The UK/EU free trade agreement: 10 points for financial services firms

With a free trade agreement between the UK and the EU agreed on Christmas Eve, there is now more visibility on the regulatory landscape for firms engaging in UK/EU cross-border financial services from 1 January 2021.

The agreement deals with financial services, albeit in skinnier terms than it does for goods and other services. The use of technical language, including the definition of financial services and prudential carve out provisions, similar to that in the WTO General Agreement on Trade in Services (GATS), perhaps highlights the similarity of the terms of the agreement with those the UK and EU would have received under WTO arrangements.

Moreover, some aspects such as the UK/EU financial services regulatory co-operation arrangements have not been agreed and represent outstanding business for the UK and EU to address in the first quarter of 2021.

Overall, there are few surprises for financial services, given the utterances from both sides leading up to the agreement, however these are our key take-away points for financial services firms.

1. The agreement does not provide passporting rights like those in the EU single market: UK and EU financial services firms will need local authorisation. EU headquartered firms that relied on passport rights to engage with UK clients will have to rely on the UK’s temporary permissions regime with a view to becoming FCA or PRA authorised, or cease to do business in the UK, or limit their activities to the terms of the UK’s overseas person’s exclusion. A UK firm doing business with EU clients will need to be authorised in an EU member state, or rely on exclusions, or temporary relief. These include the temporary “equivalence” decisions on, for example, the clearing of OTC derivatives.
2. The “level playing field” provisions are not directly relevant to financial services regulation. These are limited to “unfair competition” in subsidies and labour and social, environment or climate protection. The agreement also includes a commitment not to weaken tax legislation below OECD standards. The provisions, however, address subsidies in the context of the rescue and support of failing banks and insurance companies, and they lend strong support to climate and ESG commitments. Their likely indirect impact is more difficult to gauge.
3. The agreement does not address regulatory co-operation in financial services. By comparison, this was a feature of the EU-Japan Economic Partnership agreement. There is, however, a joint declaration stating that the UK and EU will agree by March 2021 a memorandum of understanding (MOU) establishing the framework for structured regulatory co-operation on financial services. It will aim to provide the “transparency and appropriate dialogue in the process of adoption, suspension and withdrawal of equivalence decisions”. It does commit the UK and EU to common international financial crime standards and requires them to use best endeavours to ensure that these, together with measures against tax evasion and avoidance, are implemented and applied in their territories.
4. The agreement does not address equivalence decisions. There is no single equivalence decision that would maintain the UK and EU’s level of access which each enjoyed to the other’s markets until the end of 2020. Instead there are over 40 possible equivalence decisions with a set administrative process both in the UK and the EU. Noting that there is also no obligation in the agreement to review financial services laws to improve trade between the UK and EU, it is not clear whether there will be any dispensation for the UK, the EU or their firms when making an application for recognition or registration. The MOU noted above will, hopefully, make the position clearer.
5. The agreement commits the UK and EU to establish a favourable climate for development of the trade in services. It sets out individual requirements, including those based on non-discrimination that are reminiscent of those for third country firms contained in directives, such as CRD IV. It also imposes limitations on restricting access, such as no restriction on types of legal entity or joint ventures for business, or imposition of nationality requirements on directors. In addition, it imposes limits on the UK and EU restricting the provision of “new financial services” and access to central bank payment and clearing systems, and funding and financing facilities. However it recognises the right of the UK and EU to determine their own regulatory practices, some of which the "prudential carve out”, noted above, and “reservations”, noted below, address.
6. The agreement limits the UK or EU in requiring a business to establish a local presence as a condition for the cross-border supply of a service. It also allows the entry and temporary stay of business visitors for establishment purposes and the entry, temporary stay and employment in its territory of intra-corporate transferees for various periods and short-term business visitors for a period of 90 days in any six month period, without the need for work permits. It recognises, however, that a local presence may be required for prudential purposes and the “reservations”, noted below also address local presence requirements. Moreover, the limits on the types of visitors that may enter the UK/EU suggests that anyone selling services directly to the public will not be able to rely on the exemption.
7. The agreement contains “reservations” which may limit rights under the agreement on providing financial services in the UK and in individual member states. For UK firms, EU Reservation 12 for “existing measures” and 16 for “future measures” and for EU firms UK Reservation 9 for “future measures” are directly relevant for financial services. Some, such as the requirement that depositories to UK and EU funds, and the mancos of authorised funds must be UK or EU headquartered, as the case may be, overlap. Others, such as the requirement in Italy, Hungary and Portugal that limits the management of pension funds and certain other investments to EU managers, are not. Would-be UK insurance providers, in particular, will need to check whether they require a local presence in the same EU member state as their intended clients.
8. The agreement does not set limits on the delegation of services from the EU to the UK. In the field of portfolio management, in particular, this has raised issues with ESMA’s comments on delegation to third countries in the context of revisions to the AIFMD challenging the more accommodating stance taken in speeches by their chair, Steven Maijoor. Silence in the agreement, given the EU had sought to refer expressly to limitations on delegation, is positive for UK firms although the issue has not gone away and sufficient substance requirements for EU offices of UK firms are likely to remain important.
9. The agreement allows tariff free movement of goods across borders and commits to the freedom to transfer capital and make cross-border payments. Although a UK firm using EU goods in its business is less likely to suffer business disruption than would have been the case had there been “no-deal”, it should still check the effect of the agreement on its suppliers. Although the agreement recognises the power of each party applying measures on matters such as bankruptcy and trading in financial instruments, these must not be applied arbitrarily or to disguise restrictions on capital transfers or cross border payments and “temporary safeguard measures” may only be taken in “exceptional circumstances” and for no more than six months.
10. The agreement facilitates digital trade and provides temporary relief for personal data transfers. Together with prohibiting unjustifiable restrictions on where data can be stored and transferred across borders, the agreement commits to things such as the conclusion of contracts by electronic means, access to source codes and clear and thorough information in digital communications. It also commits to the protection of intellectual property, including trade secrets. However, because the EU does not have sufficient time to pass the necessary delegated acts to grant the UK data adequacy, a “bridging mechanism” of up to six months to allow personal information to be shared in accordance with GDPR obligations has been agreed.