Brexit: What?s in store for UK?s Financial Sector?

By Sandeep Thomas Chandy

The Brexit is about to pose an incredible challenge to the UK and especially London which is the financial hub for the world. With a majority of Britishers and British politicians opting for a hard Brexit over a soft Brexit, all ties between the European Union and the UK would soon be severed. One of the biggest challenges a hard Brexit would pose for financial services operating in the UK and European Union would be the loss of their “passporting rights”.

What are Passporting Rights?

Passporting is a regulatory provision that permits financial firms based and regulated in one EU state to provide service across the union without the need for licenses in other EU states. The regulatory provision permits the financial service to operate in other EU states purely based on the home state authorisation.

This provision was introduced in 1995 and has been expanded and deepened through a series of directives issued by the EU regulator. The EU’s financial and services market regulator regulates these services and formulates rules which are binding on the state regulators.

What are the options available

There are two options before the UK if it wishes to retain its passporting rights. The first option is where the UK stays in the European single market through the European Economic Area like Iceland, Liechtenstein and Norway. This would difficult for hardliner Brexiters as the European Economic Area (EEA) comes with riders in the form of free movement of persons, goods, services and capital. However, Financial Times has reported that this scenario is now plausible due to quarrels and confusion in the UK’s ruling Conservative Party.

The second option is where UK based financial firms establish their subsidiaries in EU. This would allow the UK firms to obtain passporting rights for their subsidiaries. However, this involves extra costs for the UK firms and additional infusion of capital into these subsidiaries for meeting EU’s regulatory norms.

The third and last option is regulatory equivalence. This is an arrangement where two or more countries recognise each other’s’ regulatory standards. The first such deal for the UK was with the US on mutual access to derivatives market. However, EU’s equivalence agreements till date have been limited in scope. EU’s equivalence agreement with Egypt and Russia covers only audit framework and transitory regime. The one with Argentina covers just legal and supervisory framework of credit rating agencies. Presently, the EU equivalence arrangements only in limited sectors. Banking is one sector where EU does not have equivalence arrangements.

The cost of these options

According to the Financial Conduct Authority, around 5,500 UK registered firms hold passporting rights for conducting business in the EEA. And about 8,000 EU registered firms hold passporting rights to do business in the UK. A hard Brexit would effectively terminate passporting rights of these 13,000 odd firms.

In an analysis by management consultancy firm Oliver Wyman, a Brexit with passporting and equivalence rights and access for UK firms to EU markets similar to what they have now will cause only a modest disruption in UK-based activity. The estimated decline in revenue due to the disruption would be approximately £2BN and loss of tax revenues would be less than £0.5BN per annum. If UK is not able to retain passporting and equivalence rights and maintain access to EU markets, the loss would be approximately £18-20BN in revenue and £3-5BN of tax revenues per annum.

The Way Forward

On 12^th July, the UK Government published a 98-page white paper setting out in detail the deep trading partnership the U.K. wants with the EU. This white paper forms part of UK’s negotiating position with EU over future trading relations. According to the white paper, UK’s financial services would no longer enjoy the interconnectivity it had with EU’s single market thus ruling out the possibility for passporting rights post-Brexit. The white paper also states that the current form of equalisation regime is ill-equipped to handle the deep interconnectivity it has with EU. UK has therefore proposed for a new economic and regulatory arrangement with the EU in financial services that “would maintain the economic benefits of cross-border provision of the most important international financial services traded between the UK and the EU – those that generate the greatest economies of scale and scope – while preserving regulatory and supervisory cooperation, and maintaining financial stability, market integrity and consumer protection.”. Through this arrangement, the UK wishes to retain its regulatory autonomy and at the same time ensure interconnectivity.

The financial sector has lambasted the government’s white paper for giving up passporting rights for regulatory autonomy. Also, most of the EU members are against giving UK deep access after Brexit. It remains to be seen how May’s government would handle the situation.

Sandeep Thomas Chandy is a Research Fellow at Centre for Trade and Investment Law, Ministry of Commerce and Industry