EU Financial Services Legislation

Most EU legislation on financial services is agreed between the European Parliament and (the member states in) the EU Council. Most decisions are taken by a qualified majority vote. Where fiscal and taxation provisions are involved, the decision must be unanimous. In this context, financial services include banks, insurance companies, investment funds, investment service providers, stock exchanges and other trading venues.

EU financial services legislation applies to the European Economic Area (the European Union, Norway, Iceland, and Liechtenstein). There are bilateral agreements with Switzerland which has more limited access to the single market in financial services. Its financial services providers operate through EU  establishments many in the UK.

The common feature of financial services legislation, in common with general EU provisions on services, is the ability to provide services across the EU or to establish a branch or other presence in another EU state, based on home state prudential regulation. The general principle is that the home state regulates prudential and the other principal matters, while the host state, into which services are provided,  regulates the conduct of business.

The prudential and conduct of business rules in most financial services sectors have been harmonised at EU level, so as to facilitate ready compliance with minimal adoption, with the host state rules.

A financial service provider may open a branch in another EU state or provide services from the home state. If it establishes a subsidiary, it is generally subject to regulation by the host state. The single financial market in many financial services sectors allows for the provisions of those services throughout (such as fund services to the EU)

Banking and Insurance

Almost all financial services legislation is harmonized at EU level. Financial service firms authorized in the UK can provide services into or within other EU states without further authorisation.  They must comply with the “doing business rules” of the host state only. However, most of these rules have been harmonized by EU legislation.

The European Central Bank supervises large banks established in Euro states and certain other states that have opted into the Banking Union. The UK has opted out of the banking union. The supervision of all UK banks and subsidiaries and other banks situated in the UK and is undertaken in the UK.

Banking; the EU rules provide for the requirements for the authorisation of banks and capital requirements. There are standardised consumer/customer protection rules. Post financial crisis, there are enhanced rules for the resolution of banks in financial difficulties and for enhanced guarantees for deposits.

The Capital Requirements Directive sets out the requirements for bank capital. It implements capital adequacy standards agreed at international level in Basel III. It covers banking services, taking deposits, lending and other finance, finance leasing, payment and some advisory and trading services. There is no third country regime.

Insurance companies; authorisations are provided that cover capital and regulatory competence. There are common rules and standards which protect consumers and other customers.

The Solvency Directive sets the prudential framework for insurance. It requires insurers to hold enough capital to maintain a 99.5% confidence that they could cope with the worst losses over a year. It allows EEA firms to provide reinsurance cross-border or by way of a branch within the EU/ EEA. There is provision for third country equivalence for reinsurance but not for direct insurance.

Investment Asset Management & Other

Investment firms and financial markets infrastructure. Investment firms and other key financial services players such as central counterparties are subject to common EU rules on authorisation and doing business. The Market in Financial Instruments Directives came into effect in 2007. MiFID 2 came into effect in January 2018.

Asset management. The authorisation of investment funds and investment fund managers is undertaken under common EU legislation.

Banks and investment firms can passport services related to security funds and derivatives, including trade execution, investment advice, underwriting and placing new issues and operating trading facilities. There is a third party regime which allows firms to offer services cross-border to wholesale customers and counterparties.

The UCITS regime was updated in 2014. It allows for the sale of units in investment funds to retail investors on the basis of a single national authorization. There is no third country regime under UCITS. It may be possible to market funds as Alternative Investment Funds post Brexit.

The Alternative Investment Fund Managers Directive provides rules for alternative investment fund managers on an EU wide basis. They may be passported across the EU. The national private placement regime allows non-EEA fund managers to market funds in EEA jurisdictions to professional investors.

The facilitation of cross-border payments services is provided for under EU regulation.

There are common EU standards with respect to market abuse and transparency which support the markets in shares and securities.

UK & Financial Services

The UK is the world’s largest exporter of financial services. Net exports are $ 71 billion. The sector contributes 12% of PAYE income tax and national insurance and 15% of corporation tax.

The financial services industry accounts for seven percent of UK GDP and employs1.1 million people. Two-thirds of them are employed outside London. The industry contributes significantly to the UK tax base.

London has significant advantages as a financial hub and is significantly ahead of other European centres in that regard. It has developed creative, regulatory, legislative, funding and technology centres in a single place. It has a concentration of activities with significant economies of scale. It has deep capital markets. It is highly interconnected and the impact of changes is unpredictable.

International standards are important in financial services, given the interlinked nature of finance. There is a practical necessity in trading blocks and countries having regulatory equivalence and being able to have confidence in each other’s standards.

The lack of input into future regulation reform is undesirable for the UK. There is a risk of regulatory divergence between the UK and the EU. The UK’s influence on international standards-setting bodies such as the Basel  Committee and Financial Stability Board will be crucial in ensuring changes to regulation and internationally.

Approximately 25 percent of revenues in banking and asset management and half of the revenues in banking infrastructure relate to the European Union.

The EU regulation is based on the regulation of activities and does not necessarily regulate the firms or entity itself. Many firms will have multiple authorisations for undertaking connected activities, which are regulated under different directives and regimes.

The financial system has been described as an ecosystem with complex and enormous interconnections. Sudden regulatory change and uncertainty have the potential to be highly dislocative. Many financial services providers and most banks provide multiple services and the loss of any one or more of those services could have a significant knock-on effect.

EU Regulatory Equivalence

EU legislation contemplates third country access for specific activities. Third country equivalence must be confirmed by the European Commission. This requires demonstration of regulatory equivalence and compliance between the third country and the European Union.

In principle, the UK from a substantive position will be able to show regulatory equivalence on day one of Brexit. The matter is decided by the EU Commission.

The parameters and criteria for a decision as to equivalence are not necessarily clear. The time frames can be long. However, given the existing equivalence, it might be more readily accorded.

The third country equivalence regime has significant limitations. If the UK found itself unable to enter a trade agreement with full access to the single market in the various financial services, it would be left to resort to the more fragmented third country equivalence provisions.

These include

  • the establishment of CCPs and trade depositories,
  • marketing of alternative investment funds
  • reinsurance,
  • over the counter execution,
  • execution venue for shares and over the counter derivatives,
  • cross-border provisions of investment services.

Other major areas are not covered, include and in particular,

  • bank lending and deposit-taking;
  • retail asset management under UCITs.

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