Absent the unanimous agreement of all EU member states, the UK will leave the EU exactly two years later, and the UK and its financial service sector will become a “third country” under EU financial services legislation.
Brexit secretary David Davis is right when he says that we will have “the most important negotiation for this country for a generation”. Get it wrong and things may be bleak for a sector which contributes over £190bn to the UK economy, and almost 12% of the country’s GDP. There is however the potential to get it right, and although there will be stresses, things may end up rosy.
The impact of Brexit on the UK financial sector will depend on three things: the adequacy of the withdrawal agreement between the UK and the EU; the extent to which UK-based financial firms move operations before any agreement (adequate or not) is concluded; and the overall resilience of the UK financial sector to Brexit, through its broader global relationships and position.
The superiority of political choice above economic rationale in negotiations means that no one can predict how the UK financial sector will be disrupted or need to realign its business. We do though know the best and worst outcomes which may come from the talks.
Without passporting rights, UK firms must have state level authorisation to perform regulated activities in other EU countries. This is particularly burdensome where multi-state authorisations are required, and is subject to co-operation and goodwill from local regulators. The rosiest outcome is that the UK financial sector retains its passporting rights, either through the UK remaining in the EEA, or negotiation into the withdrawal agreement. If this happens, long term disruption may be limited.
If passporting rights are not negotiated, then UK firms may need to take advantage of Third Country Regime (TCR) access provisions. These are regimes established under EU rules covering third country established firms. Under existing EU law TCRs provides rights of access below passporting for financial services, such as conducting certain regulated activities, providing wholesale investment or portfolio management services; or fund management services, without further authorisation requirements from an EU member state.
The TCR solution will only work if our EU counterparts decide that corresponding parts of the UK’s regulatory and legal system are equivalent to those in the EU: a political decision. Many of the currently passported activities such as UCITs funds, deposit taking, and insurance mediation and distribution, would not be able to rely on TCRs as they currently stand. There would though be some existing benefit for market infrastructure activities such as UK clearing houses providing services to EU customers.
There are two further alternatives: establishing an EU branch or subsidiary. Branch access is not currently available in all areas of financial services, and indeed has been rarely used. Depending on the number of jurisdictions where a firm does business, it could also be necessary to establish multiple branches. Political will and negotiations will determine the viability of this.
If a UK firm established an EU subsidiary it would be able to advantage of existing EU passporting rights. This advantage would be accompanied by the disadvantage of transferring all or some of the UK business to the EU subsidiary. This could be simpler if the withdrawal agreement allowed operational functions, or a substantial part of them to remain in the UK: a brass plaque approach. Again, this would be a matter of political negotiation.
So in the absence of a deal, the UK financial services sector will come under pressure. However, the UK financial services industry should not lose sight of its place in the globe, and its ability to previously overcome adversity. That there will be some impact is inevitable. Indeed in the last few days, Goldman Sachs, AIG and Morgan Stanley amongst others have announced plans to start moving some jobs across to other EU jurisdictions. Frankfurt, Luxembourg and Dublin are already leading beneficiaries.
Will this be more than a trickle? It’s too early to tell, but the UK has survived worse challenges to its dominance, and it is well-placed to do so again.
Edmund Parker, head of banking & finance, Mayer Brown