This week saw another Brexit deadline come and go: the UK will not crash out of the European Union this evening, having been granted a further extension to its original two-year notice period. All sides hope that this extra time will enable a “no-deal” outcome to be avoided, but private fund managers are still unable to rule that out. Indeed, they must now pencil in 31 October 2019 as the next possible date for a disorderly (transition-free) Brexit – although the UK could choose to leave with a deal earlier than that, or could even be forced out without a deal on 1 June if the UK fails to participate in May’s European elections.

Meanwhile, the EU continues to quietly prepare for the day when the UK becomes a “third-country” (EU-speak for “not one of us”) – whether that is following a hard Brexit later this year, or at the end of any transitional period that is agreed as part of a negotiated Withdrawal Agreement. Of course, if observers of the Brexit process have learned anything during the last few years, it is that things can change: we are certainly not in a process that is linear and predictable. The UK may not end up leaving the EU at all, or it might agree to remain aligned with the single-market rulebook in exchange for full market access. But it currently looks most likely that – so far as financial services is concerned – the UK is on course to rely on the EU’s partial and unsatisfactory “equivalence” rules to establish the terms of its access to EU-based investors. That is the path the UK government opted for in the non-binding Political Declaration that accompanies the draft Withdrawal Agreement, and it has been the working assumption of law-makers and regulators that this will indeed be the ultimate outcome. Not surprisingly, that assumption has had an effect on the regulations relating to third-country access that have been in process.

Most obviously for the private funds sector, the view that the UK will one day be a third-country has scuppered any immediate hopes of the EU activating the third-country passport ordained by the Alternative Investment Fund Managers Directive (AIFMD). That has now become even more political than it already was, and the idea that UK private fund managers might have full, passported access to professional investors in the EU is one that would be hard to push through the EU’s legislative process right now. And, related to that, forthcoming changes to the rules on fund marketing could have a negative, knock-on effect for non-EU managers (as we recently reported here.)

But also significant for many UK-based firms is the right of access for third-country firms contemplated by the EU’s Markets in Financial Instruments Directive (MiFID). Many placement agents, and some private equity firms that operate as “adviser-arrangers”, are regulated by this Directive and some are currently navigating the national rules that may allow them to operate in certain EU jurisdictions after a hard Brexit. But the third-country passport written into the MiFID rulebook could offer a longer-term solution, even though this right of access has also not yet been activated by the European Commission. And, as highlighted last week in a report issued by the UK’s Parliament, the conditions for that passport are going to get tougher.

In what is clearly a response to Brexit, provisions added to the revised EU prudential rules for investment firms (published earlier this year) will require the European Commission, when it considers whether to make a positive equivalence decision for a given country, to take into account the risks posed by the services and activities that firms from that third country could carry out in the EU. When the services and activities performed by third-country firms are likely to be of “systemic importance for the EU”, that country’s regulatory regime can only be considered equivalent after a “detailed and granular” assessment. In addition, the Commission may attach specific conditions to an equivalence decision to ensure that ESMA and national regulators “have the necessary tools to prevent regulatory arbitrage and monitor the activities of third-country investment firms”. There will also be an annual reporting requirement on the scale and scope of services provided in the EU, the geographical distribution of the firm’s clients, and investor protection arrangements. There are also proposals to tighten the reverse solicitation exemption.

Given the scale of access potentially required by UK firms to EU professional investors, the requirements imposed on firms accessing any future MiFID third-country passport have been significantly extended beyond the original model of a one-off registration with ESMA. Furthermore, as the UK Parliament report points out, whether the EU grants equivalence will not merely be a technocratic exercise but will be a political question and will depend in part of the state of relations between the UK and the EU at the time. Even if the UK follows EU rules, there is no guarantee that equivalence status will be granted and, even if it is, it may come with conditions or time limits.

So, although there is good reason to hope that a close long-term relationship between the UK and the EU can ultimately be achieved, it remains sensible to plan for a less positive outcome – especially since the ultimate resolution of these questions may be some years away, with significant disruption in the meantime.


European Funds Comment will take a short break and will return on 26 April.