Guernsey offers big lessons for City's post-Brexit regulation

Photo: Tom Tardif

Lyndon Trott, Guernsey Finance chair believes that the island is the right haven for the financial community

Lying 70 miles off England’s south coast is the island of Guernsey. It has a population of around 63,000, a thriving financial community and is home to prominent financiers, including private equity titans Jon Moulton and Guy Hands.

And it is not part of the European Union or the UK.

Instead, it and the other Bailiwick – Jersey – are self-governing Crown Dependencies with their own elected politicians, legal systems and fiscal responsibilities. Specifically, Guernsey operates under Protocol 3 of the UK’s own Treaty of Accession to the European Community, which means it is part of the EU’s single market for goods, but out of it for services and people.

In the EU’s eyes, its finance industry is effectively a third country for regulatory purposes. That is significant because the finance sector plays an important role in Guernsey’s economy, estimated to have contributed 33.4% of all output in 2015.

That relationship gives Guernsey the freedom to pick and choose which EU rules it wants to comply with, and those areas where it wants the freedom to pursue a looser, or tougher regime. In some areas of finance it operates a dual regime – allowing firms to opt in to an EU-like regime to gain access to the European bloc.

But if Guernsey’s popularity makes some believe the UK should use it as an example for what to push for in Brexit negotiations, they probably have not looked at the Channel Islands’ situation in detail.

On each of the three main pieces of financial regulation, Guernsey has had to fight to be heard and has sometimes had to make hard decisions.

Still waiting on AIFMD

One of Guernsey’s specialist areas is investment funds, of which more than 1,000 are domiciled or administered on the island.

In the case of the EU’s Alternative Investment Fund Managers Directive, which aims to protect investors in investment funds spanning private equity, hedge funds, infrastructure and even wine, Guernsey acted quickly: it decided to pursue a dual regulatory regime.

That means it has created an EU-equivalent regulatory regime for those firms that want access to the EU through a third country passport, and another regime for investment managers that want to market their funds outside the EU.

Belinda Burgess, head of Channel Islands at Chicago-headquartered Northern Trust, said that without the dual regime under AIFMD, some US managers would look to other jurisdictions.

“We’re having examples of funds that may have domiciled elsewhere in the world that, given their distribution, investors now are starting to look far more to: what is your governance, what is your practice, how are you regulated?”

“So they’re looking to Guernsey because Guernsey is known for all of that. We are seeing business move from other jurisdictions because of that strong regulation and governance practice that exists here,” she added.

Fully AIFMD equivalent rules were put into effect in Guernsey from January 2014, in anticipation of one day being able to market funds throughout Europe through a third party passport, but until then funds are being marketed to EU investors under individual member states’ national private placement regimes.

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The current status is far from ideal for a jurisdiction such as Guernsey, which is keen to receive a green light from the EU in order to be sure of its status.

The European Securities and Markets Authority backed the extension of a third country passport under AIFMD in July 2016, following an assessment of the Bailiwick and 11 other non-EU jurisdictions. But Guernsey cannot celebrate until Esma’s advice is agreed on by the European Commission, Parliament and Council.

The process has been going on for a while – in July 2015, Esma had already recommended that the AIFMD third country passport be extended to Guernsey, along with Jersey and Switzerland, but the Commission asked for more details – and some believe it is because question marks remain over the status of the US.

Gregg Beechey, a corporate partner at law firm Fried Frank, said: “Some believe that the reason the Commission hasn’t put the third country passport in place yet is because the US hasn’t got a tick. Politically if you’re the EU and you want to open up a third country passport, until the US is on the list you probably can’t do it.”

Complexity with Mifid II

There are similar questions for Guernsey to address on the revised version of the EU’s trading rulebook, the Markets in Financial Instruments Directive and its associated Regulation, coming into force in 2018.

One issue is that pursuing a dual regime is potentially more complex in the case of Mifid II, which contains a provision for equivalence. Whether or not to seek equivalence under Mifid II is under active consideration in Guernsey, but there are questions to be answered in the wake of Brexit.

One issue causing difficulty is that AIFMD and Mifid II are different beasts. Whereas AIFMD is a product-based regime – oriented around funds – Mifid II is based around services. Essentially, funds have specific rules that mean they are either in line with AIFMD or they are not, but it could be hard to say that a stockbroker in Guernsey is Mifid II-compliant one day but not the next.

William Mason, the director-general of the Guernsey Financial Services Commission, the island’s financial regulator, said: “We have, for example, as Guernsey, market access to market to professional clients in the UK and, unless the UK changes its own regime, Mifir doesn’t interfere with that. It’s not in that sense maximum harmonisation.”

Living without Solvency II

On the issue of Solvency II – a regime designed to harmonise insurance rules across the EU – the island took a different approach. It rejected the chance to seek equivalence under Solvency II largely due to the burden it would create for Guernsey’s speciality: captive insurance.

“We decided we could, frankly, live without it,” said Mason. He cited the island’s smaller, nimbler insurance companies. “Unless you are a multibillion-euro insurance company [some of the Solvency II requirements are] very hard.” The objection is more to do with the compliance burden and cost associated with Solvency II rather than the capital requirements.

Picking its battles

Guernsey is upbeat about its future, partly because it feels it knows how to navigate the EU system to lobby for its interests.

Frequently negotiating alongside Jersey – the pair have a staffed Brussels office together – the challenge is often choosing its battles.

According to Andrew Sloan, director of financial stability at the Guernsey Financial Services Commission, it’s a case of going through each sector, determining where equivalence is desirable and where it is not.

Sloan said: “If you imagine the EU’s single market as a menu, then actually we go item by item on the menu. We work to market equivalence on that dossier-by-dossier basis.”

But it does not always get its own way. Mason said: “Some items on the menu will say ‘out of stock’ for us because the EU has for whatever reason decided to erect trade barriers and there are no third country access provisions.”

Despite the challenges, Stephen Ozanne, a Guernsey-based senior associate at offshore legal specialist Walkers, believes the set-up is far ahead of the UK. “At the moment it’s unclear whether or not in order for the UK to keep its access to the single market, will it be able to have the same regimes we have here – the dual regime – or will they actually have to apply all European financial services rules and regulations. So that uncertainty will be a problem for the UK – we’ve already got the certainty on that here, and a track record, so that’s where the UK is certainly going to be playing catch-up,” he said.

Others, such as Lyndon Trott, the chairman of Guernsey Finance and the island’s deputy chief minister, think the opportunity for the UK post-Brexit lies in its global approach. “You could argue that because of globalism, because of the Commonwealth, if one nation on earth genuinely understands the global community, it is Britain,” he said.

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