Brexit and the impact on the banking and financial industries

Fernando Azofra

Uría Menéndez, Madrid; Senior Vice Chair, IBA Banking Law Committee

fernando.azofra@uria.com​​​​​​​ 

Moderator

Fernando Azofra Uría Menéndez, Madrid

Philippe Dupont Arendt & Medernach, Luxembourg

Andrew Henderson Macfarlanes, London

Robert Brittain Slaughter and May, London

Alvaro López de Argumedo Uría Menéndez, Madrid

United Kingdom banks banking in the European Union and EU banks banking in the UK: are third country banks (ie non-UK/non-EU banks) in a better position?

After introducing the speakers, Fernando Azofra explained that the first part of the session would analyse the implications of Brexit on the banking and financial services industries. He stressed that the British economy as a whole (and London’s economy in particular) has been vastly biased towards the financial sector (it contributed almost £76bn in tax receipts to the UK Treasury in 2020).

He then noted that the limited regulation on banking and financial services in the Trade and Cooperation Agreement between the UK and the European Union, dated 30 December 2020 (the Agreement), was almost tantamount to the much-feared ‘no-deal scenario’ before the end of 2020. Only six of the 1,259 pages of the Agreement cover financial services.

Azofra highlighted the impact Brexit has already had by using the derivative market as an example. The transitional period ended on 31 December with no relief for EU companies on the derivatives trading obligation (DTO) from the European Commission and only limited adjustments from the UK. Despite largely identical rules, no equivalence has been granted between jurisdictions. This has left many companies with conflicting and incompatible DTOs in the EU and the UK, and with no apparent option other than to trade the relevant derivatives on a United States swap execution facility or in Singapore.

• EU companies must meet the EU DTO by trading certain OTC interest rate swaps (IRS) on EU multilateral trading facilities and organised trading facilities (MTF/OTF) or an ‘equivalent’ venue (currently limited to US swap execution facilities and Singapore-based venues).
• UK companies must meet the UK DTO by trading certain IRS on an UK MTF/OTF or an ‘equivalent’ venue (currently limited to US swap execution facilities and Singapore-based venues, with some limited relief).

This has created specific challenges:

• EU companies can only trade certain IRS subject to both the EU and UK DTOs with a UK company on a venue that allows both companies to comply with their local DTOs; and
• a UK branch of an EU company is subject to both the UK and the EU DTO.

The consequence of this paradoxical situation was significant in Euro-denominated swaps: the EU MTF/OTF share has grown from 10 per cent to 25 per cent since July 2020, while the UK venues share has fallen from just under 40 per cent to just over 10 per cent. There were UK losses and EU gains in dollar and sterling-denominated derivatives, but not as acute. Derivative trading left, but not only to the EU. As in other markets, the regional ‘infighting’ resulted in gains for other areas, such as Asia and the Americas.

The impact across the spectrum of financial services has been similar. According to an EY report dated 2 March 2021, since the Brexit referendum 24 financial services companies have publicly stated they will transfer almost £1.3tn of UK assets to the EU. As much as 43 per cent (95 out of 222) of UK financial services companies have moved or plan to move some UK operations and/or staff to Europe: 36 companies have moved or relocated people to Dublin; 29 to Luxembourg; 23 to Frankfurt, 20 to Paris, eight to Madrid and Amsterdam; six to Brussels and five to Milan.

In equities trading, the Brexit impact was no less brutal: Amsterdam replaced London as Europe’s largest share trading centre in January (where an average €9.2bn shares were traded in Amsterdam per day) as volumes in London fell to €8.6bn (London averaged a daily €17.5bn in 2020).

Finally, between 7,000 and 10,000 jobs in the financial sector have been lost in the UK because of Brexit. Yet, estimations in 2020 were significantly worse (over 250,000 jobs). The Morgan McKinley Winter Employment Monitor report (18 January 2021) confirmed this impact on jobs: a 36 per cent year-on-year decrease in jobs available and a 31 per cent year-on-year decrease in jobseekers.

Andrew Henderson recalled the fundamental change that Brexit has caused, and which determined the context in which all other issues were to be addressed: the loss of the concept of the ‘passport’. It is a very intuitive construct which essentially provides that, if a company is authorised to provide financial services in its home Member State, it will be also authorised to establish a branch or provide services directly in any other Member State. Brexit has, in this regard, deprived EU companies of their right to operate in the UK and vice versa.

Henderson then reviewed key dates of the Brexit process in the realm of banking and financial services:

• 23 June 2016: UK Brexit vote;
• 29 March 2017: UK notifies the EU of its intention to withdraw from the European Union;
• 17 October 2019: Withdrawal Agreement;
• 1 February 2020: UK becomes a ‘third country’ for EU purposes;
• 31 December 2020: EU law ceases to apply to and in the UK;
• 24 December 2020: the Trade and Cooperation Agreement between the EU and the UK (effective 1 January 2021) is announced;
• 25 December 2020: joint declaration on financial services regulatory cooperation;
• 26 March 2021: the Memorandum of Understanding on regulatory cooperation (MoU) is agreed in substance.

Philippe Dupont proceeded to scrutinise the basics of the Agreement. It provides rules on the establishment of a business and the cross border provision of services and includes for special rules in financial services matters as follows:

Establishment

• Market access: no restrictions on number of entities, number/value of operations.
• National treatment: conditions no less favourable than those accorded to EU enterprises (but there are exceptions for financial services).
• Most favoured nation clause: excluded for financial services.
• No nationality requirements for senior managers/board members.
• No performance requirements such as to achieve a given level of domestic content.

Cross-border provision of services

• Market access: see above.
• No requirements for local presence: financial services exception (investor protection rules).
• National treatment: see above.
• Most favoured nation clause: see above.

Financial services

• Most favoured nation clause excluded.
• Market access: right to require specific legal form for any EU company to establish in the UK and vice versa.
• Cross-border provision: right to adopt specific legislation.
• Prudential carve-out:
  • investor protection; and
  • measures to ensure integrity and stability of financial markets (eg, authorisation and supervision requirements).
• Data protection.
• Best endeavours to abide by international standards on regulation, fight against money laundering and tax evasion.
• New financial services.
• Access by branches to payment and clearing systems operated by public entities.

Henderson then dissected the MoU. The document defines the relationship between the EU and the UK, and the means by which the two parties will engage with one another. The logistics will be based on the existing joint EU-US Financial Services Forum. The aim is to provide a mechanism for bilateral discussions between the EU and the UK to create transparency about each party’s approach to financial regulation.

The MoU does not detail any decisions about regulatory ‘equivalence’. The arrangement will not compel the parties to reach agreements on equivalence or any other matters. Although the regularity of meetings (the schedule of which the draft MoU does not detail) will be a focal point for (mainly UK) requests for equivalence and (mainly EU) complaints about regulatory divergence, however, under the MoU both parties have undertaken to discuss their ‘autonomous decisions’ to adopt, suspend or withdraw equivalence. This could mean more dialogue and process around equivalence, albeit for instance without formal notice periods to withdraw equivalence.

The draft refers to cooperation in international forums and the promotion of timely implementation of international regulatory standards. This is a priority for the UK, which wishes to both drive international standards and promote adoption as the basis for national regulations. However, the EU might likewise point to international standards to seek to constrain the UK from diverging significantly from the EU.

Azofra reminded the audience that there was ‘brave talk’ in the UK until 2020 proclaiming that the country would be in a perfect situation to attract new businesses, new clients, new products and services, etc, as a result of a softer (or, at least, different) supervisory model being expected in the medium to long term. In contrast with this message, since late December 2020, four global wealth and asset managers (with assets under management over $10tn) have called for greater clarification over the UK’s future regulatory regime, arguing for greater alignment (rather than divergence) from Europe, focused on establishing a flexible and cooperative relationship with the EU. Azofra then asked Henderson whether regulatory alignment or divergence was to be expected in the future. Henderson flagged that, since the 2007–2009 financial crisis, there has been a global trend towards international regulatory and supervisory standards, which will continue to model any future UK development in financial services regulations (constraining significant divergence going forward).

Dupont then analysed the implications of the ‘third country’ regime. Two basic frameworks might be found:

• Financial services where there is no harmonised approach to the provision of services by non-EU entities.
• Financial services subject to certain harmonisation: ‘equivalence’ regime (there are circa 58 existing equivalence regimes).

‘Equivalence’ results from determining that two financial services regulatory regimes are sufficiently comparable. Equivalence assessment is a (usually) reciprocal technical and rather in-depth analysis of the regulations in a certain country (a ‘third country’) intended to reach the conclusion that they are homogeneous enough in relation to those of another country so as to enable banks and service providers based in the third country to access the other market while relying on their home prudential supervision and regulations. Adopting ‘equivalence’ eases the way for companies in and outside the EU to interact.

The concept of equivalence is used for two main purposes:

• as a basis for granting non-EU companies certain rights in the EU market (eg, cross-border provision of services, set up of branches and host regulations applicable to them); and  
• to define the regulatory regime when EU companies operate outside the EU (eg, treatment of capital exposures to non-EU entities).

Currently, core banking activities (eg, deposit taking, lending and payment services) have no equivalence regime. A non-EU bank establishing a bank and providing cross-border banking services in the EU is subject to the EU host country’s national regime. A UK bank’s branch set up in any EU Member State will not enjoy passport rights in any other EU Member State.

For other investment activities (eg, dealing in financial instruments such as securities, derivatives and commodities), a distinction needs to be drawn between professional clients (eg, banks, insurance companies, funds and large corporations) and non-professional clients.

For professional clients:

• there is no obligation to establish a local branch (unless there is a permanent local presence);
• if a branch is established in any EU Member State, it will be granted a passport to freely provide services across the EU (but to professional clients only), subject to an ‘equivalence’ decision of the European Commission and registration with the European Securities Markets Authority (ESMA).

An exception to the above applies: reverse solicitation (ie, financial services are rendered at the exclusive initiative of the client, without any form of solicitation by the financial service provider). The EU Commission has not taken any ‘equivalence’ decisions.

For non-professional clients, EU Member States may require the establishment of a branch for the provision of services. Any such branch will not enjoy passport rights in other EU Member States. As with with professional clients, no authorisation or national regime would apply in cases of reverse solicitation.

The EU Commission has taken ‘equivalence’ decisions around existing UK infrastructures, as follows:

• For Central Securities Depositories (CSDs) until 30 June 2021. Thereafter, UK CSDs will no longer provide notary and central maintenance services in relation to financial instruments constituted under the laws of an EU Member State (unless recognised by ESMA).
• For central counterparties (for OTC derivatives that are subject to DTO): until 30 June 2022.

There are few doubts that a technical equivalent assessment of UK regulations can easily pass through as far as the EU is concerned (the standards today are mostly the same). But politics have heavily influenced Brexit so far. The European Commission has recently strongly signalled that the UK’s temporary equivalent assessment will expire as expected.

Azofra mentioned that, although passporting and equivalence debates command the headlines, there were arguably far more complex matters involving data, capital, skilled talent and frictional costs which also needed to be settled. Since late December 2020, ten financial services companies (including some of the largest retail and investment banks and wealth and asset managers operating in the UK) have publicly urged the UK government and regulators to ensure that the UK sector remains competitive and open for business. Public statements include calling for an operating environment that is accessible to both local and international trade and services businesses, and an assurance that London does not lose its grip on its role as a key European trading hub.

English law, English courts, arbitration in the UK and financial contracts

Azofra recalled that, for decades, English law and English courts have been common choices for loans, credit facilities, hedge agreements and many other financial contracts in circumstances where (1) there was a cross-border component (whether or not specifically linked to the UK) or even (2) in local over-sized deals where syndication could not only rely on local credit providers (as international financiers had a preference for UK law and UK courts over any other continental ones).

After introducing the speakers, Azofra stated that this part of the session would analyse whether it was still wise to choose UK law and UK courts, or UK-based arbitration courts in the post-Brexit era, in light of the new burdens and constraints of seeking and obtaining judicial recognition of an English judgment in the EU.

Recognition of UK judgements in the EU – existing financial contracts before 1 January 2021

Alvaro López de Argumedo first addressed the issue of financial contracts entered into on or prior to 31 December 2020.

• Judicial proceedings initiated on or before 31 December 2020: Regulation (EU) No 1215/2012 of the European Parliament and of the Council of 12 December 2012, on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters (Brussels Recast) applies, as provided for in the Withdrawal Treaty. López de Argumedo safely concluded that Brexit had had no real bearing on this scenario.
• Judicial proceedings initiated after 31 December 2020: Brussels Recast does not apply (Article 67.2a of the Withdrawal Treaty and Section 3.3 of the EU Commission’s Notice to Stakeholders – Withdrawal of the United Kingdom and EU rules in the Field of Civil Justice and Private International Law). The conclusion here is that the recognition of any final UK courts’ decision will be subject to domestic provisions in the host EU Member State on recognition and enforcement of foreign court decisions.

Recognition of UK judgements in the EU – new financial contracts entered into on or after 1 January 2021

Robert Brittain began by saying that UK courts will now use domestic rules to determine whether they have jurisdiction over a certain matter, except when the Hague Convention of 30 June 2005 on Choice of Court Agreements applies, as it upholds exclusive submissions made in favour of another state member to the Convention, with certain exceptions.

Regarding the recognition in the EU of UK courts’ decisions rendered in respect of financial contracts entered into on or after 1 January 2021, Brittain pointed out the following:

• The Brussels Recast does not apply.
• The Hague Convention may apply. Some areas are excluded (such as consumer contracts, intellectual property rights matters or arbitration). Contrary to Brussels Recast, recognition under the Hague Convention is not automatic, but rather subject to a formal process. Asymmetric jurisdiction clauses (which are often used in financial contracts) would exclude the application of the Hague Convention, as well as hybrid and non-exclusive jurisdiction clauses.
• The Lugano Convention on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters may apply to UK rulings in respect of contracts entered into after the UK validly accedes to it. Though the UK has already requested admission, the European Commission has not yet granted permission and seems to be in no hurry to do so. Once permission is granted, the UK’s admission will be effective on the first day of the third month following the deposit of UK’s instrument of accession. Some areas (eg, arbitration or insolvency) are excluded.
• Even though a number of sectors in the UK are looking forward to the UK’s accession to the Lugano Convention, Brittain stressed that the Hague has some advantages over Lugano (even if its scope is narrower).
• If neither the Hague Convention nor the Lugano Convention is applicable, the recognition and enforcement of UK courts’ decisions shall be subject to domestic provisions in the host EU Member State on recognition and enforcement of foreign court decisions (which could potentially result in the merits of the decision being re-examined).

Recognition of UK-based arbitral awards in the EU – existing financial contracts before 1 January 2021

UK arbitration courts’ decisions can be recognised in the EU in accordance with the 1958 New York Convention on recognition and enforcement of arbitral awards. Brexit has no bearing in this regard.

Where UK courts’ decisions at the request of an arbitral tribunal (eg, judicial assistance in respect of interim measures in an arbitration) are issued in judicial proceedings initiated on or before 31 December 2020, Brussels Recast applies. Brexit has no bearing in this regard.

Where UK courts’ decisions at the request of an arbitral tribunal are issued in judicial proceedings initiated after 31 December 2020, the recognition of any such UK courts’ decisions will be subject to domestic provisions in the host EU Member State on recognition and enforcement of foreign court decisions.

Recognition of UK-based arbitral awards in the EU – new financial contracts entered into on or after 1 January 2021

Awards rendered by arbitral tribunals seated in the UK can be recognised in the EU in accordance with the New York Convention. Brexit has no bearing in this regard.

In regard to UK courts’ decisions at the request of an arbitral tribunal (judicial assistance in respect of interim measures in an arbitration), the same conclusions as above apply.