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Brexit - Some thoughts on the impact on financial services

05 August 2016

On 23 June 2016, 52% of voters in the UK referendum voted ‘Yes’ to the proposition that the UK should ‘leave the European Union’. The UK remains a member of the European Union (“EU”) until Brexit occurs, and therefore there will be no immediate change to the legal relationship the UK has with the EU and with individual EU Member States. Nonetheless, as the other articles in this briefing section indicate, the longer-term consequences of leaving the EU are potentially far reaching, although behind the already well-worn cliché of “Brexit means Brexit” lie many possibilities for the future relationship of the UK with the EU.

The long arm of EU regulation – but little change likely for Brexit Britain

Nowhere is this more clearly illustrated than in the area of financial services.  Here, the effect of EU directives and regulations is profound, governing such matters as the marketing of investment products and the conduct of business of those that operate in this area.   Banking, insurance (both life and general), investment business and collective investment management are all subject to EU requirements.  Add to that provisions governing anti-money laundering and market abuse, and it is not difficult to see how the financial services landscape could drastically change if, post Brexit, the UK decided to make fundamental alterations to existing regulation.

The important word in that last sentence, of course, is ‘if’.  Whilst it will in theory be possible for the UK, shorn of the need to conform to EU regulation, to make a complete break with that regulation and start again, in practice that is highly unlikely.  Whatever economic benefits there might be from ‘light touch’ regulation, political reality means that any major attempt to water down existing requirements and protections is a non-starter – the financial crash of 2008, and the part played in that by major financial institutions, still casts a long shadow.  In addition, even as a country outside the EU, the UK will remain bound by commitments made in other fora that impact on financial services, such as at the G20, so it will not be an entirely independent player.  Although outside the EU it would be easier for the UK to introduce a less demanding regulatory regime in some areas to encourage new entrants (and given the work the Financial Conduct Authority (“FCA”) has already done through ‘Project Innovate’ for fintech and other innovative businesses, we can expect some developments here), widespread change in the short term to the present arrangements would be very surprising.  

Keeping (or losing) one’s passport

A key aspect of many of the directives that govern financial services is the availability of a ‘passport’ that enables a firm established in one EU country to provide services in another EU country on a cross-border basis, or via a branch, on the basis of its ‘home state’ authorisation.  Thus German banks operating in London, or UK banks operating in Frankfurt, can do so without needing to be authorised by the relevant ‘host state’ regulator.  The least disruptive version of Brexit in this area would be for these passporting arrangements to continue, although this issue is almost certain to be linked to freedom of movement, concerns about which were (it would seem) one of the main reasons why voters in the referendum voted for Brexit. 

One relatively straightforward way in which UK firms could maintain their current passporting rights and arrangements would be if the UK were to access the EU single market via membership of the European Economic Area (EEA), in the way in which, for example, Norway (which is not a member of the EU) does currently.  However, in exchange for accessing the single market, Norway has agreed to the free movement of persons from EU Member States to Norway.  At the very least, it is difficult to see how UK financial services firms can continue to exercise passport rights in EU Member States without the UK agreeing to freedom of movement, as Norway and the other non EU members of the EEA (Iceland, Liechtenstein) have done.

It may be that the UK will be able to negotiate with the remaining EU Member States an accommodation whereby the financial services passporting arrangements remain in place.  If that is the case, then there will be little change to the present regulatory landscape.  UK firms will continue to operate as they do now, although the UK’s ability to make changes to present requirements would be limited (as the passport regime is predicated on there being common standards of authorisation and regulation in the countries which are able to take advantage of passport rights).  But if the UK is not able to do this, then those firms currently operating under a ‘passport’ will lose their right to do so and will need to conform to the local requirements that may apply.  One big difference that would result would be that branches of UK passporting institutions (such as banks, insurance companies and investment firms) would require to be authorised by the local regulator, rather than being able to rely on their ‘home state’ authorisation by the FCA (and, in some cases, by the Prudential Regulation Authority).

What should firms do now?

The silver lining in all this is that until Article 50 of the Lisbon Treaty is triggered, the formal process of leaving the EU will not begin – and the UK in any event cannot leave the EU until, at the earliest, two years from the date the trigger is pulled.   Nonetheless, UK firms currently operating via branches in other EU Member States may wish to consider what options are currently open to them in order to avoid potential disruption to their business at a future date. 

We have already seen certain EU jurisdictions, such as Ireland, making the point that by establishing an entity subject to local regulation, institutions that are currently established in the UK and access the financial services single market via their UK passport would be able to maintain access to that market post-Brexit, regardless of the eventual deal struck between the UK and the remaining EU.  As the entity in this example would be authorised in the EU, branches of the entity would be able to be established in other EU Member States, and services provided from that subsidiary cross-border, on the basis of its ‘home state’ authorisation.  In other words, the institution would continue to enjoy EU passporting rights, albeit the passport would be issued by another EU Member State and not by the UK.  For those foreign firms who have established operations in the UK as a means of accessing the EU financial services markets via a UK passport, such as American banks, and who need the certainty of being able to do so post Brexit, this may be an attractive option, although not a free one, as the new entity would need to be properly capitalised to meet regulatory requirements.

All that said, it seems unlikely that there will be a wholesale exodus from the UK of financial services firms until what Brexit may mean for them becomes clearer.  And even if Brexit removes the access to the EU financial services market that UK established financial services firms currently enjoy, that fact is likely to be signalled well before it actually occurs, thus giving firms a transitional period with time to plan on the basis of certain outcomes, rather than vague possibilities. 

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