Gaining Entry to the EU's Financial Services Market in the Absence of a Brexit Deal

Bartlomiej Kulpa, LLM (Twitter: @KulpaBart)

Introduction

When Boris Johnson became British Prime Minister, a no-deal Brexit appeared increasingly possible. UK-based financial services firms were left wondering if and how they would be able to continue serving clients in the remaining 27 EU countries. These firms currently depend on “passporting rights,” which allow them to operate across borders. According to The Economist, in 2016, 5,476 British financial services firms used 336,421 European passports to offer their products across the EU. In contrast, only around 8,000 firms based in the European Economic Area (EEA) used 23,535 passports to operate in the UK. This disparity highlights how the loss of passporting rights, coupled with uncertainty about the future, poses a significant threat to these firms.

**The Concept of a European Passport **

A European passport, granted under the Single Financial Market Directives like MiFID II (Markets in Financial Instruments Directive 2014/65/EU), allows EEA institutions licensed in one member state to conduct business across the EEA. If Britain leaves the EU without a deal, its financial services firms will lose these passporting rights and, with them, full access to the single market. They will then be treated as firms from any other non-EU country.

Articles 34 and 35 of MiFID II establish the legal framework for passporting rights. Article 34 allows firms authorized in their home Member State to provide investment services in other Member States. Article 35 permits firms to establish branches in other Member States to provide services, again with authorization from their home Member State. In both cases, firms must notify their home country’s authorities, essentially applying for a license. The home country authorities then inform the host Member State of the firm’s intention to operate there.

The advantages of the European passport system are numerous and significant. First, a single license provides access to a market of over 500 million consumers across 31 countries (soon to be reduced by the UK’s exit). Firms are not required to obtain separate licenses in each country they operate in. Second, this system reduces business costs. Third, it is free from political interference. Fourth, it benefits both professional and retail investors. Finally, the passport is granted indefinitely and cannot be revoked by the home Member State regulator.

It is important to note that the European passport does not function as a single, all-encompassing passport for the entire EEA. If it did, firms could operate without any further authorization. The European trademark, issued by the European Union Intellectual Property Office (EUIPO), serves as a more accurate example of a single administrative act effective across the entire EEA.

**The Equivalence Regimes **

The EU has long employed equivalence regimes (also known as third country regimes or TCR) with countries outside the single market, like the USA. These regimes allow financial service firms from these countries to operate within the EU under certain conditions, as outlined in the relevant Single Financial Market Directives and Regulations. According to Articles 46-49 of MiFIR (The Markets in Financial Instruments Regulation (EU) No 600/2014), an equivalence regime depends on two factors. First, the European Commission (EC) must decide if a non-EU country’s financial regulations are equivalent in effect to EU law. Second, it must determine if the country’s legal and supervisory framework ensures compliance with those regulations.

Once the EC grants equivalence to a country, firms from that country can register with the European Securities and Markets Authority (ESMA) within a three-year transitional period (as per Article 54 of MiFIR). This registration allows them to operate as a European hub, subject to the same rules as EU-based firms without any preferential treatment.

However, this regime only permits firms to provide services to eligible counterparties and professional clients, excluding retail clients, unlike the European passport system. Additionally, the EC can revoke an equivalence decision at any time if discrepancies emerge between the EU and the third country’s regulatory frameworks.

In the case of a no-deal Brexit, the equivalence regime might appear more beneficial to smaller firms. Large, multinational firms have already begun relocating to the EU or are in the process of establishing a presence there as part of their Brexit strategy. These firms previously used Britain as their gateway to the single market.

Regarding dispute resolution, third-country firms must agree to resolve any disputes with EU-based clients in an EU court or through arbitration (Article 46(6) of MiFIR). This means offering a forum within the EU where legal action can be pursued. If Britain were to access the single market through the equivalence regime post-Brexit, English courts would have no jurisdiction over such disputes, potentially affecting London’s standing as a global center for securities litigation.

While offering a way for UK-based firms to access the single market in a no-deal Brexit scenario, the equivalence regime has its downsides. Its unilateral nature means the decision rests solely with the EU, and the EC’s decision cannot be challenged in court. Moreover, political factors could influence the equivalence assessment.

The European Passport Light

Article 47(3) of MiFIR introduces the concept of a “European passport light,” accessible to third-country firms if two conditions are met: (i) an equivalence decision from the EC is in place; and (ii) the firm has authorization to establish a branch in a Member State under Article 39 of MiFID II. This allows the firm to provide services to eligible counterparties and professional clients in other Member States without setting up additional branches. Like the equivalence regime, it excludes retail clients but does not necessitate registration with ESMA.

The MiFID II Own Initiative Principle

Article 42 of MiFID II outlines an exception to the authorization requirement for third-country firms stated in Article 39 of MiFID II. This exception, known as the MiFID II Own Initiative Principle, applies when a retail or professional client initiates the provision of investment services. It aligns with the concept of reverse solicitation. Unlike the equivalence regime, this principle covers both retail and professional clients. However, it might not be practical for large firms aiming to expand their market share and any marketing targeting EU clients triggers the need for an EU license.

Conclusion

In a no-deal Brexit, the equivalence regime appears to be the only viable alternative to the European passport. Given that the UK government is unlikely to create a “Singapore upon Thames,” the assessment of its post-Brexit regulatory alignment with the EU should be straightforward. However, the limitations of this regime, including its exclusion of retail clients and the potential for revocation by the EC, mean it would not fully compensate for the loss of the European passport for UK-based financial services firms.