There is a paradox at the heart of the whole question of how Britain’s decision to leave the European Union will affect its financial services industry.
On one hand, the impact ought to be overwhelmingly beneficial. The City is the very epitome of the sort of business sector that should flourish outside the EU – entrepreneurial, innovative and quintessentially global. What is more, the EU has been far less successful in removing barriers to trade in services than it has regarding trade in goods.
So, while car companies, for example, understandably fret about continued access to continental markets, there being few cars made solely for sale to British motorists, banks and other financial institutions ought to be displaying an insouciance bordering on the carefree at the prospect of Brexit.
But they are not.
This was the Financial Times on January 22: “On the City of London and Brexit, silence is not golden…Bankers, traders, asset managers and insurers need clarity about what the rules will be after Brexit once the transition period is over. The Government cannot know the outcome of negotiations with the EU. But so long as its priorities remain a matter of speculation, it is hard to see how the finance industry – which employs one million Britons – can act with confidence.”
In other words, the salty merchant-venturers of the City and Canary Wharf seem less than 100 per cent keen to embrace their new, global future. At least not without securing the ability to do business in their own backyard, the remaining 27 EU member-states.
Bankers, traders, asset managers and insurers need clarity about what the rules will be after Brexit
At present, this ability is guaranteed under the so-called passport system. This dates back to the late Eighties and early Nineties, when the EU was pushing for what was known as a “single financial space”, the extension of the single market into the spheres of banking, insurance, fund management and the rest.
As financial services were increasingly regulated at the European, rather than the national, level, so national rulebooks came into line with each other. That meant there was ever-decreasing justification for a country shutting out financial institutions that had been authorised in another EU member-state or requiring them to go through the process of establishing a subsidiary in the country concerned and then applying for authorisation.
The passport allows financial services companies to sell across EU borders as if they were selling in their national, home market, and to establish branches in any member-state much as if they were setting up in their country of origin. Of course, nothing is perfect, and there remain some authorisation requirements for non-domestic EU institutions, but in general the “financial space” works as intended.
As the British Bankers’ Association (BBA) puts it: “The passporting system is built on the assumption that banks and financial services firms authorised anywhere in the EU will have met the same standards, and thus should in effect be treated as if they were locally authorised. This is reinforced by a very high level of regulatory co-operation between national supervisory authorities in the EU.”
Freedom of movement
So what happens now? The BBA notes that, were Britain to join the European Economic Area which comprises the EU plus Norway, Iceland and Lichtenstein, it could continue to enjoy “passport” privileges. But this would involve largely accepting the freedom of movement that proved a key issue in pushing UK voters towards the Leave camp.
On February 16, Reuters reported: “London bankers…[have come up] with their own plan to keep the single market open by Britain pledging to honour global standards. But Brussels has rejected that industry proposal, meaning…[the City] may have to rely instead on what is known as the equivalence system for regulation.
That legal mechanism allows countries from outside the EU to access the single market in limited circumstances. Access is patchy and can be revoked at short notice.
The BBA adds: “They [these permissions] can be withdrawn unilaterally if the EU considers that the other party’s regulatory regime no longer provides a sufficiently comparable outcome. As a result, they cannot be relied upon to allow non-EU banks to meet all their customers’ needs in the EU.”
UK negotiators remain confident that satisfactory arrangements can be put in place for the financial services sector post-Brexit, but some institutions are already arranging to relocate at least some of their activities elsewhere in the 27 remaining EU member-states, with an emphasis on Frankfurt, Paris and Dublin.
This takes us to the other side of the Brexit equation, the impact on the EU financial-services industry. European institutions, businesses and governments risk losing easy access to the continent’s deepest and most liquid financial market, as well as the professional expertise that goes with it.
In terms of rule-making, they will lose a staunch defender of open markets and opponent of un-necessary regulation – expect plans for a financial transaction tax to accelerate, along with restrictions on activities such as short-selling and derivatives trading.
It may not come to this. The Reuters report quotes a British official saying: “It is obviously in everyone’s interests not totally to turn on its head the pan-European banking system. Everyone has a lot to lose from this if we can’t get a deal.”
On that, at least, there will be widespread agreement.