Brexit’s impact on financial services
The City of London and financial services are one of the largest contributors to the UK economy. Financial services contributed £75bn in taxes in the year to March 2018. The cost of the NHS during the same period amounted to £120bn for the same period. Financial services alone therefore pay for 62.5% of the NHS. Financial services also employs 3.4% of the UK workforce, contributes 6.6% of economic output and accounts for 10.9% of UK Government tax receipts.
With these statistics in mind, let us now consider the impact of the Brexit deal on financial services. The two main documents to consider here are the Withdrawal Agreement and the Political Declaration. Think of the Withdrawal Agreement as the divorce paperwork, including the solicitor’s bill. For financial services, the main element of this is the transitional period, which avoids a cliff edge hard Brexit. Separately, the Political Declaration sets the agenda for negotiations on the future arrangements which remain wide open.
The legally binding draft Withdrawal Agreement will mitigate the cliff edge of a hard Brexit by allowing financial services firms to continue to operate as usual beyond March 29 2019. The same EU rule book will continue to apply so that businesses will not have to make any changes for the transitional period until the end of December 2020.
Crucially, firms that operate cross-border business can continue unaffected. This is what’s known as passporting within the EU where – so long as a financial firm is based in London and regulated by UK regulators – it can also operate across all EU member countries without needing to apply for a separate licence. A transitional period would provide the much needed certainty for firms in this period as a future relationship is being negotiated.
“We do not know what is at the end of the transitional period”
As in many other sectors, financial services regulations are regularly being reviewed and updated. For example, following the global financial crisis that started in 2007, regulations were toughened up to make it less likely that banks will fail in the future. Whenever significant changes are made to regulations, there is a transitional period to allow firms time to adjust to the different requirements.
However, the Brexit transitional period is in fact quite different. It’s different because firms do not need to make any adjustments and we do not know what is at the end of the transitional period. So, it’s not an amount of time for firms to adjust – transition – to a new regime. Rather, it simply buys time for further negotiations on the future framework. It’s not, in substance, any different to extending article 50 negotiations other than that it gives politicians a chance to declare victory and by finalising the cost and terms of the exit it gives more space for negotiations on the future framework. The reality is that there would need to be a further implementation period after December 2020 to allow firms time to adjust, depending on what any future arrangements end up looking like.
The regulators and UK Treasury have, as you would expect, been busy preparing for the worst and monitoring to see that regulated firms do the same, including by developing a number of different safety nets.
The EU (Withdrawal) Act 2018 transposes the full EU rulebook of directly applicable EU law onto UK statute books. It also gives Ministers secondary powers to make corrections to that legislation so that it works smoothly in the UK. A programme of laying statutory instruments (SIs) – to cover the 50 or so pieces of financial services regulations – is now underway.
Initiatives to prepare for a no-deal Brexit
The FCA has published its proposed approach to making revisions to its Handbook. The changes ensure that the FCA has a fully functioning rulebook in place whatever the outcome. Likewise, a temporary permissions regime has been developed in case there is no deal. This provides certainty to EU firms that are currently operating in the UK through EU passports when passporting falls away.
All of these initiatives are to prepare for a no deal Brexit. If the deal is agreed then they fall away. However, the many thousands of hours of work will not be wasted because, as mentioned above, there is likely to be a need for another transitional period to the future arrangements, so they would come back into play again later if there was a deal that successfully passed both our UK Parliament and the EU Parliament.
Outstanding issues that cannot be fixed by these safety nets include:
- Devising a way forward for the 5,000 or so UK firms operating in the EU through passporting. The EU has not set up an equivalent of the UK’s temporary permissions regime.
- There is also an open question about the continuity of cross-border contracts such as insurance, although there are some useful tips on the FCA’s website on the kinds of questions that firms can ask themselves if they have cross-border contracts or pass data between the UK and EEA.
Political declaration document
The equally important document which is not receiving as much attention – as its lack of formal legal standing is being misinterpreted – is the Political Declaration which was approved by the EU27 on Sunday November 25. This declaration includes lots of positive words and lots of caveats, and some sentences are long and contradictory which indicate the difficulty of the negotiations ahead. However, it does need to be included in the Withdrawal Agreement meaningful vote, according to section 13 of the Withdrawal Act 2018.
In this Political Declaration, the section on financial services – just three paragraphs – starts with references to “financial stability, market integrity and investor and consumer protection and fair competition,” or, in other words, the statutory objectives of the FCA and PRA. This will help to avoid any weakening of UK financial regulations or consumer protection: the regulation light world so many Brexiteers appear to dream about.
There is a commitment for equivalence assessments to commence “as soon as possible after the UK’s withdrawal from the Union, endeavouring to conclude these assessments by the end of June 2020”. This puts some pressure on the European Commission to perform an assessment of whether UK rules achieve a similar outcome to EU rules and allow a degree of market access (also open to all other non-EU countries). In terms of the technical work, this should be a very easy assessment as the rules will, in substance, be close to identical.
The declaration refers to a free trade agreement (FTA) covering all sectors including specific mention of financial services. However, the short section on financial services is dominated by the discussion on equivalence with no mention of an FTA. It is hard to predict where the next round of negotiations will land but it is notable that there are fewer grand aspirations on financial services compared to other sectors given the importance to our GDP.
Risk of a cliff edge Brexit
To summarise, the relative weight and content of the main documents show that most progress has been made in establishing the terms of the UK’s exit from the EU including the cost. There are still significant political risks to the draft withdrawal agreement being fully ratified.
A number of initiatives are in place to mitigate the risks of a cliff edge Brexit, and while a transitional period has major benefits for financial stability, we are in effect treading water, so another transitional is likely to be needed to allow firms time to transition to any future market access agreement once it is clearer what that looks like. In other words, the future for the financial services sector is still unknown in terms of Mrs May’s Withdrawal Agreement and the Political Declaration MPs will be voting on in their meaningful vote.
In economic terms, we still don’t know what any future deal looks like, so we don’t know the full scale of the impact of Brexit. A shift of operations from the City of London to other European financial centres such as Paris, Frankfurt and Dublin is already underway and is being actively encouraged by EU authorities (and why wouldn’t they?) While the number of job losses to the EU are not yet clear, what is clear is that the impact will be negative for the UK. There is no upside of Brexit for financial services.
The City is already a global centre and its attractiveness as a base for non-EU parent firms can only decline once it ceases to have passporting access to the rest of the EU. It is clear in the Political Declaration that the future deal will not include passporting in its current form. So, while the City may continue to generate tax receipts sufficient to fund more than half the annual cost of the NHS through the transitional period, this ability is only set to decline. The only open question is how quickly?
Ruth Doubleday is an independent risk consultant in the financial services industry. She has previously held senior roles in international banking regulation and leading Brexit work at the UK Financial Conduct Authority.