Brexit and financial services
Six months to go. The inevitability of Brexit is now pretty much universally accepted. In a best case scenario, agreement will be reached on the terms on which the UK leaves the EU in time for a no-deal scenario to be avoided. This will be combined with a political declaration as to the future UK-EU relationship, and a transitional period will then be put in place until the end of 2020 to enable some form of arrangements to be agreed for Britain’s future trading relationship with the EU outside of the internal market and customs union.
Most industry sectors have contingency plans more or less in place if they are not already in the process of implement- ing them. There are few sectors, however, where the potential impact of Brexit will be quite as significant, and the implications quite as far reaching, as for financial services. Key issues concern the end of Euro-denominated clearing through the City of London through so-called central counterparties, the loss of passporting rights that currently provide financial institutions with EU wide access to financial markets, the end of free movement for the European employees and managers, on whose expertise the City of London currently depends, the continuity of cross-border contracts with and between financial institutions, and doubts about the legal framework for the cross-border transfer of data between the UK and the EU currently governed by GDPR, to name but a few. Financial institutions have already moved some staff and service lines out of the UK and more are likely to follow. Lloyds of London has set up an operation in Brussels. The European Banking Authority is leaving London f’or Paris.
For the UK, these are by no means theoretical problems: in 2016, financial services contributed some 119 billion GBP to the British economy, half of which was generated in London. Britain has a significant trade surplus with the rest of the world in financial services (some 60 billion GBP in export compared to imports of just about 10 billion GBP) and 44 percent of financial services exports go to the EU.
So how is the UK preparing the financial services sector for Brexit? The European Union (Withdrawal) Act 2018 envisages that, on the day of Brexit, all existing and directly applicable EU legislation (the so- called ‘acquis communautaire’) will automatically be incorporated into British law and continue to apply. In the area of financial services, it is difficult to see how this will work in practice, given that EU financial services law relies significantly on regulatory bodies (such as the EBA, ESMA, EIOPA and ECB) which Britain will cease to be a member of at the same time. The withdrawal legislation therefore envisages that the newly nationalised EU law will be adapted where necessary to the new circumstances. In the context of financial services regulation, this will require UK bodies, such as the Financial Conduct Authority, Prudential Regulation Authority and Bank of England, to be given the requisite powers and structures both nationally and for cooperating with their EU and other international counterparts. Little has so far happened in this respect.
The recent and now much debated Chequers proposal provided no comfort to the financial services industry, given that it jettisoned a future reliance on passporting rights before they even reached the negotiating table. Instead, the UK is aiming for regulatory independence from the EU, combined with an expanded equivalence framework, mutual recognition of equivalence, supervisory cooperation and regulatory dialogue. Existing free trade agreements between the EU and third countries, such as Canada, Japan and South Korea make no or only very limited provision for financial services and therefore do not provide a template for closer cooperation, and the EU has so far not been for the idea of including financial services in a possible future free-trade agreement with the UK.
And if there is no deal? The government sought to answer this question with its technical paper Banking, insurance and other financial services if there’s no Brexit deal, published on 23 August 2018. It proposes inter alia to put in place a temporary permissions regime that will allow EEA firms currently passporting into the UK to continue to do so for a limited time and further proposes to implement a temporary recognition regime for non-UK central counterparties to ensure continuity of clearing services for UK firms. At the same time, the government recognises that the UK will lose access to the EU financial market infrastructure, including Target 2 and SEPA.
So what are possible outcomes of Brexit to the financial services industry? At present, it looks most likely that the current EU third country regime and equivalence rules will be applied to the UK, combined with a formalised process for bilateral consultation. Let’s hope that a transition period will not only be agreed but also be used effectively to put in place workable solutions for the future of the financial services industry.