Today we are starting a series of e-bulletins dedicated to considering the consequences of BREXIT on business in general, starting with the impact of BREXIT on the financial services industry.
There is no denying that the financial services industry is now facing challenging times, where threats will be generally more visible than opportunities yet to be explored.
From a financial services regulatory perspective, one main threat ahead is the risk of losing EU passport rights whilst one main opportunity is deregulation, but both threat and opportunity are only potential at this stage, as the decision to leave the EU is not yet effective and nobody knows the extent to which gains and losses will effectively materialise.
From a purely EU passport perspective, the later the decision to leave the EU enters into force the better, as more time will be given not only to enjoy the passporting regime but also to prepare for facing all possible BREXIT scenarios including the least comfortable one where no immediately available equivalent of the EU passport rights will be made available from or towards the UK.
The question of timing is therefore important. In this respect, Article 50 of the European Union Treaty provides for a 2-year notice for exit unless a withdrawal agreement has been reached earlier or “unless the European Council, in agreement with the Member State concerned, unanimously decides to extend [the two-year] period”. The 2-year notice starts from the date on which the leaving Member State notifies the European Council of its intention (this has not yet been given). From a purely EU passport perspective, as explained above, rushing things would not be the best option.
It is also worth noting that Article 50 (not drafted to be actually enforced but rather to frighten prospective leavers) only says that the “framework” of the future relationships should be taken into account when negotiating and concluding a withdrawal agreement. However, there is no denying that it does make sense that both issues be agreed at the same time as part of the same deal, in order to avoid a black hole in between.
Whether the risk of not relying on a satisfactory equivalent of the EU passporting regime to and from the UK will materialise is uncertain. All depends on the outcome of the negotiations between the UK government and the EU.
If the risk materialises, financial services firms from both sides have a lot to lose, i.e. not only UK financial services firms passporting to the rest of the EU but also EU financial services firms passporting to the UK.
Over the last decade or so, banks, investment firms, asset managers and payment services providers licensed in the UK have been relying a lot on the EU Freedom to Provide Services (“FPS”). Doing business directly out of London has been a dominant trend, with fewer and fewer firms deciding to set up or maintain branches in other EU countries under the EU Right of Establishment (“RE”). Cost, convenience and efficiency have been the key driving factors.
By being stripped of the EU passport to do business across the entire EU market, UK licensed financial services firms would have to rely on locally licensed subsidiaries set up in the EU. The likes of Barclays have already such subsidiaries and would “only” be working on relocating staff and activities on an intra-group basis, subject to seizing sale opportunities. As a general rule, EU branches of UK licensed financial services firms would either have to be closed down or converted into branches of the EU subsidiary chosen to provide services all across the EU (subject to exploring sale opportunities). Smaller firms are likely to be those who will most suffer, as setting up a licensed subsidiary is time consuming, uncertain and costly, as is trying to buy one of the few existing EU licensed businesses available for sale on the market.
EU financial services firms holding a passport to do business in the UK would face similar issues, save that the scale of the reshuffling will be narrowed down to the UK and to London in particular.
The risk of not being granted an immediately available and satisfactory equivalent of the FPS and the RE is only the tip of the iceberg. Below the surface, restructuring of credit syndication or euro trading activities currently centralised in London would need to be carried out. Incidentally but noticeably, one would expect EU supervisory bodies based in London to relocate to a country which will still be part of the EU when the UK effectively leaves it. The EBA is the most visible example of the move ahead.
One should also note that UK licensed banks will no longer be part of the European guarantee deposit scheme once BREXIT becomes effective, which leads to the question whether the UK government will decide to provide better, equivalent or lower protection than that available in the EU.
Whilst losses are still hypothetical and one should not panic at the thought of them materialising, one should also coolly think about the alternative opportunities brought about by BREXIT, including that of deregulation. One should not forget that the financial services industry itself has for years vehemently complained about overregulation in many areas such as regulatory capital, remuneration or investor/customer protection.
However, deregulation does not mean that financial service firms licensed in the UK should stop preparing themselves for complying with EU directives adopted at EU level but yet to be implemented nationally (e.g. MiFID2, AMLD 4 or PSD 2), as the risk of having to comply with them or with equivalent rules when providing services towards EU markets, as part of a possible BREXIT deal, may materialise.
Having said that, opportunities for growing a financial services industry more lightly regulated, turned towards non-EU markets, should indeed be explored as much as the potentiality of losses should be assessed. The current burden of EU regulation on activities turned towards outside the EU should not be overestimated, as EU law does not generally regulate services provided towards non-EU countries as much as it regulates services provided towards the EU. But gaining market shares outside the EU will be challenging as there is no readily available equivalent of the FPS or RE outside the EU and local regulations will continue to apply after BREXIT.
The possibility of enjoying the “best of both worlds” is likely to require restructuring business models to segregate deregulated activities turned towards non-EU jurisdictions from activities turned towards the EU. As many EU regulations apply on a group basis, businesses structured as groups of companies will need to be revisited.
The FIN TECH sector can be partially protected from, and can even continue growing despite the loss of EU passporting rights from and to the UK, but only to the extent of those technology services the provision of which towards the EU does not require holding such rights. However, one example where EU regulation will be soon regulating a significant number of FIN TECH firms is PSD2 (due to enter into force before the 2-year Article 50 deadline), under which licensing requirements will be extended further to reach payment aggregators, initiators and the like. And one cannot rule out that the EU will threaten, and even seek to further extend the scope of what it is subjecting to licensing requirements in order to protect the EU market from outsiders.