Brexit Effect on FCA Regulated Entities and License Passporting

2016 delivered a change of the political landscape in the European Union, as the pro-nationalist parties were able to secure a referendum victory on the “leave” vote, which on June 23 of that year, opened the door for the UK to leave the European Union. Hitherto, the UK had been part and parcel of the European Union and the single market that was developed courtesy of MiFID I. Financial regulators in the EU and the UK had also been answerable to the European Securities and Markets Authority (ESMA), a body formed in 2011 by the European Commission to govern the financial markets in the EU.
The Financial Conduct Authority (FCA) is the UK’s financial market regulator, and by virtue of the UK’s membership and signatory status to MiFID, was subject to the authority of ESMA. This authority has manifested in several ways. When ESMA amended the rules of how financial trading products were to be marketed, distributed, sold and traded within the EU, UK brokers under FCA supervision all complied with the rules. The passporting regime also allowed EU brokers to setup shop in the UK and to source clients from there. Brexit it seems, may instantly alter everything with regards to financial market operations. What will represent the effect of Brexit on FCA regulated entities with regards to ESMA supervision, and what will happen to the passport licensing regime as far as brokers on both sides of the divide are concerned?

FCA Regulation and Brexit

London is one of the major financial centres of the world, and the UK is regarded as one of the biggest trading hubs. That is why trading between the hours of 8a.m. GMT and 4 p.m. GMT is regarded as the “London session”. When it comes to regulation of the financial markets, the UK is known across the trading industry as a hub with some of the strictest regulatory regimes on the planet. Regulation by the FCA is considered tighter than regulation by many European national regulators, including the Cyprus Securities and Exchange Commission (CySEC).
It is more expensive to set up shop in London, licensing processes are more expensive and these tend to be a lot more vigorous than you would find in other jurisdictions. For traders, verification of accounts was also more stringent. Where other regulators were fine with scanned copies of a government-issued ID and a utility bill, the FCA routinely required an extra step: notarization of these documents with the full details of the Notary Public embossed on the scanned copies. But the coming of MiFID II was supposed to harmonize these processes in the UK and the rest of the EU, in the spirit of supervisory convergence. Or so it seemed.
Fast forward two years from 2018 when MiFID II became functional and ESMA’s new rules took effect. It has become apparent that post-Brexit, the areas of concern with brokers and traders in the UK and EU alike are:
a) The issue of passporting of licenses from the EU to the UK.
b) Whether the FCA will continue to apply ESMA’s rules on UK brokers.
c) What the status of traders of EU origin who have accounts with UK brokers will be, and what the status of UK traders who are clients of EU brokers will be as well.

Issue Number 1: Passporting of Licenses

EU businesses have always been granted “home status” in the UK. Brexit could potentially cause that to go away. When it comes to financial brokerages, the ability of an EU-regulated brokerage to setup shop in the UK without having to undergo additional licensing processes is something that EU brokerages have enjoyed under MiFID II. This “license passporting” process will continue to be available during the Brexit implementation period that lasts from February 1, 2020, to December 31, 2020. The managed funds sector will see some changes. ESMA’s UCITS and AIFMD marketing licenses will no longer be available to fund managers in the UK post-Brexit.

Issue Number 2: Will the FCA Become Independent of ESMA?

Will the FCA cease to become an ESMA-affiliated body post-Brexit? Some clarity has been provided on this matter by ESMA itself, citing portions of the Withdrawal Agreement which legislated on the matter.
Under the conditions stipulated by the Withdrawal Agreement, the UK will continue enjoy member state status of the EU, making it subject to EU law until the transition period ends on December 31, 2020. Therefore, the FCA will continue to report to ESMA and will also fulfil all other obligations under MiFID/MiFIR, EMIR, AIMFD and CSDR. However, the Withdrawal Agreement also states that after February 1, 2020, the Financial Conduct Authority (FCA) will cease to be a member of ESMA’s Board of Supervisors and will no longer be part of any other governance bodies of ESMA.
This is pretty clear. FCA has in effect, ceased to be an ESMA affiliated regulator, but will continue to fulfil its existing mandates under MiFID II until the transition period is over.

Issue Number 3: What Happens to Brokerages and Traders Who Trade Across the Divide?

A Temporary Permissions Regime (TPR) has been created to enable EU brokers and fund managers notify the FCA on their intention to continue operating within the UK. The first window closed on January 31, 2020. Another window may be opened by the FCA later in the year for this purpose.
Once the window is shut, EU firms that have enjoyed the license passporting privileges pre-Brexit will have to undergo full authorization by the FCA. At this time, how this will affect clients of such firms is presently unknown. These are some of the issues that could be ironed out during the negotiations taking place between EU and UK trade representatives. The talks were ongoing but have had to be halted because of the ongoing coronavirus pandemic.
How about UK brokerage firms that intend to operate in the EU, or who at present have branch offices there? At the moment, the status is unclear because the European Commission has launched a public debate to kickstart the process of amending the provisions of MiFID II. Therefore, any changes that will affect the ability of UK brokerages to do business in the EU may be reflected in the new MiFID document. There are some suggestions that independent countries within the EU could make their own provisions for UK companies. This is still a matter of speculation and market watchers expect all this to be reflected in the upgraded MiFID articles.
With the coronavirus pandemic currently ravaging the world and putting all forms of business and social life on hold, it is likely that some of the dates and time-bound processes mentioned in this article may be moved to allow for the end of the pandemic and restoration of normalcy.