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On 19 March 2018, the European Commission and the UK Government published a revised version of the draft Article 50 Withdrawal Agreement. Both Michel Barnier and David Davis hailed the publication as a “decisive step” although Barnier also cautioned that “nothing is agreed until everything is agreed”. The publication of the draft Withdrawal Agreement is an important step on the basis that the transition part (Articles 121 to 126) is all highlighted in green signifying agreement between the EU and the UK. The transition period will last until 31 December 2020 and during that period the UK will continue to participate in the EU Single Market and firms will passport under EU Single Market Directives as is currently the case.

Once the transition period has concluded it appears that UK firms will not be able to passport into the EU nor will EU firms be able to passport into the UK. On 23 March 2018, the European Council (Council) guidelines on the framework for post-Brexit relations with the UK stated that the four freedoms of the EU Single Market (the free movement of goods, capital, services and labour) were indivisible and that there could be no “cherry picking” through participation in the EU Single Market based on a sector-by-sector approach. In addition, the Council confirmed in the guidelines that whilst it was prepared to work towards a wide-ranging free trade agreement (FTA) this could not offer the same benefits as EU membership and cannot amount to participation in the EU Single Market or parts thereof.

The loss of the passport has been accepted by the UK Government for some time. In her letter to the President of the Council which triggered the Article 50 notification, Prime Minister Theresa May stated that the UK did not seek membership of the EU Single Market post Brexit. Instead the debate has focussed on equivalence provisions and more recently mutual recognition.

It is widely accepted in the City that equivalence in its current form will not compensate for the UK’s loss of passporting rights. One of the key drawbacks is the patchwork-like framework of equivalence provisions across EU legislation with some noticeable gaps (for example the lack of equivalence provisions for lending activities under CRD IV). There is also the opacity of the European Commission (Commission) decision-making process for determining equivalence which can be both lengthy and politically contentious. In addition, there is the problem that the Commission can withdraw an equivalence determination on very short notice should it conclude that domestic legislation has diverged too far from EU law. This can mean that firms are reluctant to conduct long-term planning based on an equivalence determination.

In a speech by the UK Chancellor of the Exchequer, Philip Hammond, on 7 March 2018 the UK Government argued for mutual access on the basis of mutual recognition and reciprocal equivalence which would be objectively assessed. Both the Commission and the Council have rebuffed this approach.

Interestingly, the European Parliament’s Economic and Monetary Affairs Committee published a draft report on third country equivalence on 6 April 2018. This own initiative report intends to set out the European Parliament’s position on equivalence procedures arguing in particular for more transparency in equivalence determinations and for the European Parliament to play a greater role in them. Although the report is not binding when finalized it may have an important role as the Commission is currently reflecting on how best to reform the equivalence process. A vote on the report is expected in September 2018.

While scenarios that involve re-applying for EEA and EFTA membership or agreeing bilateral agreements with EU member states would mean that UK firms might retain a degree of access to EU capital markets, they would differ in one aspect. So long as the UK is a member of the EEA, this could provide a comprehensive market architecture and regulatory framework. A bilateral scenario would require the UK to voluntarily apply rules to UK firms. This would likely need to be complemented by ‘indigenous’ UK-specific market architecture and regulation for those firms not operating in Europe. As a result, a bilateral scenario (and to some extent where UK firms fall outside the framework) would likely result in UK firms needing to comply with overlapping UK and EU requirements. Such requirements might not always be consistent.

If UK firms were excluded from direct access to EU markets, they would likely seek to participate as third country participants (similar to the access by US firms). This would require compliance with both EU and UK rules. In such a scenario, the UK will be unable to prevent the adoption by the EU of rules that are adverse to the interests of UK firms.

The London insurance market is currently the largest global centre for insuring commercial and specialty risks. A substantial amount of insurance and reinsurance is distributed and underwritten both into and out of the UK.

The main challenge for insurers arising from Brexit is that on leaving the EU and absent any political agreement to the contrary, UK insurers will lose the right to conduct business in the EU at the end of any transition period. Similarly, EU insurers will lose their right to carry on business in the UK. In theory this means that insurers who have written contracts before Brexit will not be able to either pay claims or accept ongoing premium payments after the UK leaves the EU. Solvency II requires that all those conducting insurance business in the EU must be authorised in one of the Member States (or one of the EEA States). This restriction could affect around £27 billion insurance liabilities and 10 million policyholders in the UK. In the EU this would affect around £55 billion insurance liabilities and 38 million policyholders. Clearly, it is in no one’s interests that it should become illegal to pay claims to policyholders. For this reason, agreement of the ability to service insurance contracts after Brexit is high up the political agenda.

UK insurers may still be able to cover European insurance risks after Brexit without seeking local licences. They could do so by insuring European risks out of London where local EU law does not trigger the need for a local licence (known as operating on a non-admitted basis) on the basis that no regulated activity has taken place within the territory. In addition to the ability to write non-admitted business, WTO rules enable marine, aviation and transport (MAT) risks to be covered (subject to the application of prudential requirements) across borders (although the UK is currently a signatory under the EU so would need to sign independently, unless agreement was reached on this issue).

Solvency II does provide for limited equivalence determinations to be made (in relation to the application of group solvency requirements, group supervision and reinsurance provided by a third country insurers). If UK equivalence under Solvency II is determined by the Commission, EU insurers could continue to treat reinsurance purchased from a UK reinsurer in the same way as reinsurance purchased from an EU reinsurer. There is no ability to treat UK intermediaries as equivalent under the Insurance Distribution Directive so local licenses must be sought.

Brexit has caused uncertainty in the UK funds industry and UK investment fund managers have been devising and implementing a variety of contingency plans based upon various post Brexit scenarios.

Since many UK based fund managers already use Irish or Luxembourg UCITS and alternative investment fund (AIF) platforms for pan-European distribution, the effect on the UK as a fund domicile is likely to be relatively limited, although there has been some evidence of asset managers seeking to rebalance their operations and build greater presence in the EU where they did not already have this.

The big issue for the UK asset management industry is the risk of changes to delegation rules that enable MIFID investment firms, alternative investment fund managers (AIFMs) and UCITS management firms to delegate to a UK based investment manager.

On 20 March 2018, the chair of the European Securities and Markets Authority (ESMA) sought to clarify earlier comments on delegation that the European Supervisory Authority made in its July 2017 sector specific principles on relocations from the UK to the EU27. He stated:

"As I have repeatedly clarified, we are not looking to question, undermine or put in doubt the delegation model. We know that this is a key feature of the investment funds industry and that the flexibility to organise centres of excellence in different jurisdictions has contributed to the industry’s success. To put it more bluntly, to us delegation is not a dirty word.

What our opinions are seeking to address is the risk of letterbox entities. I hope you would all agree that it is in no-one’s interest to allow the creation of such entities. Both the UCITS Directive and the AIFMD explicitly require there to be enough substance in the entity established in the home Member State.

In other words, financial centres in the EU27 should be free to compete based on the particular strengths they can offer relocating firms, like speed and efficiency, but in all cases the EU rulebook should be consistently applied. Otherwise, there could be insufficient substance in the EU27, which may pose risks to ESMA achieving its stability and investor protection mandates."

In terms of other recent activity, the Alternative Investment Management Association published a position paper in April 2018 in which it argued that the UK should seek a deal with the EU that ensures UK firms’ relationship with EU investors and clients can continue uninterrupted by virtue of ‘grandfathering positions’. A series of technical points that need to be addressed during the transition period are outlined in the paper, with the aim of ensuring a smooth journey for asset management firms as they revise their approach to reflect the UK’s new third country status.

We suspect that Brexit may have limited impact, probably even less so than asset and wealth management unless financial investors are seen to be providing advice or services to third parties. European investors are not a large contributor of funding to UK private equity managers. Also, UK hedge funds and private equity companies may face a relatively easier test than others should they wish to continue providing services to customers in the EU. The key test is the “equivalence” of UK regulation compared with international standards, such as those set by the Financial Stability Board. Other financial institutions such as banks may face a more difficult hurdle with the key test being the equivalence of UK regulation with those in the EU. One would hope that any exit arrangements would deal with any adverse tax consequences relating to where funds are established, assets held or beneficiaries reside.

The UK is currently subject to over 40 Level 1 (primary) EU Regulations and Directives on financial services, which are supplemented by a significant number of technical Level 2 (secondary) legislation which are shaped by the European Supervisory Authorities and these generally take the form of directly applicable EU Regulations. The UK remains bound by this EU legislation (and any EU legislation that comes into force) during the transition period.
 
After the transition period it is questionable whether the UK will radically depart from EU financial services legislation. Financial services rules are often the product of an international standard setting process which now exists following the 2008 financial crisis  in a much deeper way for banks and for other areas of the financial sector (financial market infrastructure and the like). The UK has played an important role in shaping international standards and drafting EU financial services legislation.

In addition, the depth of interdependence between the UK and the EU means that there is likely to be mutual interest in some form of ongoing cooperation, in order to align regulation and ensure financial stability. This may also restrict the scope for regulatory innovation.

The Capital Markets Union (CMU) package of reforms under development by the EU aims to unify capital markets across Europe in order to promote investment and growth. Between now and 2019, a wide range of reforms will be proposed under the CMU umbrella. The UK Government has said that it is fully committed to the CMU, which it regards as being of critical importance to building a stronger and more competitive European economy. At the same time, the UK Government has expressed concerns that will involve the transfer of direct supervision of UK market infrastructures or firms to European level. However, it is difficult to conceive an effective comprehensive architecture for that would not involve such centralisation.

Exactly what the consequences of Brexit would be on the UK’s involvement would depend on the terms of the Withdrawal Agreement reached between the UK and the EU. In the meantime, however, the resignation of Jonathan Hill as Commissioner for Financial Stability, Financial Services and Capital Markets Union means that the UK has lost a strong voice in the shaping of the CMU project. His portfolio has been transferred to Latvia's Commissioner, Valdis Dombrovskis. At this stage, Mr. Dombrovskis has not indicated any intention to change direction with respect to the liberalisation of European capital markets. Diminished influence from the UK may, however, tip the balance towards greater centralisation of supervision and regulation.

While scenarios that involve re-applying for EEA and EFTA membership or agreeing bilateral agreements with EU member states would mean that UK firms might retain a degree of access to EU capital markets, they would differ in one aspect. So long as the UK is a member of the EEA, this could provide a comprehensive market architecture and regulatory framework. A bilateral scenario would require the UK to voluntarily apply rules to UK firms. This would likely need to be complemented by ‘indigenous’ UK-specific market architecture and regulation for those firms not operating in Europe. As a result, a bilateral scenario (and to some extent where UK firms fall outside the framework) would likely result in UK firms needing to comply with overlapping UK and EU requirements. Such requirements might not always be consistent.

If UK firms were excluded from direct access to EU markets, they would likely seek to participate as third country participants (similar to the access by US firms). This would require compliance with both EU and UK rules. In such a scenario, the UK will be unable to prevent the adoption by the EU of rules that are adverse to the interests of UK firms.