_ESMA releases consultation paper on Draft technical standards on the provision of investment services and activities in the European Union by third-country firms under MiFID II and MiFIR.
On the day of Brexit (31 January 2020), the European Securities and Markets Authority (ESMA) launched a consultation on draft technical standards on the provision of investment services and activities in the European Union (EU) by third-country firms under MiFIR (Regulation (EU) No 600/201) and MiFID II (Directive 2014/65/EU)1.
This consultation considers the MiFIR and MiFID II positions on the provision of investment services and activities in the EU by third-country firms as amended by the Investment Firms Regulation (EU) No 2019/2033 (IFR) and Directive (EU) 2019/2034 (IFD).
Given the importance of these measures the UK firms, before looking at this in more detail, it is important to note that there are significant caveats to the possibility of EU financial market access by third country firms.
Third Country Access Refresher
As a starting point, it should be noted that enterprises in third countries may opt to establish their own full-authorised and regulated entity under Article 34 of MiFID II, which would allow them to enjoy the freedom to provide investment services and activities. This requires a sufficient level of substance in a chosen host member state, sufficient capital, that the subsidiary’s sound and prudential management are within MiFID II and CRD IV, and the subsidiary must not be unduly influenced by the non-MiFID parent.
Given that the subsidiary would then be fully subject to MiFID II, this is not third country access for these purposes, as the subsidiary would have first country access. The key advantage being that this status allows ongoing access within the EU for these firms, subject to onward passporting requirements.
Beyond this, the two main2 mechanisms for third country access are as follows:
- Article 39 of MiFID II gives member states the option to require a third-country firm to establish a branch if it wishes to provide investment services to retail clients and elective professional clients in that member state; and
- Article 46 of MiFIR gives third-country firms the right to provide investment services or perform investment activities (with or without any ancillary services) to EU eligible counterparties and professional clients without establishing a branch and without being subject to supervision by an EU competent authority.
There are various pre-conditions before either of these mechanisms may be utilised.
For third country access under MiFID II, the key issue is that it is not one of the mandatory provisions under MiFID II, so many countries (including the UK) decided not to adopt it and are permitted to apply their national laws, provided these are not more favourable to third-country firms than the provisions in MiFID II.
Where a target member state allows access under Article 39 of MiFID II, there are significant pre-conditions that a firm and its home state must comply with, including capital requirements, substance and oversight, tax transparency and investor compensation requirements in the third country.
Market access under Article 46 of MiFIR is subject to the firm being registered in a register of third-country firms maintained by ESMA. This is the subject of the IFR and this consultation, but this itself is subject to a significant pre-condition: the European Commission must have first determined that the relevant third country has rules that are equivalent to key EU regulations and has an effective equivalent system for recognition of investment firms authorised under third-country laws. As we know, the UK is day-1 equivalent, but nevertheless, there is a requirement for an equivalence decision.
It should be noted that firms wishing to access eligible counterparties and per se professional clients in Luxembourg, without the benefit of any further EU passporting, may rely on Luxembourg’s domestic provisions, described further here (article p.11).
The above is a brief overview of the challenges, as these are significant topics in themselves, but it should briefly be noted the relevance of the IFR and IFD amendments. These changes include new reporting requirements from third-country firms to ESMA on an annual basis, and also grants ESMA the power to ask third-country firms in the ESMA register to provide data relating to all orders and all transactions in the EU, whether on own account or on behalf of a client, for a period of five years.
The consultation and draft RTS include a draft of the information that would be required in a firm's application under one of these mechanisms, its business activities and the information that would also need to be supplied on an ongoing basis.
This is critical, as any equivalence decision that is given under MiFIR would otherwise be hampered by a lack of RTS around the processes, but this is still not an equivalence decision.
Furthermore, there is no change to the timing of the application procedure under MiFIR. The position is maintained that ESMA has 30 working days from receipt of the application to assess whether it is complete. The ESMA review process for a complete application under MiFIR is still up to 180 days.
Comments on the consultation must be received by 31 March 2020. ESMA will then consider the responses it receives in Q2 2020 and expects to publish the draft technical standards and send the final report to the European Commission for endorsement in Q3 2020.
The timing of the consultation is curious and possibly mischievous, but firms should note that there are still a number of significant caveats to the third country market access positions under MiFID II and MiFIR.
Given what a significant bargaining chip third country market access will play in the Brexit negotiations that will take place throughout the rest of 2020, it’s highly unlikely that any equivalence decision will be granted quickly, regardless of the UK being “day-1 equivalent”. However, even in the event of an equivalence decision, firms would have to wait for the RTS to be in force before they are then able to make an application, and the timing for that application will extend well beyond the end of the Brexit transitional period.
As such, while the consultation and draft RTS are a step in the right direction, the position for UK firms wishing to provide investment services and activities in the EU at the end of the transitional period currently remains the same. As such, firms that need to guarantee their EU market access at the end of the transitional period should select a more politically-resistant market access model that suits the scale of its activities in the EU, whether via a subsidiary or a suitable use of third-party providers.
For any enquiries about structuring access to the EU via Luxembourg following the end of the Brexit transitional period, please do not hesitate to contact our Investment Funds Practice Group or Banking & Finance Practice Group.
2. While there is a limited reverse solicitation provision under Article 42 of MiFID II, given the regulatory scrutiny over this and the fact it is not discussed in the consultation, it is being discounted here. Furthermore, this note does not consider national-level mechanisms for third-country access.