On 1st June 2017, ESMA has published an opinion setting out general principles to support supervisory convergence in the context of the United Kingdom withdrawing from the European Union1, in particular as concerns the relocation of entities, activities and functions from the UK (the Opinion).
The Opinion takes into account the European Parliament resolution and the European Council guidelines following the UK’s notification under Article 50 TEU2 and has been issued due to the increased requests from financial market participants seeking to relocate to the EU27.
In this respect, ESMA seeks to ensure that the EU27 National Competent Authorities (NCAs) will follow a consistent approach dealing with firms relocating from the UK in order to avoid supervisory arbitrage risks.
To achieve so, ESMA establishes nine general principles (General Principles) for the authorization, ongoing supervision and enforcement of relocating firms including the criteria to be met for the delegation and the outsourcing of essential and critical activities such as management’s delegation for management companies and AIFs’ managers.
These General Principles have been specified on the assumption that the UK will become a third country after its withdrawal from the EU and are the following:
- Principle one : No automatic recognition of existing authorisations ;
- Principle two : Authorisations granted by EU27 NCAs should be rigorous and efficient ;
- Principle three : NCAs should be able to verify the objective reasons for relocation ;
- Principle four : Special attention should be granted to avoid letter-box entities in the EU27 ;
- Principle five : Outsourcing and delegation to third countries is only possible under strict conditions ;
- Principle six : NCAs should ensure that substance requirements are met ;
- Principle seven : NCAs should ensure sound governance of EU entities ;
- Principle eight : NCAs must be in a position to effectively supervise and enforce Union law ; and
Principle nine: Coordination to ensure effective monitoring by ESMA.
II- Scope of legislation and issues covered by the Opinion on relocation activities
The Opinion covers all legislation referred to in Article 1(2) and (3) of the Regulation (UE) n°1095/2010 establishing ESMA, in particular Directive 2011/61/EU (AIFMD), Directive 2009/65/EC (UCITS Directive) and the Directive 2004/39/EC and Directive 2014/65/EU (MiFID I and MiFID II).
Additionally, the Opinion on relocation activities is largely focused on relocating firms’ outsourcing or delegation arrangements. Notably, ESMA raises awareness on the fact that “There cannot be any automatic recognition of the authorization granted by the UK regulator into the EU27” and that “Any outsourcing or delegation arrangement from entities authorised in the EU27 to third country entities should be strictly framed and consistently supervised.”
III- Key Topics covered by the General Principles
1. Objective reasons for the relocation in the EU27
NCAs are instructed to check and verify that the relocation’s requests will be driven by EU 27 based activity and will meet objective criteria3.
In this regard, candidates to the relocation must present a programme of operations to justify their request for relocation covering both:
- the geographical distribution of planned activities including the targeted clients/prospective investors, and
- the location of development of products or services.
2. Rejection of letter-box entities and key functions to keep inside the EU27 (substance requirements) for the outsourcing and delegation to third countries
NCAs are instructed to “reject any relocation request creating letter-box entities where extensive use of outsourcing and delegation is foreseen”.
In particular, ESMA highlights that outsourcing and delegation to third countries is only possible under strict conditions, and is conditional on the ability of the entity which wants to delegate/outsource to third countries to direct and control outsourced and delegated functions.
Additionally, outsourcing and delegation arrangements should not have an impact on business continuity, confidentiality, and conflicts of interest. Therefore, the Opinion states that the following key activities and functions cannot be outsourced or delegated outside the EU:
- internal control functions ;
- IT control infrastructure ;
- risk assessment ;
- compliance functions ;
- key management functions ; and
- sector-specific functions.
3. Avoidance of regulatory arbitrage inside the EU27
ESMA stresses that NCAs shall be vigilant to identify where an entity may seek authorization in a Member State in order to evade stricter standards in force in other Member States.
To promote consistent decisions by NCAs , ESMA will establish new practical convergence tools in the form of a forum-the Supervisory Coordination Network- for reporting and discussions among NCAs regarding market participants seeking to relocate entities, activities or functions to the EU27.
4. On-going supervision of outsourced or delegated activities to third countries
NCAs are requested by the Opinion to lead continuous-basis controls to verify that i) the objective reasons to relocate and ii) the substance requirements are met not only at the time of the authorization but on an ongoing basis.
In addition, ESMA expects NCAs to ensure that any outsourcing or delegation does not impact their ability to enforce the relevant legislation, and should be able to conduct on-site inspections of outsourced or delegated activities or functions without any prior third party authorization.
Key executives and senior managers of EU authorized entities should be employed in the Member State of establishment and work there to a degree proportionate to their envisaged role, if not on a full-time basis.
NCAs have to check that EU entities comply with governance requirements and that they have the ability to effectively control the outsourced or delegated activities or functions.
6. Next steps
ESMA is set to adopt further sector-specific guidances in July. Three opinions are expected to provide sector specific details on the aspects described in today’s general opinion as regards asset managers, investment firms and secondary markets.
ESMA may also deploy other supervisory convergence tools, such as issuing Q&As, providing additional opinions to NCAs, and conducting peer reviews.
IV- FROG’s initiative to increase Paris Market Place attractiveness
Launched in February 2016 on the initiative of the Autorité des marchés financiers (AMF) and the French Asset Management Association (AFG), the FROG initiative as stated in its report is to “offer both French and foreign players a choice to domicile their investment funds in France under optimal conditions for their international development”.
To implement the recommendations in this report, the AMF has amended on March 2017 its General Regulation4 to increase the transparency about i) conditions to be met when to delegating key functions such as the financial management of a fund to another authorized entity established in a third country provided that ii) there is effective cooperation between the AMF and the supervisory authorities of the relevant country5.
In particular, the Articles 313-72 and 318-58 of the AMF General Regulation and the AMF policy on delegation of the financial management have been updated respectively on 8 and 15 March 2017 to clarify on which extent French management companies can delegate their financial management function to third countries firms.
In this respect, the delegation set-up should be implemented in order that:
- the delegating asset management company has control risk functions with suitable experience on strategy and the underlying assets ; and
- the delegating asset management company may ensure an efficient control.
However, a full delegation of financial management is only possible if i) strengthened risk controls and risk management are implemented and ii) to the extent the French management company does not become a letter-box firm.
As a result, the revised AMF framework is consistent with the Opinion while already allowing French management companies to delegate fully their financial management function, provided that they maintain internally the essential risk controls.
CMS Bureau Francis Lefebvre is part of the French ecosystem and very supportive of the FROG initiative. Our experts that have already assisted their clients in benefitting from these new possibilities stand ready to help you to analyse and implement your reorganization plan.
1 On 29 March 2017 the United Kingdom (UK) notified the European Council of its intention to withdraw from the European Union pursuant to Article 50 of the Treaty on European Union. The withdrawal will take place on the date entry into force of a withdrawal agreement, or failing that, two years after the notification on 30 March 2019.
2 European Parliament resolution of 5 April 2017 on negotiations with the UK following its notification that it intends to withdraw from the European Union (2017/2593 (RSP)); European Council guidelines on 29 April following UK’s notification under Article 50 TEU (EUCO XT 200004/17).
3 Inspired by the concept of the Member State of reference under AIFMD for the authorization of third country AIFMs.
4 Articles 313-72 and 318-58 of the AMF General Regulation and the AMF policy on delegation of the financial management have been updated respectively on 8 and 15 March 2017.
5 22 march 2017, FROG: the AMF updates its policy on the asset management delegation, CMS BFL publication: https://cms.law/en/FRA/Publication/FROG-the-AMF-updates-its-policy-on-the-asset-management-delegation