Another Brexit Day Has Come and Gone – What’s Next?

October 31, 2019

A politician needs the ability to foretell what is going to happen tomorrow, next week, next month, and next year. And to have the ability afterwards to explain why it didn't happen.

Winston Churchill

Today should have been Brexit Day. Without parliamentary approval of the renegotiated Brexit deal, the UK careened towards the October 31 cliff edge. However, this possibility was avoided earlier this week as lawmakers agreed to a so-called “flextension” with a new Brexit deadline of January 31, 2020. That means if both sides can agree to terms prior to January 31, the separation will happen then. Otherwise, the end of January will be the final cutoff for a deal.

In the interim, the UK will run an election on December 12 where Brexit will be the key policy issue that all parties and their candidates run their campaigns upon. While the politics continue to play out and the new government composition will ultimately dictate the shape and timing of Brexit, most financial firms set in motion transition plans months ago and are well-prepared for the Brexit changeover, whatever that may be.

That doesn’t mean cheers of delight couldn’t be heard from the operations, systems, and IT departments at many asset management and other financial services firms at the extension and new deadline. Since October 31 was a Thursday, any systems changes that needed to occur in the Brexit switchover would have had to take place overnight and be ready for trading on November 1. January 31 however is a Friday, which gives technical teams the weekend to make any changes or updates before markets open again for trading on Monday, February 3. It is small nuances like this that can often get lost in the cacophony of political decrees. However, for asset managers and Brexit, the devil is most certainly in the detail and remaining loose ends need to be tied up as best as they can. 

Many asset management firms have transferred assets and staff to EU financial centers such as Ireland and Luxembourg in anticipation of the end of EU financial passport requirements that currently allow UK firms to operate in all EU countries. And in an effort to avoid turmoil in the markets in the event of the upcoming exit, European and UK authorities agreed to keep market machinery well-oiled during a transition period.

UK becoming a third country

While the renegotiated deal is still being worked out, it’s likely on the day the UK exits the EU formally that it will immediately be considered a third country under EU regulations which operate on the basis of equivalence. However, the European Securities Markets Association (ESMA) already reached two key memoranda of understanding with the UK's Financial Conduct Authority (FCA) in February, which allows EU-based UCITS and alternative fund management companies to continue to delegate investment management to UK-domiciled entities.

One of the agreements was a multilateral memorandum of understanding that covers investment supervision, information exchanges, and enforcement. The pact allows them to share information about market surveillance and asset management activities, which will allow outsourcing to UK-based entities to continue.

But another important change is that UK UCITS funds will become third-country alternative investment funds at the stroke of midnight on January 31, if not sooner. One result is that UK alternative investment funds (AIFs) hoping to market to the EU need to depend on each of the 27 members' national private placement regime, which differs from country to country. (Conversely, EU funds need to get passporting privileges to market to UK customers).

Derivatives trading protected

ESMA also has recognized the three UK central clearing counterparties — LCH Limited, ICE Clear Europe Limited, and LME Clear Limited – to permit them to continue providing derivatives services in the European Union for a period of 12 months from the day Brexit actually happens.

In addition, ESMA agreed to allow Euroclear UK and Ireland, a central securities depositary that operates the CREST settlement system used for Irish equities listed on Euronext Dublin and the London Stock Exchange, to operate as “equivalent" for 24 months from Brexit. ESMA said the decision was taken to avoid any negative effects on the Irish equity market.

Regulatory equivalence under review

On the other hand, equivalence may not be granted to UK listed securities under the Capital Requirements Regulation, meaning they would not be permissible investments under the EU Money Market Fund regulations. EU money market funds may have to look beyond UK securities and issuers until such time that equivalence is granted to the UK by the EU.

The EU has granted equivalent status to several third countries whose securities laws and regulations meet the EU's rigorous requirements. But these designations are only temporary, as demonstrated when the EU allowed its equivalence agreement with Switzerland to expire at the end of June, preventing European firms from trading Swiss equities on European exchanges. Increasingly, equivalence appraisals are seen not just through the regulatory prism, but they are becoming more a political tool used in negotiations between various country governments and trading blocs. 

The move regarding Swiss shares may be read as message to the UK that the EU wants to be able to decide whether or not to grant access to its markets as it deems appropriate. There are three areas in which different equivalence agreements are required: UCITS, AIFMD, and MiFID, each with its own nuances.

In addition to the equivalence debate, UK-based firms will still be required to comply with strict rules concerning data protection and privacy because of the General Data Protection Regulation (GDPR) of 2016 concerning data that is sent to a third country. Asset managers must have put in place strict Standard Contractual Clauses at their UK-based entities to remain in compliance with the GDPR.

What’s next

On Tuesday, the UK House of Commons approved a December election after a strong push from Prime Minister Boris Johnson. He hopes that new lawmakers will support his “do or die, come what may” stance and finally follow through with leaving the bloc. However, it’s always possible that the newly elected officials will be just as divided as the current ones. It’s also possible that more than three years since the initial referendum, voters are exhausted from the ongoing debate and reflect that with their vote. Many outcomes are still on the table and asset managers should stay on top of the news, work closely with their service providers, and be prepared for any possible outcome.

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