ESMA Peer Review on relocation to the EU in the context of the UK’s withdrawal from the EU
On 8 December 2022, ESMA released a peer review into the NCAs’ handling of relocation to the European Union (“EU”) in the context of the UK’s withdrawal from the EU (the “PR”). ESMA was to ensure a level playing field among jurisdictions in the context of relocation of entities and activities from the UK to the EU. The PR aims at assessing the application by national competent authorities (the “NCAs”) of the relevant requirements set out under the regulation and clarified in the ESMA Opinions when authorising relocating entities and activities from the UK to the EU.
NCAs of Cyprus, France, Germany, Luxembourg, the Netherlands and the Republic of Ireland were reviewed but the recommendations provided for in the PR concern all NCAs. National supervisory practices are not unified in specific areas such as governance and substance requirements set for relocating firms. Thus, such areas could benefit from further convergence work.
The PR covers the assessment of three distinct types of sectors: firms providing investment services and activities (MiFID firms), (ii) trading venues and (iii) fund managers. The PR shows that the supervisory practices of some NCAs did not meet supervisory expectations, notably regarding the overall number of senior managers and human and technical resources and (ii) NCAs allowed for an extensive use of outsourcing/delegation arrangements. These results raise the question whether an adequate part of the activities has actually relocated into the EU and (ii) how autonomous and independent the relocated entities are. Consequently, ESMA provides for recommendations which aim at strengthening the authorisation process of the NCAs, without being limited to the Brexit one-off event (the “Recommendations”). The Recommendations relate to the same topics for each of the three sectors covered by the PR. First, regarding MiFID firms: *on governance ( i.e. on the interpretation of Article 9(6) of MiFID II), the Recommendations pertain to the setting up of requirements as to the minimum time that senior managers should be committing to the management of the firm, (ii) the setting-up of concrete and effective materiality threshold on alternative arrangements when a firm will be managed by only one managing director, (iii) the setting up of conflict of interest policy at authorisation stage and its review by the NCAs and (iv) dual hatting situations;
on outsourcing, the Recommendations pertain to the assessment of situations where extensive outsourcing arrangements may render an applicant firm a letter-box entity, (ii) the existence of outsourcing arrangements at the moment of the authorisation or, at the very least, at the commencement of operations, (iii) increased control over outsourcing arrangements made into group entities that may lead to conflicts of interest;
on the independence of internal control functions, the PR recommends that all NCAs increase scrutiny before allowing the combination of control functions with other functions (such as executive, operational or other control functions);
on both governance and substance requirements, the PR recommends that NCAs establish a formal process for recording all conditions of authorisation and (ii) implement a formal process to ensure follow up regarding the phasing out of transitional arrangements.
Secondly, regarding trading venue:
On governance, the Recommendations pertain to the setting-up of clearer minimum requirements with respect to the overall governance structure of trading venues, (ii) the establishment of more concrete safeguards to strengthen the autonomy of the boards and to limit the actual influence of the group on its EU subsidiary. It is also recommended that all NCAs set in place concrete controls and checks during on-going supervision to monitor the effectiveness of the decision-making powers that lie with relocated trading venues and their boards.
On intra-group outsourcing, the PR recommends that all NCAs apply controls and checks, tailored to the nature and inherent features of intra-group outsourcing, that are typically required for outsourcing of activities to third-party providers, as part of on-going supervision. In addition, all NCAs shall adopt systematic and formalised IT checks and controls, given the increasing importance of IT issues for trading venues. Finally, NCAs should encourage the relocation of certain activities and (ii) limit outsourcing to duly justified cases such as technical support for the execution of core activities.
Thirdly, regarding fund managers including both external AIFMs and internally managed AIFs as well as UCITS management companies and self-managed UCITS investment companies, the PR focuses on independent and effective decision-making, (ii) safeguards against conflicts of interest, (iii) adequacy of the role of internal control functions, (iv) sufficiency of staffing and technical resources, (v) assessment of delegation arrangements and (vi) monitoring of White Label service activity.
Regarding governance, the PR recommends that all NCAs introduce a more systematic and thorough approach to reviewing delegation arrangements and (ii) potential and actual conflicts of interest during the authorisation stage and scrutinising more closely the combination of responsibilities, roles, functions or reporting lines which may result in a conflict of interest or impair the principle of independence of control functions. They should also have in place a more systematic and thorough approach to review key policies and procedures of applicant firms, including the adequacy of human and technical resources and (ii) the establishment and strong role of internal control functions, verifying in particular the appropriate interaction between portfolio and risk management and sound escalation procedures.
Regarding the monitoring of White Label service activity, the PR stresses on the need to have White Label service providers in each jurisdiction, notably Brexit-related White Labelling arrangements and (ii) improve supervisory convergence in relation to the authorisation and supervision of fund managers providing White Label services.
Finally, the PR sets forth good practices that have been identified in each NCA, subject to the PR.
Should you have any questions on the above, please do not hesitate to contact one of our experts of the regulatory team and of the funds team.  Article 9(6) of Directive 2014/65/EU of the European Parliament and of the Council on markets in financial instruments (MiFID II) states: “Member States shall require that at least two persons meeting the requirements laid down in paragraph 1 effectively direct the business of the applicant investment firm. By way of derogation from the first subparagraph, Member States may grant authorisation to investment firms that are natural persons or to investment firms that are legal persons managed by a single natural person in accordance with their constitutive rules and national laws. Member States shall nevertheless require that: (a) alternative arrangements be in place which ensure the sound and prudent management of such investment firms and the adequate consideration of the interest of clients and the integrity of the market; (b) the natural persons concerned are of sufficiently good repute, possess sufficient knowledge, skills and experience and commit sufficient time to perform their duties.”