The United Kingdom is clearly one of the key drivers of Europe’s financial services industry and London undisputedly takes the crown amongst its financial centers. The surprise vote in Britain to exit from the European Union (“EU”) and as a consequence from its harmonised market raises many questions. This in particular also affects many Swiss financial intermediaries who have so far relied on the UK as their hub of choice for accessing the EU market with their products and services or who have entered into strategic relationships with UK players.
Everything changes. Fundamentally.
First the good news: Irrespective of the Brexit the UK will remain a member of the World Trade Organisation (“WTO”), and as such will continue to be entitled to all benefits of WTO membership regarding international trade in goods and services. But the exit from the EU will of course mean that the UK will in principle no longer be able to enjoy the intra-EU preferential trade benefits or preferential arrangements negotiated between the EU and third countries.
The impact on the regulatory front is expected to be severe as the UK will no longer be subject to the harmonised EU product and service market regulations which, as history has shown in the past few decades, had led to the creation of true dominant designs with significant impact on competitiveness and indeed success in the European financial services arena. As the UK will lose the benefit of the principle that goods sold and services offered in one EU market are presumed to be suitable for sale in others, its industry will depend on successful negotiations of regulatory approvals and mutual recognition policies. For UK-based financial services firms that means that they will lose their current passporting right and hence their ability to undertake EU-cross-border business for example as EU credit institutions, investment firms, alternative investment fund managers or insurance undertakings. This is a situation Switzerland and its financial intermediaries are well familiar with but unlike the Swiss, the UK has little experience with this and is in addition burdened with uncertainty surrounding the details of how this will play out. This may ultimately lead to situations where players if in doubt will opt for the more certain option, which is what we currently already observe with some of our clients who consider moving operations back to Switzerland or in the case of products to other domiciles.
From the perspective of applicable rules it can be expected that EU legislation which has been transposed into the UK framework and is in force will remain applicable until changes are made. When it comes to new EU rules currently under way such as for example MiFID II or PRIIPs, the situation is far less clear. The same is true for EU regulations which so far have become directly applicable and where this modus operandi is now not given any more. This regulatory vacuum and legal uncertainty clearly is the most undesirable situation for financial services firms trying to run efficient regulatory change projects or implement a truly competitive regulatory set-up.
All of this is further amplified by the fact that the UK’s exit from the EU also means that UK citizens will no longer have the right to move freely to work within the EU, and EU citizens no longer have the right to work within the UK, which impacts on firm’s growth strategies which are often built around the ability to deploy key talent. Of course it should not be forgotten that there will also be a negative impact on firms currently doing cross-border business into the UK or via branch structures and on EU products distributed into the UK.
How are Swiss financial intermediaries with UK structures or EU products geared towards the UK affected?
A – Asset Management: Fund Managers and Fund Distribution
Swiss promotors who have launched UK funds qualified as UCITS or EU AIFs will most likely lose the benefit of such status for their products with according impact on their ability to distribute competitively to their respective audiences across the EU. This threat is further amplified by the fact that national private placement regimes for non-EU AIFs are potentially phased out in the near future, which would then potentially even shut that door on them. At the same time EU products of Swiss promotors distributed in the UK may face higher entrance barriers. What is true on product level also applies for institutes. UK UCITS managers, ManCo’s as well as AIFMs will potentially lose their passport, which might be particularly challenging when services are rendered vis-à-vis structures domiciled in the EU. In the AIFMD-context to correct this the UK will require accessing the third country passporting regime based on equivalence of regulation considerations, which effectively puts the UK in the same spot as Switzerland, only that Switzerland is already further advanced in these efforts as the European Securities and Markets Authority (ESMA) has already issued a clean bill of health on behalf of Switzerland last summer. If this should not work out, UK AIFMs would become downgraded to non-EU AIFMs with limited ability to manage EU AIFs and effectively forcing them to seek licensing elsewhere in the EU or contract appropriately licensed service providers to then back-delegate portfolio management to them.
B – Banking and Payment Services
A number of Swiss banking groups also have UK entities and are engaged in providing a broad range of services covering the entire spectrum from investment banking to retail and private banking, and stand-alone wealth management or payment services. As far as these entities are not only dedicated to serving the UK market but also to cater to clients within the EU – either via branches or via cross-border activities – the impact of the Brexit may be significant on such business models as again required status for the provision of services may be lost. Affected passports will clearly be the ones under the Capital Requirements Directive, MiFID and the Payment Services Directive. If branches of UK banks are established throughout the EU, it will likely be necessary to convert them into legal entities and to get them authorised by the competent authorities in target countries with according impact on capital, resource and infrastructure requirements as well as tax consequences.
C – Capital Markets and Insurers
Many UK operations of Swiss financial intermediaries are focused on the offering of securities and in doing so very often benefit from the availability of passports in particular of prospectuses according to the EU Prospectus Directive to cater to all of the EU. Loss of this may significantly impact on business models.
Lastly we would like to point out that also the insurance sector will be impacted by Brexit and the anticipated loss of passports this may likely cause for UK-domiciled entities also of Swiss groups. It should be noted though that already today most Swiss players extensively use Luxembourg, Irish or Liechtenstein solutions or have in the recent past started to transition to these. This will be of lesser relevance to the re-insurance sector but even there an impact may be felt.
Call to action
We have in the past months leading up to the vote worked with various clients on developing response scenarios and the one thing that has become very clear is that in particular the impact in the regulatory sphere is tremendous and that all modifications to existing structures require thorough planning, significant time to implement and also must consider tax consequences. It goes without saying that in all instances overall strategies require revisiting and entire business models may be severely impacted. Uncertainty around the way the Brexit will take effect will continue for some more time but now clearly is the time to put this on the top of the agenda. We are at your disposal and would be most happy to share our insight with you.