Brexit financial services deal will be difficult

The industry has accepted that so-called “passporting” rights will not be possible after Britain leaves the EU. The concept of “equivalence” has been mooted as a solution but even agreeing to that will be difficult.

Negotiations are about to begin on the future relationship between the UK and the EU post-Brexit. Financial services will feature prominently in these negotiations as the industry is strategically important both for the UK and the EU 27.

For the UK, financial services exports to the EU are a major contributor to employment and tax revenue. For the EU, London is an important financial centre providing services to its corporates and governments. But some in the EU are uncomfortable at having its financial centre outside of its jurisdiction, and some EU states, France particularly, are keen to attract business from London. Agreeing a solution will be difficult.

The industry has accepted that passporting will not be possible after Britain leaves the EU, possibly with the benefit of a transitional period. The concept of “equivalence” has been mooted as a solution. The EU allows some financial services to be provided by businesses in jurisdictions based outside the EU if their regulatory regimes are deemed equivalent to those of the EU.

But the equivalence arrangements cover only a fraction of financial services, are at the discretion of the Commission and can be withdrawn at virtually no notice. The industry and the government are agreed that this is not an option. The industry has been promoting the concept of mutual market access – the EU and the UK agreeing to recognise each other’s regulatory regimes, with a disputes mechanism to settle differences. The government has now adopted this as its official position.

What is the prospect of success? Early indications from the EU are not favourable – the concept was immediately dismissed by the Commission and more explicitly by the French government. Michel Barnier has rightly pointed out that no free trade agreement has a significant financial services content. However, that argument is weakened by the fact that the mutual recognition concept was put forward by the EU in the TTIP negotiations with the US.

This does not alter the fact that securing agreement will be difficult, as the concept does not fit into the EU framework. To have any hope of success Britain will have to blur its red lines in other areas such as the jurisdiction of the European Court of Justice and budget contributions.

But in the meantime the clock is ticking. Financial institutions have no choice but to prepare for a worst-case, no-deal, scenario. Agreement on a transition is helpful but it does not have legal certainty and regardless of any comfort that regulators may offer this may not be sufficient for some customers and therefore for the businesses themselves.

Financial services businesses with cross-border operations have all developed their post-Brexit plans – collectively devoting huge resources to doing so. These are at varying stages of being implemented, depending on the nature of the business and the way that the business is currently organised. Subsidiaries are being established in the EU 27 and some functions are in the process of being transferred. This is generally being done with the minimum of publicity – there is no advantage to a business in seeking publicity for relocating activities as a result of Brexit.

For the most part businesses are doing the minimum necessary. Major location decisions will be taken some years into the future, when the final relationship between the UK and the EU is settled and businesses are able to evaluate effectively the merits of alternative locations.

So what will the effects be? Brexit will not destroy the UK’s financial services sector – the industry will adapt as it always has done and London will continue to be one of the world’s leading international financial centres. But Brexit will result in a smaller proportion of the total market being based in London and the UK, the extent of the reduction depending on the outcome of the negotiations.

A worst-case scenario could mean the loss of 70,000 jobs and some £10 billion annually of tax revenue, according to the most authoritative study by the consultants Oliver Wyman.  A best-case scenario – adoption of mutual market access – will mean that the adverse effect will be negligible.

What about the effect on the EU? No single financial centre will come near to supplanting London. Frankfurt, Dublin and Luxembourg, and to a less extent Paris, Berlin, Brussels and Amsterdam, will gain some business, as will Singapore and particularly New York, which could prove to be the biggest beneficiary of Brexit.

The financial markets in Europe will fragment to some extent, which is likely to result in less efficient markets and therefore a higher cost of financial products, although probably not to the extent that European corporates will die in a ditch to seek to protect London. Financial institutions have in the past seen the benefit of centralising their operations in as few locations as possible. Now the economic benefit of doing so has to be measured against the political risk.

This opinion article is a companion piece for longer paper “Brexit and the financial services industry: the story so far”, published by the Centre for European Reform.

Mark Boleat is senior associate fellow at the Centre for European Reform (CER), a London-based think tank. He is also a former Chairman of the City of London’s Policy and Resources Committee.