to show movement in the mandate handed to him by EU Member States, there was ‘little to no point’ in actually meeting. We understand that at a time of increased political pressure domestically about its handling of COVID-19 lockdowns in the recently won north of the UK, Number 10 is reluctant to make any further compromises with the EU. With just ten weeks left until the end of the transition period, Prime Minister Johnson said that the UK must now make an assessment of the the likely outcome and prepare accordingly. This will likely include further debate over the controversial Internal Market Bill, a move likely to anger EU stakeholders further.

European response:

Responding to Prime Minister Johnson’s statement, Ursula von der Leyen, President of the European Commission, tweeted that the EU would continue to work for a deal, ‘but not at any price’, echoing comments made yesterday by European Council President Charles Michel in the fuller formal setting of the Leaders’ Summit. As planned, President von der Leyen noted that the EU negotiating team will be travelling to London next week to ‘intensify negotiations’, but that it was up to the UK to provide answers to questions about state aid and level playing field obligations.

Critically, we understand that the Commission is now under mounting pressure from EU Member States most affected by a no-deal scenario to publish additional contingency plans, but the Commission is holding off so as to not to send the wrong signal to UK negotiators and because it’s unclear what final outcome of negotiations will be. We understand Member States may also be preparing to issue additional transitional measures of their own, as we saw in the build-up to October 2019 to mitigate the worst effects of a no-deal on key sectors. Heading into this week, Barnier was keen to stress the importance of the EU27 maintaining its unity. However, with the French threatening to veto any agreement that leads to reduced fishing rights, and the Germans concerned about the economic impact of a no-deal at time of considerable strain on the EU budget post-Covid, this unity could break at any moment.

Impact for industry:

The announcements today will do little to change the outcome of Brexit for the investment management industry, with the Commission having in July already ruled out equivalence under Article 47 (1) of MiFIR for the short to medium term. In discussions with Commission officials it has been made clear, however, that failure to reach a wider agreement between the UK and the EU will ‘limit or exclude’ any discussion about equivalence for the UK post-Brexit. Citing the need for clarity about the UK’s approach to regulation of financial services, we understand that the Commission could use a breakdown in negotiations, and failure to reach a deal, as grounds to continue, not slow down, its efforts to relocate certain financial services activity to the continent. Assuming a Free Trade Deal can be concluded in time, while it will not include market access provisions, it is likely to include specific articles in a financial services chapter regarding information sharing, regulatory cooperation, and dispute resolution – all prerequisites for a relationship with the EU based on equivalence.

Update on Share Trading Obligation:

The application of the EU’s Share Trading Obligation in the event of a no-deal Brexit has been the subject of intense discussion in recent weeks, most notably in European Parliamentary deliberations on the EU’s ‘Capital Markets Recovery Package’. The package, originally introduced to address a number of investor protection and market efficiency issues arising out of COVID-19, was targeted by Irish and French MEPs as a way to address the difficulties caused by the introduction of both a UK and EU STO post-Brexit. However, MEPs concluded that changing the STO via amendments to Level 1 at this stage would not be possible given the opposition within the Commission to make any necessary changes, with ESMA instead tasked with addressing the concerns raised about overlapping obligations instead at Level 2.

We understand that refining the scope of the EU STO was discussed last week at ESMA, with the Secondary Markets Standing Committee agreeing ESMA should be the one ‘delivering a solution’ to clarify the scope of the STO ahead of Brexit. We understand that ESMA is planning to provide a statement to the market within the next two weeks which would clarify that, in the context of Brexit, the scope of the EU STO will focus on EU ISINs (as announced previously), but will be limited further to exclude EU ISINs traded in GBP. However, whether this solution would be enough to cater for Irish concerns regarding dual listed shares remain to be seen.  The Irish could still attempt to pursue additional exemptions/clarifications for dual listed shares not traded in GBP in the context of the ESMA communication.

As we have briefed previously, the FCA maintains that a reciprocal equivalence determination is the preferred outcome, and will be the only way by which an overlap in obligations between the UK and the EU can be avoided. The IA will continue to press the FCA for a formal commitment regarding application of the UK STO in the event that no equivalence determination is forthcoming, including at an industry roundtable scheduled for next Friday. We continue to make the point that a geographic limitation, such as the use of an EEA and UK ISIN, to determine where shares can be traded will lead to fragmental in capital markets and sub-optimal outcomes for investors. We argue that the primary consideration should be ensuring firms can meet their Best Execution obligations, and can treat customers fairly.