The Commission says in the Communication that it “will not adopt an equivalence decision in the short or medium term” (emphasis added) for certain legislation set out in footnote 21 of that Communication. Footnote 21 refers, among other things, to
Regulation (EU) No 600/2014 on markets in financial instruments (MIFIR)… Art. 47(1) — Investment firms providing investment services to EU professional clients and eligible counterparties
It is unclear what “short or medium” terms means, but the fact that the Commission says that it “will not” adopt an equivalence decision, with no suggestion, for example, that it is continuing to work with the UK towards an equivalence decision, suggests that equivalence is not going to be granted before the Brexit transition/implementation period expires on 31 December 2020.
Given that a wider trade deal between the UK and EU is not generally focussed on financial services (and there has not been any meaningful progress on negotiations to date), investment management firms should ensure that they plan for a “no-deal” Brexit.
As discussed previously, a no-deal Brexit will have implications for fund marketing carried on by UK MiFID firms for U.S. managers/alternative investment fund managers (AIFMs) as well as introduce complications to the share trading obligation and derivatives trading obligation under MiFID II.
Temporary equivalence granted for UK central clearing counterparties (CCPs)
The same Communication above states that the Commission is considering a time-limited equivalence for UK central clearing counterparties (CCPs), allowing them to continue providing clearing services for EU entities when the Brexit transition period expires on 31 December 2020.
Despite widespread fears of European businesses being shut off from UK CCPs, UK CCPs would be allowed to carry on serving their EU-based clients under the proposed temporary equivalence decision for UK rules on derivatives clearing. This is particularly relevant as clearinghouses need to give three months’ notice to customers that they can no longer use their services.
The length of the equivalence recognition is not stated in the Communication, and the Commission notes that equivalence decisions can be unilaterally withdrawn at any time, in particular if third country frameworks diverge and the conditions for equivalence are no longer fulfilled.
Still no equivalence granted for UK trading venues
Note, however, that although the above equivalence for UK CCPs is helpful for the obligation of EU firms to clear their derivative transactions on EU CCPs or “equivalent” third country (non-EU) CCPs such as those in the UK, there is still no equivalence for UK trading venues for purposes of the MiFID II derivatives trading obligation and share trading obligation.
This lack of equivalence for UK trading venues is made clear in the Commission’s Markets in Financial Instruments Stakeholder Notice, revised on 13 July 2020 (originally published on 8 February 2018). The Stakeholder Notice specifically notes the loss of authorisation for UK trading and execution venues:
[T]he Commission is empowered to declare third-country trading venues equivalent for the purposes of the EU share and derivatives trading obligations. While the assessment of the UK’s equivalence in these areas is ongoing, the assessment has not been finalised. All stakeholders thus have to be informed and ready for a scenario where shares and derivatives subject to the EU trading obligations can no longer be traded in the UK trading venues. In both cases, EU counterparts need to reassess their trading arrangements to ensure continued compliance with their obligations under the MiFID framework
Please see the sections “ISDA Brexit Cliff-Edge Paper” and “Report on MiFIR Transparency regime — share trading obligation (STO)” below for implications of the above lack of equivalence for the MiFID II derivatives trading obligation and share trading obligation, respectively.
ISDA Brexit cliff-edge paper
On 31 July 2020, the International Swaps and Derivatives Association (ISDA), the European Banking Federation (EBF), Assosim (the Italian Financial Markets Intermediaries Association), the Danish Securities Dealers Association, and the Swedish Securities Dealers Association published an update to their Brexit cliff-edge paper.
The paper sets out reasons why a “no-deal” Brexit scenario could create a disruptive “cliff-edge” change in the EU regulatory requirements that apply to over-the-counter derivatives business in a way that might adversely affect EU or UK firms and their EU and UK clients and counterparties (going beyond those effects resulting from the loss by UK and EU firms of their single-market passports).
In particular, the potential delay or refusal by the EU to grant equivalence decisions in a number of areas under the UK and EU’s regulatory and supervisory frameworks could lead to market participants’ facing huge operational challenges, and the paper urges EU national competent authorities (NCAs) to take action to mitigate these adverse effects by extending existing exemptions to UK entities, adopting equivalence decisions, and approving applications for recognition or endorsement, including granting recognition to UK CCPs (see above for temporary equivalence).
Commission Asset Management Stakeholder Notice
On 7 July 2020 the Commission published an Asset Management Stakeholder Notice (originally published on 8 February 2018).
The notice addresses the fact that UK-authorised Undertakings for the Collective Investment in Transferable Securities (UCITS) and alternative investment funds (AIFs) will no longer benefit from EU passporting post-Brexit, and their management companies (Mancos) and AIFMs, respectively, will be treated as third country (non-EU) managers. Therefore, all collective investment undertakings registered or authorised in the UK will become non-EU AIFs and will be treated accordingly in EU member states under the Alternative Investment Fund Managers Directive.
The stakeholder notice also informs participants that UCITS Mancos and AIFMs must take appropriate steps to inform investors of the consequences of the end of the Brexit transition period.
Further, the Notice states that delegation of portfolio management or risk management by an AIFM or a UCITS Manco to a UK-based provider may still be undertaken, provided a cooperation arrangement/memorandum of understanding (MoU) between the NCA of the AIFM or UCITS Manco and the FCA is in place (see below).
Memoranda of Understanding between the FCA, ESMA, and EU NCAs
On 17 July 2020, the FCA and the European Securities and Markets Authority (ESMA) published statements (FCA and ESMA statements, respectively) confirming that the FCA, ESMA, and EU national securities regulators agreed Memoranda of Understanding (MoUs) in early 2019. These MoUs, which covered cooperation and exchange of information in the event that the UK left the EU without a withdrawal agreement in March 2019, remain relevant and will come into effect at the end of the transition period on 31 December 2020.
These MoUs are important because they are needed for EU firms, such as AIFMs and UCITS Mancos, when delegating portfolio management or other services to UK firms.
Luxembourg regulator clarifies “provision of investment services in Luxembourg” for third country firms
On 1 July 2020, the Luxembourg Commission de Surveillance du Secteur Financier (CSSF) published a new Regulation and Circular (CSSF Regulation No 20-02 and CSSF Circular 20/743, respectively) aimed at clarifying the legal regime for third country firms intending to provide investment services in Luxembourg, under Article 32-1 of the 1993 Law on the Financial Sector (the LFS).
The Circular clarifies the concept of services provided “in Luxembourg” under Article 32-1 of the LFS. Investment services are deemed to be provided in Luxembourg where
- the third country firm has an establishment (for instance, a branch) in Luxembourg, the third country firm provides an investment service to a retail client established or located in Luxembourg, or
- the place where the “characteristic performance” of the service is provided, that is, the essential service for which payment is due, is Luxembourg.
The Regulation provides for a list of “equivalent third countries” pursuant to Article 32-1(1) of the LFS. This list includes Canada, Switzerland, the United States, Japan, Hong Kong, and Singapore. These jurisdictions are considered as applying LFS-equivalent supervision and authorisation, and firms in these jurisdictions are permitted to provide investment services in Luxembourg on a cross-border basis. Notably, the list does not include the UK for the time being.
Please note Sidley Austin LLP does not practice Luxembourg law; we would be happy to introduce clients to Luxembourg counsel to elaborate on the above.