Hard Brexit – outsourcing as a way out?
The latest political developments have not reduced the likelihood of a “hard Brexit” on 29 March 2019. In this article, we sum up the regulatory consequences of a hard Brexit for cross-border banking and financial services and look at the possibility of outsourcing as an option.
No more passporting after a hard Brexit
A hard Brexit would clearly mean that regulated banking and financial services institutions no longer profit from the “European passport” in cross-border legal transactions with the United Kingdom. The passport allows institutions from Member States of the European Union (EU) or the European Economic Area (EEA) to provide their services in other EU/EEA Member States. If the European passport were to cease to apply with the onset of a hard Brexit and if no interim solution is found, institutions would need a special licence from the local regulators to be able to continue their business operations in the country concerned (see interview with Kai-Michael Hingst: “Passporting rights after Brexit”). UK-based institutions wanting to do business in an EU/EEA Member State from the United Kingdom after a hard Brexit would then have to obtain a special licence from that EU/EEA Member State, and institutions based in the EU/EEA would need a special licence from the regulatory authorities in the United Kingdom.
Involving subsidiaries by way of outsourcing
As an alternative to applying for new licences, an institution can consider integrating existing entities in the target country, such as subsidiaries, and by means of outsourcing. Such outsourcing would in principle be possible in two directions: (i) A licenced institution in the UK outsources activities and processes to an EU/EEA entity which is able to use an existing licence throughout the EU/EEA by passporting. (ii) A licenced EU/EEA institution outsources activities and processes to an entity in the UK, for instance in order to leverage the existing language skills and business connections for its own business in the UK. By integrating existing business and HR structures in this way, it will be possible to maintain considerable synergies in individual cases and to avoid having to invest the time and money needed to apply for a new licence.
Applicability of the outsourcing principles
It is true that, up to now, no details exist of how group companies will work together following a hard Brexit. Nevertheless, the fact that the UK will become a third country under supervisory law if it comes to a hard Brexit does not automatically mean that such cooperation is ruled out. However, the regulators will be strict about ensuring compliance with the principles for outsourcing applying up to now. This involves three main aspects: (i) The possibilities for outsourcing core banking areas and front-office activities remain limited. (ii) The German Federal Financial Supervisory Authority “BaFin” will continue to ensure that there is an adequate supervisory framework with wide-ranging rights on the part of the outsourcing institution (based for example in Germany) to issue instructions to the service provider (based for example in London). (iii) In service agreements between a (German) subsidiary and an (English) parent company, certain rights of information and control by BaFin as the home-country supervisory authority must be guaranteed.
No “empty-shell banks”
As the European Banking Authority (EBA) has indicated, there is a “hard” boundary in place for outsourcing structures to prevent the emergence of empty-shell companies in EU/EEA Member States that would otherwise in effect trade solely from the United Kingdom (see EBA/Op/2017/12, p. 13 onwards). So in the event of a hard Brexit it will not be possible for a bank domiciled in the United Kingdom to use a Frankfurt subsidiary for the continental European market as an “empty-shell bank”, but to continue to provide key banking services from London, for example. This makes it all the more important to plan and adapt outsourcing structures to fit requirements in the short and medium term.
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Any Questions? Please contact: Prof. Dr. Dr. Kai-Michael Hingst; Dr. Karl-Alexander Neumann
Practice Group: Financial Services Regulation