Banxit – What now?
Structuring Options for UK and other Third Country Institutions
On 24 June 2016, it became official: 51.9 per cent of the electorate voted for an exit of the United Kingdom from the European Union. This vote is not legally binding. However, the UK government will not be able to ignore the outcome of the referendum. The exit negotiations have not yet started and it is presently entirely unclear when and with what result they will end. It appears very unlikely that access to the Common Market will be granted without acceptance of just those EU standards from which the Brexiteers wished to escape.
As a consequence, the UK would officially become a “third country”, i.e. a state which is neither a Member State of the EU nor a state party to the Agreement on the European Economic Area (EEA). Banks and MiFID investment firms (institutions) from third countries do not benefit from the European passports (branch or cross-border passport). UK institutions will therefore have to restructure their EU activities. This will not only affect institutions of UK origin, but also groups from other non-EU Member States utilising their London subsidiary as a hub to conduct banking business and provide financial services in EU Member States.
If the plan is to retain a physical presence in Germany, there are the following options: either the German EU branch can give up its regulated activities and merely operate as a representative office, whose activities, however, would be very limited and would not even allow marketing activities for the UK institution. This is therefore not a very attractive option. Or the German presence applies for a local licence. Such a licence is available as a third country branch licence (presently held by numerous banks with their origin in the US, Asia or the Middle East). Alternatively, the German branch could be converted into a subsidiary with its own licence.
The regulatory effort for both of these options is comparable in terms of own funds requirements as well as proper organisation including risk management and controlling. The German subsidiary would have the advantage of the EU passport and could therefore be used as the new EU hub. The branch solution would avoid the onerous transfer of the business operation which is exacerbated, in particular in the case of retail banks, by the inflexibility of UK law, which complicates transfers without clients’ consents.
A UK bank could, as a third option, scale down its German operation to a mere introductory function which may, depending on the nature of the intermediated business, require only a financial services licence which is much less onerous and costly to maintain than a full banking licence. Such a financial services institution would be limited to the marketing and client relationship management for its UK parent which would also be the “booking centre” for that business.
If it is planned to close the German presence (and to concentrate on cross-border business) or to apply for a mere financial services licence, the UK institution would require an exemption from the German financial regulator (BaFin) as both the cross-border marketing of the UK institution’s products and services in Germany (via Internet, email, mail, telefax, etc.) and the German subsidiary’s marketing activities for its parent, as a general rule, trigger licensing requirements for the UK institution. BaFin has exempted not only various German undertakings (e.g. trust companies, utility companies and purchasing co-operatives) but also numerous foreign (primarily Swiss, but also US, Canadian and Australian) institutions from German licensing requirements.
One of the pre-conditions for such an exemption is that the manner in which business is conducted in Germany does not require supervision. As a consequence, foreign institutions must be subject to prudential supervision in accordance with international standards in their home state by authorities which are willing to co-operate with BaFin.
However, marketing to private clients requires intermediation of an EU credit institution; only Swiss banks benefit from the privilege to market directly to private clients if they complete a so-called “simplified” notification procedure. Institutional clients (Federal Government, Federal states, municipalities, BaFin-regulated entities as well as medium-sized and large corporations), on the other hand, can be contacted directly or by the aforementioned introducing agent.
It should be noted that the third country branch licence and the exemption procedures are not based on EU rules and will be amended or replaced by EU regulation in the coming years.
By way of example, MiFID II provides that already from 2018, third country firms must establish a branch in each Member State where they wish to provide investment services to private clients and those clients who opted for treatment as professional clients if so required by the respective Member State. This branch must meet certain EU standards but generally does not benefit from an EU passport itself. An EU passport would only be available for the provision of investment services to professional clients (by nature) and eligible counterparties and only once the European Commission has determined the equivalence of the third country standards with EU standards.
As a consequence, if it is envisaged to establish a sustainable structure for access to the German (and simultaneously to the entire EU) market, there are very good arguments for the establishment of a German branch provided the business plan justifies the resulting additional costs.
No German licence requirements exist for banking and investment services provided outside German territory exclusively upon the client’s express request. However, this so-called “passive freedom of service” (or “reverse solicitation”) is no sustainable business model! Only institutions wishing to continue their German business exclusively from the UK without intending to acquire new clients could live with this approach.
If the UK institution does not wish to turn its back on the German market entirely, it should now commence its analysis of various alternative business models to find the best fit for its business. All models have in common that they require a thorough preparation and a subsequent licensing or exemption procedure. Practice shows that these procedures normally take at least 12 months and, in the case of banking licences (due to the involvement of the European Central Bank), could take even significantly longer.