Anxiety over the UK’s planned exit from the European Union transcends any single industry. Political discourse has yet to provide the crystal-clear certainty that businesses of all shapes and sizes urgently require to be able to adequately plan, invest and grow – which is why firms have subsequently been forced to read between the lines and start planning for the worst-case scenario of a no-deal Brexit without the benefit of having any official advice or tangible policy.
Cadbury is stockpiling chocolate ingredients, drug companies are buying up every pill they can get their hands on, and multinationals like Unilever are now refusing to invest any further in London. Yet, Brexit’s potential impact on chocolatiers pales in comparison to the ways in which a no-deal Brexit could totally redefine Europe’s financial sector and its ancestral home in London.
That’s why industry bodies such as the British Banker’s Association, the Association of British Insurers, the City of London Corporation and TheCityUK have been attempting to issue urgent guidance on how banks and financial services providers should be preparing for every scenario.
Over the course of 2018, there’s been a surge in financial institutions heeding those calls, implementing changes and kick-starting new processes to mitigate the threat of a bad Brexit deal – and a huge proportion of those changes stems from justifiable fears that banks and payments providers will soon be kissing goodbye to the EU’s convenient passporting system.
Wave goodbye to the EU’s passporting system
The EU’s current passporting system for banks and financial services providers is a mechanism that allows approved firms in any EEA state to trade freely with minimal authorisation. The scheme offers nine different passport types for financial services companies to apply for to provide core B2B and B2C banking services – and to enjoy use of each type of passport, individual EU member states must adhere to the associated regulatory regime and enshrine it into domestic law.
Unfortunately for those based in the City, the EU’s hassle-free passporting is totally unavailable for non-EEA companies. Because financial services providers operating outside the EU already struggle with cross-border regulatory barriers when attempting to provide banking or investment products to counterparties and consumers within the single market, the UK’s inability to leverage the EU passporting system will seriously disrupt the City’s access to EU customers and clients.
There are theoretical workarounds. First and foremost, removal from the passporting system will only affect a UK financial services provider’s right to sell – not the right of EU customers to buy. That means a firm in Italy would still be able to get in touch with a UK-based financial services company and purchase a financial product on an unsolicited basis.
But that hardly gives solace to UK-based financials that are already heavily embedded in European markets.
There is also scope for the UK to be granted ‘third country’ status in Europe. This would allow the UK’s non-EU based financial services providers to extend certain products or services to EU markets, if the UK agreed to adopt a relevant regulatory regime accepted by Brussels as being ‘equivalent’ to EU financial law.
It’s this route of equivalence that seems to be the UK Government’s best hope of securing certainty for the City. Yet as with virtually every other aspect of the ongoing Brexit negotiations, implementation of the equivalence model is anything but certain.
Equivalent regimes for equivalent access
When delving into the equivalence model and its potential applications for the UK as a non-EU member state, it’s crucial to bear in mind that it is by no means a one-size-fits-all regulatory solution. The benefits of equivalence do not tend to be uniform for all companies or third countries, and are known to vary wildly depending on the specific European law being used to grant access. Generally, equivalence is less secure, covers less areas and takes years to implement.
Having said that, third-countries granted equivalent access to the single market’s financial services sector can ordinarily expect to enjoy at least a minimal degree of access rights for their banking institutions – including favourable treatment for local EU branches and a more open regime surrounding an EU financial institution’s ability to maintain exposures to a foreign bank or financial services firm.
Of crucial importance is the fact that EU equivalence is not something the UK can negotiate. It is something the UK Government needs to request. After that request is made, EU officials would then theoretically launch a series of assessments at their leisure – and after equivalence is granted, it can be revoked at any time. For this reason, the road to equivalence is most likely going to be fairly rocky from a political point-of-view.
However, it nonetheless appears to be the UK Government’s route of choice to safeguard the City’s global influence.
Although it has since deeply fragmented Theresa May’s cabinet and ignited a couple of key resignations, the Brexit roadmap produced in July at Chequers did spell out guidance for UK financial services providers in the event of a no-deal scenario. That guidance makes for a somewhat sobering read, too.
May has proposed a Temporary Permissions Regime (TPR) that will effectively allow EEA companies, payments providers, and account information service providers currently passporting into the UK to continue operating on that basis for a transition period of up to 3 years, after which time they can apply for full authorisation to UK regulators.
That’s spectacular news for EU firms wanting to do business with UK service providers, but the Government has admitted this planned transition arrangement is unilateral. EU states have yet to formally offer the same sort of deal to UK-based companies currently passporting into the single market, and not all analysts are confident it will be extended.
Soundbites on daily news programmes make clear that it is the UK Government’s intention to secure a similar temporary access scheme for UK financial services providers operating in the EU prior to March 2019, and British politicians certainly appear confident a long-term equivalence scheme is on the horizon.
In the meantime, financial industry representatives and government bodies alike are advising financial services providers that there are only a few sure-fire ways to mitigate the looming threat of a no-deal Brexit – and the top safety measure is simply moving overseas.
How are financial services planning for a no-deal scenario?
Believe it or not, the UK Government’s own Brexit guidance issued in August advises UK financials who are currently passporting that their best bet to ensure they can continue trading in Europe after Brexit is to establish an EEA-based subsidiary. In turn, service and product offerings would theoretically go uninterrupted, and there would be enough time before March 2019 to transfer existing business over to freshly incorporated EU subsidiaries.
According to researchers at Ernst & Young, just over one third of financial services companies based in the UK are considering moving operations and staff over to the EU if they haven’t already.
Standard Chartered has applied to German and European regulators to transform its Frankfurt branch into a full-blown subsidiary by the end of 2018; Bank of America has selected Dublin as its new European headquarters; Barclays began buying up office space in Ireland and Citigroup is planning to launch a new subsidiary in Frankfurt by the end of 2018.
On the flip side, there has also been a noticeable rise in European companies incorporating a UK subsidiary through Companies House to circumnavigate any lack of equivalence post-Brexit. Yet, industry preparation extends far beyond simply attempting to lure EU companies across the Channel.
Another key mitigation effort has been for financial services providers to kick-start assessments of their existing contracts and do everything they can ensure the continued validity of those agreements.
Contract continuity will hit areas like insurance, derivatives and pensions particularly hard – and although the ABI has pointed out a huge aspect of this continuity rests on regulatory convergence. TheCityUK maintains – as part of its Brexit guidance – that transferring contractual arrangements to a new entity is one of few solutions available to private sector firms to mitigate uncertainty.
Lloyds has already acted on that advice, and is in the process of transferring all relevant contracts from London to Brussels, where it will be launching a new subsidiary on 1 January 2019. That subsidiary is already approved to start trading and capitalised under Solvency II, and it will immediately take over writing all non-life risks from EEA states.
In turn, Lloyds has claimed Brexit will not impact their trading rights or their ability to fulfil customer contracts in the slightest.
Unfortunately, not all UK financial services providers have the capacity or resource to launch an overseas subsidiary or drop everything to transfer and validate contracts to a new corporate entity. Industry bodies say smaller start-ups and their businesses are still very much in the hands of the UK Government, and its ability to negotiate a favourable equivalence deal for financial services providers both at home as well as in the EEA. For those firms unable to act, uncertainty will continue to pester their businesses well beyond 29 March 2019.