EU regulator warns UK companies against use of letterbox companies

UK financial firms have been warned they will not be allowed to set up letterbox companies in the EU following Brexit in order to get around supervisory rules in an opinion published by the European Securities and Markets Authority (ESMA)

 The opinion is targeted at national competent authorities (NCAs) in the  EU27 member states.

ESMA wants to build a common approach to dealing with firms that wish to continue to benefit from access to EU financial markets support supervisory convergence in the context of increased requests from UK financial market participants seeking to relocate to the EU27. It covers all legislation referred to in the ESMA regulation, in particular the AIFMD, the UCITS Directive, MiFID I and MiFID II.

Steven Maijoor, ESMA chair, said: ‘The UK plays a prominent role in EU financial markets and the relocation of entities, activities and functions to the EU27 creates a unique situation requiring a common effort, at EU level, to safeguard investor protection, the orderly functioning of financial markets and financial stability.

‘Firms need to be subject to the same standards of authorisation and ongoing supervision across the EU27 in order to avoid competition on regulatory and supervisory practices between member states.’

ESMA claims that UK-based market participants may seek to relocate entities, activities or functions to the EU27 in order to maintain access to EU financial markets.

Financial institutions in the UK are already eyeing up relocation options with Dublin and Brussels top of the list. Yesterday, insurance giant RSA announced plans to set up a European headquarters in Luxembourg, while earlier in the year Lloyds of London targeted Brussels.

There is already an issue with letterbox companies in Europe, highlighted at an EU tax committee grilling of Jean-Claude Juncker on 31 May, where MEPs questioned the use of Madeira and Luxembourg as a registration centre for multinationals operating across the EU.

ESMA wants to minimise the transfer of activities or functions from the UK into the EU27, through outsourcing and offshoring functions while retaining the main operations in the UK.

It added that this ‘outsourcing and delegation could generate supervisory arbitrage risks’. It warns that any outsourcing or delegation arrangement from entities authorised in the EU27 to third country entities should be ‘strictly framed and consistently supervised’.

‘Outsourcing or delegation arrangements, under which entities confer either a substantial degree of activities or critical functions to other entities, should not result in those entities becoming letterbox entities nor in creating obstacles to effective and efficient supervision and enforcement,’ warned ESMA.

The EU27 NCAs need to prepare to handle more requests for authorisation and supervision.

ESMA will set up a forum - the  supervisory coordination network – to monitor and discuss cases about relocating UK market participants.

ESMA sets out nine principles, including:

  • no automatic recognition of existing authorisations; authorisations granted by EU27 NCAs should be rigorous and efficient;
  • NCAs should be able to verify the objective reasons for relocation;
  • special attention should be granted to avoid letter-box entities in the EU27;
  • outsourcing and delegation to third countries is only possible under strict conditions; 
  • NCAs should ensure that substance requirements are met;
  • NCAs should ensure sound governance of EU entities; 
  • NCAs must be in a position to effectively supervise and enforce EU law; and
  • coordination to ensure effective monitoring by ESMA.

ESMA’s opinion on general principles to support supervisory convergence in the context of the UK withdrawing from the EU is here

Reporting by Pat Sweet and Sara White

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