The Impact of Brexit on Financial Services Trading Between UK and European Firms

 

Author

Aodhan Devlin

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Published
Monday 10 August 2020
Brexit

In the General Election of December 2019, the Conservative Party managed to secure their largest majority since 1987, running on a promise to “Get Brexit Done”. Almost immediately following this election, the Government finally managed to secure a consensus in parliament for a withdrawal agreement. This came into effect on 23 January 2020 (just over a week before the deadline to leave the EU with an agreement), allowing them to start work on achieving this goal. What still remains to be seen is what “Get Brexit Done” entails. Does the securing of a withdrawal agreement mean that the Financial Services Industry can breathe a sigh of relief having avoided a potentially disastrous and feared ‘Hard Brexit’, or are there still further difficulties ahead?

Passporting

In order to determine the effect that leaving the European Union will have on the UK’s Finance Industry in the UK, we must first look at how the industry operates at the moment. Financial Services currently make up around 7% of the UK’s overall economic output[1], with the City of London acting as the Financial Services capital of Europe, trading with and hosting thousands of European registered firms. As part of the “European Single Market”, these firms currently rely on a system of “Passporting”.

Passporting is a right enshrined in several EU directives[2] which allows any firm which is authorised to operate in any country within the European Economic Area (EEA) to access the markets of any other country within the EEA, without requiring further approval from any regulatory bodies.

Transition period

The UK has entered a transition period until the end of 2020 wherein it is technically no longer part of the European Union or any of its political institutions, but will still be able to enjoy the “four freedoms” of the single market (the free movement of goods, capital, people and services). This allows UK financial institutions to rely on their Passporting rights to trade with EU firms as they did prior to the withdrawal agreement, and vice-versa.

This will undoubtedly be somewhat of a relief, as it gives banks valuable time to implement their various Brexit transition strategies and to tie up any remaining loose ends. However, although a withdrawal agreement has been agreed, this does not mean that a no-deal scenario is off the table. If by the end of 2020, the UK and EU fail to negotiate a trade agreement (and provided there is no extension to the transition period), the UK will lose access to the single market and will have to find other solutions to continue trading with the EU.

Affiliate firms

A common strategy that many firms have adopted is to open new affiliate entities in cities situated within the European Union, for example, Dublin, Paris or Frankfurt. This allows UK based firms to migrate existing trading agreements with their European counterparties from their UK based entity to the new EU based entity.

However, this is a costly and time-consuming endeavour as it involves registering a new company, applying for new credit ratings, buying new office space, hiring/relocating staff, not to mention mass repapering of potentially thousands of trading agreements. Nevertheless, this has been a strategy taken by a number of firms including JP Morgan, Goldman Sachs and Morgan Stanley[3], potentially as an insurance measure in the scenario that UK and EU negotiators do not reach an agreement in time.

Equivalence

Another proposed solution is to rely on ‘Equivalence’. This is a system in which the EU reviews the regulatory structure of countries outside the single market to determine if they are equivalent to their own regulations[4]. Theoretically, given the City of London is one of the world’s largest financial centres and no stranger to the EU’s robust regulations, especially in the wake of the 2008 Financial Crisis, it should have no problem meeting the conditions required for equivalence. Indeed, the UK and the EU laid out their commitment to securing equivalence for the financial sector by July[5].

Nevertheless, equivalence is a unilateral decision made by the European Commission with no input from the UK, and therefore is not guaranteed. Further, as EU financial regulations are essentially a patchwork system by nature, relying on equivalence will inevitably result in a level of access to the market which is inferior to that which the UK currently enjoys, and which will involve significantly more red tape.

Temporary Permission Regimes

Another approach that some European firms have taken to mitigate the loss of access is to rely on a Temporary Permission Regime (TPR). A TPR allows EEA firms that are currently passported into the UK to continue operating within the UK for up to three years after the exit date. They can then use this time to apply for any relevant authorisations they need to continue to trade[6].

Some downsides of this measure are that (as the name suggests) they provide only temporary relief and are also only one-way. Individual EEA countries will still need to reciprocate by implementing their own TPR arrangements in order for UK firms that are passporting into the EEA to benefit from them, otherwise, these firms will need to rely on an alternative approach.

Brexit and COVID-19

In recent months, we have witnessed the development of the Coronavirus pandemic across the world, and the disruption this crisis has caused to every aspect of life, Brexit being no exception. The UK and EU’s leaders have quickly had to shift every bit of their attention towards their response to combatting the pandemic. Meanwhile, the banks have had to adjust to a majority of their workforces moving to working from home, while facing almost unprecedented market volatility and the looming threat of a potential recession. In light of this, it would seem logical for the UK to request an extension to Brexit talks. However, a spokesperson for Downing Street has denied that they will be asking for an extension or accepting one if offered. Whether this is out of a sincere commitment to the promise of “Get Brexit Done”, or merely an exercise in political brinkmanship, is impossible to say. What is clear is that the COVID-19 crisis has raised the stakes of a potential no-deal Brexit astronomically.[7]

Conclusion

As with most things Brexit related, the future of the UK and EU’s trading relationship in Financial Services is impossible to predict. We do not know what kind of agreements the negotiators will eventually come up with but, as we have seen, the uncertainty surrounding Brexit has already caused numerous firms to move their business away from the UK. On the other hand, we have also recently seen over 1,400 EU based firms apply to use the TPR to operate in the UK, of which over a thousand have never operated in the UK before[8]. It would, therefore, seem that for many firms, despite Brexit, the reputation of London as the financial hub of Europe still holds strong. What remains to be seen is what effect potential of triple-threat of Brexit, COVID-19 and a global recession may have on the future of UK finance.

 

References

 

[1] https://researchbriefings.parliament.uk/ResearchBriefing/Summary/CBP-7628#fullreport

[2] https://www.bankofengland.co.uk/prudential-regulation/authorisations/passporting

[3] https://www.theguardian.com/politics/2018/nov/29/london-to-lose-800bn-to-frankfurt-as-banks-prepare-for-brexit

[4] https://www.ft.com/content/fc85d94e-0a28-11ea-b2d6-9bf4d1957a67

[5] https://ec.europa.eu/commission/sites/beta-political/files/revised_political_declaration.pdf

[6] https://commonslibrary.parliament.uk/research-briefings/cbp-7628/#fullreport

[7] https://www.thetimes.co.uk/article/7088f200-92d6-11ea-b833-0d83599da676?shareToken=5d851a8b35ef737044b696d17eb1175d

[8] https://www.bovill.com/london-set-to-remain-financial-services-capital-of-europe-as-over-1000-eu-firms-plan-to-open-uk-offices/

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