Brexit Update: What Happened So Far

The last year of the old decade brought so many twists and turns on the subject of Brexit that one could easily lose track. Hence, our first blogpost of the new decade will shed some light on the current Brexit situation and the next steps currently planned by British and European politicians. As always, we will focus in particular on the effects on the financial market.

Current Situation: What Will Happen Now?

Since the British Parliament approved Johnson´s Brexit deal in December 2019, the UK will leave on 31 January 2020. An 11-month transition phase will then come into force: the UK will remain in the EU single market and the customs union until the end of 2020. During this period everything will remain mostly the same for the time being.

During the transition period, the EU and the UK will have to reorganise their relations with each other, with future economic relations as well as security and defence cooperation being key issues. First of all, a comprehensive Free Trade Agreement is to be concluded, which can above all prevent customs duties at the borders. But other economic areas, such as the financial market in particular, must also be regulated, either as part of the Free Trade Agreement (which would be unusual from a legal perspective) or through a separate agreement.

11 months are a short time and one may have doubts as to whether this time will be sufficient. The European Commission is already considering equivalence assessments for the financial market. However, there will be not ONE equivalent decision (see here) for an earlier analysis of the equivalence principle of the EU). There are currently around 40 equivalence areas which need to be assessed in each case. Most equivalence decisions provide for prudential benefits, some provide for burden reduction and some can lead to market access. There will also have to be close cooperation between the UK and EU financial supervisory authorities. During the assessment process the EU will look at UK legislation and supervision and will take a risk-based approach – as for all other third countries. This means that the higher the possible impact on the EU market, the more granular will the assessment be conducted. In case the UK will stick with the current EU regulation, this will be an easier task. But as soon as the UK will break new ground to make the UK financial market more attractive the impact on the equivalent status will need to be considered.

It can be assumed that the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdiensteistungsaufsicht – BaFin) and the other European financial supervisory authorities will monitor the negotiations regarding a financial market agreement very closely during the transition phase and will adapt and communicate their intentions for action accordingly.

To Be Continued

Although a hard Brexit has been avoided, there will still be uncertainties about future relations between the EU and the UK. Financial market participants should follow the negotiations between the EU and the UK closely and not rely on the fact that a financial market agreement can be concluded successfully in the short transition period.

Germany is paving the way for an informal transition period for the financial market in case of hard Brexit

On 20 November 2018, the Federal Ministry of Finance of Germany published a Draft Act on Tax-Related Provisions concerning the withdrawal of the United Kingdom of Great Britain and Northern Ireland from the European Union.

The Draft Act proposes amendments to the German Banking Act (Kreditwesengesetz) and the Insurance Supervision Act (Versicherungsaufsichtsgesetz) and aims to avoid any harm to the functioning or stability of financial markets in case of a hard Brexit, i.e., the withdrawal of the UK from the EU by the end of March 2019 without an agreement.

BaFin will be allowed to grant a transition period until the end of 2020 for passporting financial services into Germany

The proposed amendment to the KWG will allow the German Federal Financial Supervisory Authority (BaFin) to permit firms based in the UK, which have been providing cross-border banking or financial services based on a European passport before Brexit, to continue to operate financial transactions in Germany until the end of 2020 at the latest. The proposal reads:

In the event that the United Kingdom of Great Britain and Northern Ireland withdraws from the European Union at midnight on 29 March 2019 without having concluded an agreement on withdrawal from the European Union […] the Supervisory Authority may determine, in order to prevent disadvantages for the capacity of financial markets to function or for their stability, that the [passporting] provisions […] are to be applied accordingly, fully or partially, for a period of up to 21 months following the time of withdrawal, to companies based in the United Kingdom of Great Britain and Northern Ireland that on 29 March 2019 conduct banking business or provide financial services in Germany through a branch in Germany or by providing cross-border services [under the passporting regime]. [This] only applies to financial transactions that are completed after 29 March 2019 insofar as these transactions are closely connected to transactions that existed at the time of withdrawal.

As already mentioned here the FCA has been planning to take similar precautions for a hard Brexit. Now Germany is following.

The Draft Act, which needs to go through parliament before entering into force, authorises BaFin to extend the current passporting regime at its own discretion. BaFin may adopt a generally applicable rule for all institutions concerned or restrict it to individual supervisory areas that are highly affected. The transition period can also be shortened by BaFin. In addition, BaFin may attach conditions to its permission regime and abolish its measures at any time.

According to the currently proposed wording of the Draft Act, the transition period only applies to financial transactions concluded before Brexit. New financial transactions are only included if they are closely related to existing ones.

During the transition period, the companies concerned must prepare themselves to either apply for a respective license in Germany in order to to submit their German business to the supervisory regime for third countries, or to bring their German business to an end.

Transition period also proposed for the insurance sector

The Draft Act authorises BaFin to adopt a similar transition period for insurance undertakings in order to avoid disadvantages for policyholders and beneficiaries. This will enable insurance companies based in the UK to either transfer or terminate existing contracts within a reasonable timeframe, or meet the necessary prudential requirements for an orderly run-off of such contracts, where this is not possible.

Draft Act subject to European law

In case the EU comes up with a similar and uniform transition rule to protect the financial markets from any chaotic disruption due to Brexit, the EU rule will prevail.

Who is Who? European Supervisory Authorities – How they Cooperate and Interact

If you are looking for guidance from national and European supervisory authorities, it is not easy to see at first glance how they work together and whose guidance is most relevant. We want to shed some light on the ‘Who is Who?’ of German and European regulators.

Financial market supervision in Germany

The first go-to regulator in Germany is the Federal Financial Supervisory Authority (BaFin), which is entrusted with the tasks of banking, insurance and securities supervision and acts as a universal financial supervisory authority. BaFin is also responsible for ensuring that financial services, banking and insurance transactions are not conducted without a license and can also sanction any violations against the regulatory regime – and does so regularly. One of the newest additions to the list of tasks of BaFin is supervising compliance with consumer protection rules within the financial market. This primarily concerns cases in which regulated institutions violate regulatory provisions that protect consumers. If these infringements go beyond individual cases, they are pursued in the public interest by BaFin. BaFin, together with criminal enforcement authorities, is also responsible for pursuing money laundering and terrorist financing and supervising compliance with AML requirements. BaFin’s banking and insurance supervisory office is based in Bonn, the office responsible for securities supervision, asset management and bank resolution is based in Frankfurt am Main.

In Germany, the task of banking supervision is shared by BaFin and the German Central Bank (Deutsche Bundesbank). BaFin and Deutsche Bundesbank, e.g., oversee whether the banks have sufficient financial resources and whether business operations are properly organised. BaFin and Bundesbank receive the necessary information from the banks themselves or obtain it through on-site audits. The Bundesbank is responsible for the majority of operational banking supervision, namely the reporting and evaluation of audit reports submitted by the institutions and the performance of special audits. Guidelines for ongoing supervision and interpretation of legal requirements are mainly issued by BaFin.

The supervision of insurance policies by BaFin is intended to ensure that the insurance companies are capable of providing the benefits to which they are obliged. To this end, BaFin checks, for e.g., whether the insurance companies have sufficient financial resources and assess risks correctly.

BaFin’s supervision of securities serves the purpose of ensuring the availability of sufficient information and transparency for all market participants by monitoring the proper publication of relevant information. BaFin also monitors insider trading and price manipulation.

European financial market supervisory regime

BaFin and Deutsche Bundesbank are not the only regulators you have to keep up with when you are a regulated institution. At the European level, the European Securities and Markets Authority (ESMA), the European Banking Authority (EBA), the European Insurance and Occupational Pensions Authority (EIOPA) have their say and the European Central Bank (ECB) is also responsible for financial market supervision within the Eurozone.

The Single Supervisory Mechanism (SSM) has entrusted the ECB with the direct supervision of significant financial institutions in the Eurozone. These are about 120 banks and banking groups. To fall within the ECB’s responsibility, a bank must either have a balance sheet total of more than €30 billion or more than 20% of its home country’s GDP. If these thresholds are not met, the ECB monitors the 3 largest banks in each of the countries participating in the SSM (which are 19 countries in the Eurozone). All other banks will continue to be supervised by the national supervisory authorities.

If the ECB is in charge, the ECB cooperates with the national supervisory authorities of the banks’ home countries. Joint Supervisory Teams (JSTs) are set up by the ECB for coordination. These are composed of staff from the ECB and the national supervisory authorities. In Germany JSTs consist of members of the ECB, BaFin and Deutsche Bundesbank. A consistent supervisory practice can be established through the JSTs, taking into account national standards and a uniform standard within the Eurozone.

In contrast to the day-to-day supervision of the national regulators and the ECB, the European supervisory authorities EBA, ESMA and EIOPA (together ESAs) generally do not act directly vis-à-vis individual financial institutions, but ensure uniform standards within the EU. They also monitor the application of EU law by national supervisory authorities and the market. For this purpose, they use convergence instruments such as guidelines and Q&As (Questions and Answers), which aim at a consistent application of EU law by the national supervisory authorities. In practice, however, European directives are not always implemented equally in each Member State since the directives also leave a scope of interpretation for the national legislator on certain aspects of regulatory law.

The guidelines issued by EBA, ESMA and EIOPA are binding for the national regulators in Europe. They are not directly binding for the institutions but become directly binding when adopted by the national regulators. BaFin publishes on its homepage whenever it adopts guidelines, and also when guidelines are specifically not integrated within the German administrative practice. The advantage of the ESA’s approach of having a single rulebook and consistent rules throughout the EU for the market is that the provision of cross-border services becomes easier if just one set of rules apply.

EBA, ESMA and EIOPA are also actively involved in the European legislative process by supporting the European Commission in drafting legislative proposals based on their knowledge of the European financial market and its supervisory mechanisms.

Although the ESAs do not act directly vis-à-vis the majority of the regulated institutions, it is worth monitoring their publications to get an early grip on regulatory developments. The European administrative practice is essentially formed through the ESAs. It is also worth noting that the ESAs usually publish drafts of their envisaged guidelines for consultation purposes. For lobbying purposes it is essential to participate in such consultations.