Brexit update: The FCA’s temporary permission regime

HM Treasury has published a number of draft Statutory Instruments (“the Draft Sis”) including a Temporary Permissions Regime (“TPR“) as a temporary measure to replace the passporting regime in Schedule 3 and 4 of the Financial Services and Markets Act 2000 (“FSMA”) in the event of a no-deal Brexit. The legislative framework for the TPR is found in the EEA Passport Rights (Amendment, etc., and Transitional Provision) (EU Exit) Regulations 2018 (SI 2018/1149), enacted on 6 November 2018.The FCA has issued a consultation paper on the TPR for inbound firms and funds, that recently closed on the 7 December 2018, with final rules ready to pubish in early 2019, ahead of the UK’s departure on 29 March 2019 (“Exit Day”).[1]

IN WHAT CIRCUMSTANCES WOULD A TPR BE NEEDED?

The TPR would only come into effect in the event of a ‘no deal Brexit’ (i.e., if no agreement is reached on the terms of the UK’s withdrawal from the EU), in which case there would be no transitional period immediately following the Exit Day.

The TPR is an opt-in regime: firms must, between 7 January and 28 March 2019, either make an application for authorisation under Part 4A of FSMA or notify the relevant regulator of their choice to opt-in.

The TPR would last a maximum of three years and its effect would be to temporarily authorise an EEA-domiciled firm so it could continue to undertake its regulated activities in the UK covered by the firms current passport[2]as if it were authorised under Part 4A of FSMA 2000. The TPR will also permit an EEA-domiciled fund to continue to be marketed to UK investors after Exit Day while the firm or fund seeks, respectively, the authorisation or recognition necessary under FSMA.

Notably, the TPR is a one-way street: it will enable EEA firms to continue to operate in the UK, but it will not enable UK firms to continue to operate in the EEA. At the moment there is no indication that the EU or individual member states generally are considering implementing their own reciprocal regimes.

On the contrary, on 19 December 2018, the European Commission (the “Commission”) began implementation of its “no deal” Brexit Contingency Action Plan, and has stressed that financial operators established in the UK would lose the right to provide their services in the EU27 under existing EU financial services passports in the event the Withdrawal Agreement is not ratified.

The Commission warned financial institutions that wish to provide banking or insurance services in the EU that they should take all necessary steps to be properly authorised by Exit Day, including by establishing a presence in the EU27. It also noted in its Q&A that payment institutions authorised by UK competent authorities would not be allowed to provide payment services in the EU under their current authorisations following a “no deal” Brexit.

WHICH FIRMS WILL NEED TO APPLY FOR A TPR?

The TPR will temporarily authorise a firm to undertake those regulated activities already covered by its passport. The firm will then continue to be an authorised person for regulatory purposes.

The types of firms affected and set out in the FCA’s consultation paper concern the following:

  • EEA firms which passport into the UK under an EU directive (such as the UCITS Directive and AIFMD) and FSMA 2000;
  • EEA firms which have access to the UK’s markets through rights under EU treaties (Treaty Firms);
  • managers of EEA-domiciled AIFs that market those funds in the UK – this includes European Venture Capital Funds (EuVECAs), European Social Entrepreneurship Funds (EuSEFs), European Long-Term Investment Funds (ELTIFs) and AIFs authorised as Money Market Funds (MMFs) under the MMF Regulation;
  • managers of EEA-domiciled UCITS (including MMFs) that market those funds in the UK; and
  • EEA electronic money and payment institutions and registered account information service providers which passport into the UK.

Firms that passport into the UK and have a top up permission[3]will also need to notify the FCA that they wish to use the TPR to ensure that the part of their permission which relies on passporting continues beyond Exit Day.

ENTERING AND EXITING THE TPR FOR FIRMS

Entering the TPR

On Exit Day, the TPR will begin to apply to all firms which opt into it and whose relevant regulator is the FCA (“TP Firms“).A firm wishing to make use of the TPR will have to notify the FCA through its online Connect system.[4]The FCA will then send an email to the firm to confirm that its notification has been received.

On 9 November 2018, the FCA confirmed that the notification window would open at 9 a.m. on 7 January 2019 and would close on 28 March 2019, one day just before Exit Day.[5]Once the notification window has closed, firms that have not submitted a notification will not be able to use the TPR.

Further details of the exact dates, and how to complete the notification process, will be published by the FCA in due course.

In addition to this, the FCA will allocate all TP Firms a ‘landing slot’: a three-month period within which they must applyfor full Part 4A authorisation under FSMA. There will be six landing slots, with the first commencing in October 2019, the last closing at the end of March 2021. The FCA will issue a direction indicating which firms have been allocated to which landing slot and will also write to firms individually confirming their landing slot.

Firms with a temporary permission in the TPR will be shown on the FCA Register.

Exiting the TPR

If a firm does not apply for full authorisation during its landing slot, or withdraws its application without submitting another, the FCA may cancel the firm’s temporary permission.

Firms will exit theTPR upon gaining (or failing to gain) such authorisation or by failing to apply for Part 4A authorisation during theirallocated landing slot.

FCA SUPERVISION

TP Firms will be treated as third country firms with Part 4A authorisation. TP Firms will still fall under the supervision of the FCA and its powers under FSMA, but the FCA will also cover matters which were previously handled by the firm’s home state (such as supervision of the firm’s business carried out in the UK), albeit in such cases firms which comply with their home state rules will be deemed to have complied with the FCA’s rules (i.e. “substituted compliance”). Certain other FCA rules necessary for consumer protection or funding will also apply.

However, the FCA will not cover TP Firms’ home state rules related to capital adequacy, other than those rules that apply to the firm immediately before Exit Day (for example, where the firm has a top-up authorisation and is required to hold certain capital as a result).

As a result, the FCA will apply all of the Principles for Business to TP Firms except Principle 4 (financial prudence). To give effect to this approach, the FCA will introduce a new overarching rule in its General Provisions sourcebook rather than amend its individual sourcebooks. TP Firms will need to apply this approach themselves to determine which FCA rules they will need to comply with. As an exception to this approach, the FCA will introduce a new Chapter 14 in its Client Assets sourcebook to include rules for TP Firms which receive or hold client assets in connection with insurance mediation, implementing the Insurance Distribution Directive.

WHICH FUNDS WILL NEED TO APPLY FOR A TPR?

Only funds authorised or recognised by the FCA can be promoted to retail investors in the UK.

The following funds can continue to market in the UK without the need for a TPR:

  • UK authorised funds (i.e., UCITS, NURS and QIS);
  • funds marketing in the UK using exemptions under the Financial Promotion Order 2001 (as amended) or the Promotion of Collective Investment Schemes (Exemptions) Order 2001 (as amended);
  • non-EEA AIFs marketed in the UK through private placement (including certain feeder funds of a non-EEA master AIF);
  • AIFs recognised under s.272 of FSMA 2000, with the right to market to all investors in the UK; and
  • closed-ended investment companies whose securities are officially listed or admitted to trading on a regulated UK market.

Provided they (a) were eligible to be marketed in the UK under a passport before Exit Day and (b) had notified the FCA for temporary permission, the following funds would be able to use the TPR:

  • EEA-domiciled UCITS recognised under s.264 of FSMA 2000 to market to all investors in the UK;
  • EEA-domiciled AIFs entitled to be marketed to professional investors in the UK under the UK’s AIFM Regulations 2013;
  • EuVECAs and EuSEFs notified to the FCA for marketing in the UK under the EuVECA or EuSEF Regulation before Exit Day; and
  • ELTIFs entitled to be marketed in line with the notification procedures for AIFs.

In the case of an umbrella fund, the TPR effectively operates at sub-fund level but, for a sub-fund to be able to make use of the TPR, it must have been both (a) eligible to be marketed in the UK under the passporting regime before Exit Day and (b) specifically notified to FCA of its intentions.

ENTERING AND EXITING THE TPR FOR FUNDS

Entering the TPR

The notification process for UCITS ManCo or AIFM are the same as per TP Firms. Where a sub-fund has not been included in the notification, that sub-fund may not be marketed under the TPR following Exit Day.

Details of EEA-domiciled UCITS which have temporary permission to be marketed in the UK will be shown on the FCA Register.

Landing slots

Shortly after Exit Day, managers which have notified the FCA of their wish to use the TPR will be allocated a landing slot (as described above) in which to submit an application for recognition under s.272 of FSMA or notification under the national private placement regime (“NPPR”).

The FCA notes that, other than in “exceptional circumstances”, managers will not be able to request changes to their funds’ landing slots.

Exiting the TPR

If a manager failed to apply for recognition (or submit a notification under the NPPR) for a fund during its allocated landing slot, the fund would lose its temporary permission (presumably on the expiry of the landing slot) and the manager would no longer be able to market it on the same basis as before Exit Day.

Equally, if a manager of a fund which has notified the FCA to fall under the TPR and establishes a new sub fund after Exit Day, the new sub-fund could only be marketed to investors in the UK if it was recognised under s.272 of FSMA.

The TPR may be seen as a temporary solution, imposing a holding pattern which enables a firm to take the next step of seeking recognition. As such, the most obvious option for leaving the TPR is for the fund to become recognised for sale to the public under s.272 of FSMA – an avenue to achieving recognition which has, to date, been seldom used.[6]

As above, applications for recognition under s.272 of FSMA, or notification under the NPPR, must be submitted to the FCA using its online Connect system.

Following receipt of a valid NPPR notification, the fund’s manager would receive confirmation from the FCA that the notified fund or funds may start marketing in the UK under the NPPR.

The FCA and HM Treasury intend to provide further information on how funds will exit the TPR in due course.

Failing to notify the FCA

Where a manager fails to notify the FCA in time that it wants to use the TPR to continue to market an EEA domiciled fund to investors in the UK, the fund would not enter the TPR and would lose its marketing passport rights. The manager would have to cease marketing the fund by 11 pm on Exit Day.

Although the manager would be able to reapply to market the fund outside the TPR, approval would take time to process and might be refused – alternatively, the fund may not be granted permission to market to the same category of investors as before.

Changes to funds structure during the TPR

Under the TPR, a manager would be able to continue to market a fund to the same category of client as it was able to before Exit Day. It will not, though, be able to:

  • add new schemes to the funds in the TPR, whether stand-alone or umbrellas;
  • add new sub-funds to umbrella schemes in the TPR; and
  • change or extend the category of client to which it can market while a fund is in the TPR.

FCA SUPERVISION

A fund marketed under the TPR would remain subject to the same UK rules as applied to it on Exit Day and would be supervised by the FCA on that basis. Where a rule applies to the fund or its manager in its home state, however, the FCA will not supervise compliance with that rule.

However, fund managers would be obliged to provide the FCA with updates to fund documents as currently required by s.264 of FSMA or by the AIFM UK Regulations 2013.

Additionally, where information must currently be notified to the fund’s, or its manager’s home state regulator, the fund manager will have to notify the FCA instead. The FCA will provide further information on this in due course.

FEE STRUCTURE FOR THE TPR

The FCA is entirely funded by the firms it regulates and covers its total annual funding requirement for the year through periodic fees, paid annually. The amount needed to meet its funding needs is spread across a series of fee-blocks, which reflect broad sectors of the industry and are based on the regulated business activities that firms undertake in the UK. Depending on the activity and type of firm, the FCA charges periodic fees, or special project fees.

Funds have a separate fee-block within this system.

Funding the TPR

The FCA proposes that there would be no fee for the notification to join the TPR however, an authorisation fee would be payable where a firm exits the TPR by applying for full authorisation. This fee would be linked to the regulated activities the applicant is applying to undertake and the fee-block into which those regulated activities would place the applicant.

Funding for TPR by TP Firms

The FCA proposes that:

  • there would be no fee for the notification to join the TPR;
  • an authorisation fee would be payable where a firm exits the TPR by applying for full authorisation. This fee would be linked to the regulated activities the applicant is applying to undertake and the fee-block into which those regulated activities would place the applicant;
  • firms in the TPR would pay periodic fees from the 2019/20 fee-year generally on the same basis as UK firms;
  • in respect of periodic fees, firms would be allocated to the fee-blocks based on the equivalent UK regulated activities that apply to the passport they hold at the point they enter the TPR;
  • EEA branch firms in the TPR would remain in the fee-blocks that apply for fees calculation purposes at the point of entry to the regime;
  • EEA services firms (which stopped paying periodic fees from 2008/09) in the TPR would now pay periodic fees and would be told, when entering the TPR, which fee-block would apply to them;
  • firms in the TPR would not pay fees to the FCA in respect of prudential regulation (since, as mentioned above, the FCA will leave prudential regulation to the firm’s home member state authority); and
  • periodic fees payable by firms in the TPR would relate to the whole of a given fee year and would not be refundable. This is in line with the situation for UK firms.

Funding for TPR by funds

The FCA proposes that:

  • funds in the TPR would pay periodic fees from 2019/20 fee-year aligned to the current structure, based on the types of funds and number of sub-funds;
  • funds in the TPR would pay recognition fees aligned to the current application fee structure, if they apply for recognition as the route to exit the TPR application fees paid on application would not be refunded if the applicant withdrew its application or the application were refused; and
  • periodic fees payable by funds in the TPR would relate to the whole of a given fee year and would not be refundable. This is in line with the situation for UK funds.

SENIOR MANAGERS AND CERTIFICATION REGIME AND APPROVED PERSONS REGIMES

The Senior Managers and Certification Regime (“SMCR”) currently applies to all firms with permission to accept deposits in the UK and this includes incoming EEA branch firms. Near final rules have been published which will extend the SMCR to all insurers (from 10 December 2018) and solo-regulated firms (from 9 December 2019), including EEA branch firms. The SMCR will replace the Approved Persons Regime (“APR”), which currently applies to individuals carrying out specified roles for relevant firms.

Since some Senior Management Functions in the EU are reserved to the home state regulator; therefore, currently the FCA receives more applications from third-country firm branches than from an EEA branch firms (which will have already applied to their home state regulator).

The FCA intends to maintain the current requirements that apply to an EEA branch firm under the SMCR and (until the SMCR commences for solo-regulated firms) the APR throughout the firm’s time in the TPR.

As a result, the additional controlled functions and requirements that apply to UK branches of third-country firms under SMCR will only apply once an EEA branch firm in the TPR has been fully authorised as a third country branch.

FINANCIAL SERVICES COMPENSATION SCHEME (“FSCS”)

The FSCS is an industry-funded scheme which acts as a compensation safety net for customers of authorised financial services firms. Most incoming EEA firms are not covered by the FSCS but may be covered by a home state compensation scheme if they undertake certain activities in the UK, for example, as MIFID investment firms. The compensation schemes across the EEA offer varying levels of cover in terms of scope and the amounts of compensation that could be paid for a claim.

Accordingly, following Exit Day, customers of incoming EEA firms may lose compensation scheme protection offered by home states.

The FCA aims to address the potential harm of some customers losing compensation scheme protection by requiring that customers of EEA branch firms in the TPR (i.e., firms with a UK establishment) have FSCS protection. This will provide cover equivalent to that available for customers of other UK authorised firms.

FINANCIAL OMBUDSMAN SERVICE

Since it is not currently clear that UK consumers of EEA services firms would continue to be able to access alternative dispute resolution (“ADR”) schemes in other EEA member states if the UK leaves the EU without an agreement, the FCA proposes to include EEA services firms in the Compulsory Jurisdiction (“CJ”) of the Financial Ombudsman Service and to apply its complaints-handling rules to them.

The CJ covers the activities of UK and EEA authorised firms and their appointed representatives if carried out from an establishment in the UK. The FCA’s proposal intends to ensure that clients of such firms will be able to refer complaints to an ADR scheme following Exit Day.

For further information on the TPR, please click here.

For more information or any guidance or advice on Brexit and its implication for the financial service industry, Cleveland & Co external in-house counsel, your specialist outsourced legal team are here to help.

Foot notes

[1]For the full text of the consultation paper, please see: FCA TPR

[2]For a full explanation about passporting rights and equivalence regime, please refer to our previous Brexit newsletter:Impact of Brexit on Financial Services.

[3]Incoming EEA firms, treaty firms and UCITS qualifiers can apply for Part 4A permission where they need to top up their authorisation because part of their business constitutes a regulated activity business in the UK but does not fall under an applicable EEA passport.

[4]Please see: Connect system

[5]Please see: FCA Direction

[6]The FCA indicates that, as at February 2018, only seven standalone funds and seven umbrella funds had been individually recognised under s.272 of FSMA 2000.

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