Brexit and Beyond: What Next for the Payments Sector?

The end of EEA-UK regulatory passporting

EU regulatory passporting between the UK and the European Economic Area¹ (EEA), which previously enabled financial services firms established in the UK to establish branches or provide cross-border financial services across the EEA on the basis of their UK authorization and vice versa, ceased on December 31, 2020, on the expiration of the Brexit implementation period. UK financial services firms seeking to provide regulated services in the EEA are now generally required to provide such services from appropriately licensed EEA entities. 

While the UK has provisions to allow EEA firms to continue to provide certain regulated services in the UK on a temporary basis (see below), the EU has provided no such general transitional provisions for UK firms. A UK firm that contracts with EEA clients to provide regulated services will therefore need to

(a) transfer those contracts to an appropriately licensed EEA entity or

(b) consider on a country-by-country basis whether local laws permit the firm to continue servicing such EEA clients without local authorization (for example, under an exemption, exclusion, or national transitional arrangement).

Temporary UK arrangements for EEA firms

The UK has implemented certain transitional arrangements to enable continuity of operations of EEA firms already providing services in the UK and to assist such firms with some of their new UK regulatory obligations.

The Temporary Permissions Regime

The Temporary Permissions Regime (TPR) enables EEA firms that had previously passported into the UK to continue providing regulated services in the UK, within the scope of their former EU passports, for up to three years while they seek full UK authorization. To participate in the TPR, firms were required to notify the UK Financial Conduct Authority (FCA) or UK Prudential Regulation Authority (PRA) (as applicable) prior to the end of the Brexit implementation period.

The Financial Services Contracts Regime

The Financial Services Contracts Regime allows EEA firms that had previously passported into the UK but are not in the TPR (or that subsequently leave the TPR) to continue servicing UK contracts entered into before the end of the Brexit implementation period (or the time they leave the TPR) in order to conduct an orderly exit from the UK market.

Temporary transitional powers

The FCA has also been provided with temporary transitional powers to enable the regulator to make transitional provisions to assist firms in adapting to changes to UK regulatory rules (and their application) resulting from Brexit.

EU equivalence decisions

In the coming months, the EU is expected to begin making decisions on whether the UK’s rules are “equivalent” to the rules of the EU. These equivalence decisions relate to certain areas of EU financial services regulation for which firms in a non-EEA country that is determined to have regulatory rules that are equivalent to those in the EU are given market access rights without needing to obtain full regulatory authorization in an EEA member state.

While this has important implications for some financial services firms, no such EU equivalence regime exists for payment services, electronic money, or deposit taking, so these decisions are unlikely to affect most payment service providers directly.

Outsourcing arrangements

Despite the apparent intentions of the European Commission during the early negotiations of the TCA, the final version of the agreement does not include provisions that would restrict the outsourcing of financial services. Regulated entities in the UK and the EEA can therefore generally continue to outsource certain functions to group affiliates (including EEA to UK affiliates and vice versa).

However, regulated payment service providers will continue to be subject to restrictions on outsourcing, including the European Banking Authority (EBA) guidelines on outsourcing arrangements, which apply to intragroup arrangements. Regulated payment service providers will also continue to be subject to local governance, risk management, and “substance” requirements, pursuant to which they will need to maintain a minimum presence in their country of establishment and ensure they have sufficient resources and expertise to monitor and supervise any outsourcing arrangements (including with group affiliates).

Regulatory treatment of cross-border services

Firms in the payments sector that provide cross-border services into the UK from another jurisdiction (including from outside the EEA) should pay attention to any changes being made to existing UK regulatory guidance on the territorial scope of UK regulation.

The UK has traditionally taken a relatively liberal approach to firms providing payment services from outside the UK to UK customers (for example, with respect to online payment services where the provider has no UK presence). However, the UK government and regulators are reviewing regulatory rules and guidance in the wake of Brexit. It is possible that any changes made to the existing rules, or their interpretation, could result in a stricter approach to the provision of cross-border services into the UK by non-UK firms, particularly if the EU takes a more restrictive approach in respect of UK firms providing cross-border services into the EEA.

Further, although there is no EU “equivalence” regime for payment services (as noted above), individual EEA member states could decide to enter into bilateral arrangements with the UK or unilaterally exclude certain cross-border services from the scope of local licensing requirements. Alternatively, EEA member states could decide to take a more restrictive approach and further limit the ability of non-EEA firms (including UK firms) to provide cross-border services to customers located in their territory.

The potential for EU/UK regulatory divergence

Another key question for financial services firms is whether and when the EU and UK will start to diverge in their approach to regulation of payments and fintech.

It is no secret that the views of some UK policymakers and regulators differ to those of the EU on certain more granular aspects of payments regulation. For example, the FCA has repeatedly deviated from the EBA’s guidance on the time frame for implementing strong customer authentication for remote electronic payments. In a similar vein, the governor of the Bank of England, Andrew Bailey, recently told UK lawmakers, “I would strongly recommend we do not become a ruletaker [from the EU].”

It would therefore not be surprising if the UK started to take a different approach from the EU in certain areas, for example by adopting less prescriptive and more principles-based regulation instead of EU regulatory technical standards and guidelines.

Upcoming tests for divergence will include the reaction of the UK to EU proposals for a regulation on digital operational resilience and another on markets in cryptoassets, both of which are currently subject to the EU’s legislative processes. For further information on the latter, please refer to our Update of November 12, 2020.

A further test for divergence, of particular significance for the payments sector, will be the UK’s reaction to the European Commission’s review of the second EU Payment Services Directive (PSD2), which is expected by the end of 2021.

As trade negotiations between the EU and the U.S. have demonstrated, the further the EU and the UK diverge on financial services regulation, the more difficult it is likely to be to negotiate a trade agreement that includes financial services. The UK could therefore face some difficult choices in the months and years ahead on where to follow EU rules and where to adopt a different approach. These choices will have significant implications for firms and should be monitored on an ongoing basis.

What should firms do next?

While EU and UK policymakers and regulators have powers to make certain changes to the existing regulatory rules applicable to the payments sector on relatively short notice, more substantive changes are likely to involve public consultations as well as informal discussions between policymakers and industry representatives. Firms in the payments sector should actively monitor and assess the effects of proposed changes with the points above in mind. Where appropriate, firms should also engage with regulators and policymakers —directly, through trade associations, or both — to ensure that regulators and relevant market participants properly consider any regulatory changes arising from Brexit.

^{1 -} Comprising the member states of the EU plus Norway, Iceland, and Liechtenstein.