Preparing for Brexit: the impact of ESMA’s Opinion on Financial Institutions

• Netherlands

10-07-2017

 

On 31 May 2017, the European Securities and Markets Authority (ESMA) published its snappily-titled opinion: “General Principles to Support Supervisory Convergence in the Context of the United Kingdom Withdrawing from the European Union”.

The opinion establishes nine principles designed to “achieve supervisory convergence” in the approach to increased requests from financial market participants seeking to relocate in the EU27 as a result of Brexit.

The principles can be grouped into three broad categories, although the doctrine of “no special treatment” is a common thread:

• Rigorous authorisation requirements  
• A substantial presence in the EU27 Member State  
• Effective supervision and enforcement of EU law

In assessing the impact of the principles, the question for UK-based firms looking for base in the EU 27, the main question is whether the principles signal a departure from existing EU law or practice. In most cases, the opinion is a restatement, albeit with further detail. However, firms should take heed of:

• the need to justify the choice of a particular EU27 Member State;  
• the need to have senior executives employed in the EU27 entity;  
• the need to ensure that any delegation arrangement enables access to data held outside the EU27; and  
• the ability to present that data to the relevant EU27 regulator clearly.

Putting the Principles in Context: Scope and Purpose of the Opinion

The European Securities and Markets Authority (ESMA) premises its opinion (the Opinion) on the assumption that the UK will become “a third country” after Brexit. In other words, it assumes a “clean/hard” Brexit with no special access for UK-based firms to EU markets agreed between the UK and the EU.

ESMA addresses the Opinion to the national competent authorities (NCAs) in the 27 EU Member States that will remain in the EU described as the EU27.

The Opinion seeks to address, in ESMA’s own words “regulatory and supervisory arbitrage risks that arise as a result of increased requests from financial market participants seeking to relocate in the EU27 within a relatively short period of time.”

While the Opinion seeks to cover all the laws in Article 1(2) and (3) of the ESMA Regulation, the Opinion highlights the AIFMD, UCITS Directive, MiFID I and MiFID II. ESMA indicates that it will develop sector-specific opinions in areas for asset managers, investment firms and secondary markets. More is to come.

1)  Rigorous Authorisation Requirements

Principle One: No automatic recognition of existing authorisations

The Opinion confirms that, like any other third country entity, a UK-established entity will need to establish itself in the EU27 to be able to continue to benefit from the EU passport after Brexit. It will also need to seek authorisation from the relevant EU27 NCA.

Impact: This is consistent with the EU Directives and Regulations. ESMA does not, however, refer to the third country passports under the AIFMD and the MiFID 2 Regulation. If available to UK firms, these would offer any alternative process albeit that the MSAs and ESMA itself would still disregard the fact that the UK-based applicant had been authorised under an EU-based regulatory regime.

Principle Two: Authorisations granted by EU27 NCAs should be rigorous and efficient

NCAs should ensure that conditions set by the relevant legislation are met from day one of the authorisation.

Impact: This is consistent with the EU Directives and Regulations and is linked to Principle One – a UK-based firm should be treated like any other third country firm.

Principle Three: NCAs should be able to verify the objective reasons for relocation

This is important and the full text is set out:

“NCAs are expected to check that the planned EU27-based activity is the main driver for relocation of entities, activities and functions. The entity’s programme of operations should provide a clear justification for relocating to the Member State of establishment.

In order to establish a clear view on the geographical distribution of planned activities from the perspective of targeted clients and/or services development, as part of the programme of operations NCAs should obtain information such as that on:

1. prospective investors or marketing and promotional arrangements; and  
2. location of development of products or services.

In addition, NCAs should obtain information from the applicant entities on whether they have engaged with, or their application has been rejected by, another NCA 

ESMA expects that NCAs will particularly scrutinise applications where it appears that an entity intends to pursue the greater part of its activities in other Member States and will only grant authorisation if fully satisfied that the Member State of establishment was not chosen for the purpose of evading stricter standards in force in other Member States.

The application of this principle does not impair the rights of authorised entities to provide services on a cross-border basis in accordance with principles of Union law and financial sector legislation.”

Impact: There is no clear basis for this in any relevant EU Directive although the “Member-State-of-Reference” for third country AIFMs in the AIFMD bears a passing resemblance. Firms will need to be clear about why they are choosing a particular EU27 Member State as their base and think, for example, about the registration of products, such as funds, as a nexus justifying their choice of the particular EU27 Member State.

2) A substantial presence in the EU27 Member State

Principle Four: Special attention should be granted to avoid letter-box entities in the EU27

Noting that outsourcing and delegation can also pose challenges both for firms and for the relevant NCAs, NCAs should reject any relocation request creating letter-box entities where, for instance, extensive use of outsourcing and delegation is foreseen with the intention of benefitting from an EU passport, while essentially performing all substantial activities or functions out-side the EU27.

Impact: This is consistent with the EU Directives and Regulations is linked to Principle Six on substance and regulatory oversight– a UK-based firm should be treated like any other third country firm.

Principle Five: Outsourcing and delegation to third countries is only possible under strict conditions

Generally, firms can only outsource or delegate tasks or functions, but not responsibilities and will remain fully responsible for the tasks or functions that are outsourced or delegated. In other words, the delegating or outsourcing firm must always retain the ability to direct and control outsourced or delegated functions.

Impact: This is consistent with the EU Directives and Regulations and is linked to Principle Six on substance and regulatory oversight– a UK-based firm should be treated like any other third country firm.

3) Effective supervision and enforcement of EU law

Principle Six: NCAs should ensure that substance requirements are met

Firms must structure outsourcing or delegation arrangements in a way that does not hinder NCA’s ability to efficiently and effectively supervise them. Firms must provide information that is sufficient to ensure that NCAs understand the outsourcing and delegation arrangements in question in order to properly supervise them. They must also ensure that NCAs have effective access to all data related to the outsourced or delegated activities or functions and to the business premises of the entity to which the activities or functions are outsourced or delegated. Finally, Outsourcing and delegation arrangements should not have an impact on business continuity, confidentiality and conflicts of interest, which have to be appropriately managed.

Impact: This is consistent with the EU Directives and Regulations is linked to Principle Five on the strict requirements for delegation and outsourcing arrangements. A key issue is on access to data and the presentation of that data to the relevant NCA to put it in position to understand the firm’s business.

Principle Seven: NCAs should ensure sound governance of EU entities

Firms must ensure that board members and senior managers in the EU27 have the effective decision-making powers on compliance, even where the entity is part of a corporate group. The key executives and senior managers of the EU entity will need to be “employed in the Member State of establishment and work there to a degree proportionate to their envisaged role, if not on a full-time basis”. The Opinion emphasises the ability to effectively control the outsourced or delegated activities or functions, including having the technical knowledge and power to make changes to the outsourced or delegated services. Finally, the EU entity will require adequate levels of own funds as well as liquidity, which are readily available to them, also taking into account possible insolvency.

Impact: This is consistent with the EU Directives and Regulations is linked to Principle Four on letter-box entities. The need for senior executives “employed” in the EU27 is noteworthy and arguably represents a hardening of the position.

Principle Eight: NCAs must be in a position to effectively supervise and enforce Union law

NCAs should have adequate resources and capacity both to monitor the effective applica-tion of the relevant legislation and respond to market developments.

Impact: This is consistent with the EU Directives and Regulations

Principle Nine: Coordination to ensure effective monitoring by ESMA

ESMA will establish new practical convergence tools in the form of a forum for reporting and discussions among NCAs regarding market participants seeking to relocate entities, activities or functions to the EU27. This Supervisory Coordination Network will be put in place to promote consistent decisions are taken by NCAs.

Impact: This is consistent with the EU Directives and Regulations but there is the risk that ESMA, and the other EU Supervisory Authorities following suite, will become more interventionist on a case-by-case basis.

Contact us:
For the UK: Andrew Henderson and Ros Kellaway
For the Netherlands: Matthijs Bolkenstein and Lucas Lustermans 

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