How to achieve a win-win Brexit deal for UK-EU financial services

How to achieve a win-win Brexit deal for UK-EU financial services

In seeking the best post-Brexit outcome the UK needs to put on the table reasonable propositions that can be put into action – whilst at the same time preparing for the possibility that those propositions will not be accepted. The comprehensive blueprint I have set out in A Template for Enhanced Equivalence: Creating a Lasting Relationship in Financial Services between the EU and the UK for Politeia, which I seek to summarise here, is the most reasonable possible proposition for a financial services deal from a legal and regulatory perspective.

It builds on existing EU law concepts for building relationships with countries outside the EU, which are called “third countries”, as the UK will be after Brexit. The proposal offers what is effectively a win-win replication of the current set-up under the so-called EU financial services passport, where UK businesses can provide services cross-border across the EU without having a physical presence in the EU, whilst being solely regulated in the UK. They can also provide services through an EU physical presence, that is to say a local EU branch, where only the branch is regulated locally. The proposal allows EU institutions to do the same in the UK.

In essence, my proposition, which is fully fleshed out and circumvents the politics on both sides, gives the financial services industry a new version of passporting from outside the EU, based on the existing concept of equivalence. It also includes the draft legal framework for such a settlement – a draft for an EU Regulation, draft UK implementing measures and a draft bilateral UK-EU agreement.


In return for accepting this deal, the EU would obtain continued easy access to liquidity in the City and the ability to continue to operate or establish significant branches here, facilitating the access to London’s extensive and global customer base which it enjoys under the current passport arrangements. Those benefits would otherwise disappear after Brexit. The proposed deal would also avoid any UK businesses having to move from London, or having to establish special EU subsidiaries, both of which steps would merely render the EU less competitive since the costs arising from such steps would ultimately be put back onto EU customers.

An Enhanced Equivalence Framework

The proposal is based on the EU’s equivalence concept which is to be found throughout current EU financial services laws. Under this concept, if a third country – in this case the UK after Brexit – has laws and regulations deemed to be equivalent to those in the EU, businesses established in the third country obtain access to the EU markets in a similar manner to under the passport. This concept is in use for the US, for instance, with access for US clearing houses to the EU markets being permitted given that the EU has determined that the US laws and regulations on clearing achieve equivalent outcomes at a technical level to those in the EU. There is also an equivalence determination for reinsurance with the US. And there are equivalence determinations across many areas of City business for countries ranging in financial significance from Singapore to Mexico.

Because the existing equivalence regimes are not extensive enough to cover the fuller spectrum of UK financial sector activities, but are currently more a patchwork, the proposal fills in the gaps. The possible objections – that reliance on an equivalence regime would not provide certainty because the EU has discretion over whether to grant an equivalence determination and could withdraw it swiftly on a whim – are dealt with by the proposed bilateral procedural deal. That would provide for commitments to equivalence, notice periods and procedural certainty around the equivalence process. This proposal would give businesses a firm basis for their operations, with a similar level of certainty to that under current arrangements.

Meeting the sovereignty requirements of the referendum result

My proposal makes no concessions on UK or indeed EU sovereignty, in that the US, Singapore, Mexico and elsewhere have made no sacrifices of sovereignty to be given equivalence-based access to EU markets in specific areas.

The UK would avoid becoming a rule-taker – that is, a country required to apply someone else’s rules, which would be highly risky for the markets and indeed unacceptable for the UK. This is because equivalence would be applied in accordance with how the notion is already interpreted in the EU, which does not require the third country’s rules to be identical. Equivalence is instead founded on an outcomes-based test.

In the words of one notable EU official, the test “involves identifying any differences between our respective legal and supervisory arrangements and assessing whether similar regulatory outcomes are nonetheless achieved; namely the reduction of systemic risk in the financial markets”. Those were the words used by Michel Barnier in a letter as European Commissioner to the Chairman of the International Organisation of Securities Commissions’ Asia Pacific Regional Committee on 20th December 2013.

The approach therefore allows the UK to make laws and regulations in its own way as it thinks most appropriate, subject of course to observing international standards agreed in Basel, the FSB and IOSCO; and subject to having an eye to any additional outcomes required for equivalence where that is sought. International standards and the EU’s are generally similar in outcome. So the observation of international standards, which the UK has played and continues to play a significant role in setting, should generally be sufficient for an equivalence determination.

Notably, whilst this approach provides a benefit for the industry that is similar to the existing financial services passporting arrangements, it does not arise from the laws relating to the single market and does not bring with it the application of the EU concept of the four freedoms (including freedom of movement).

How it would work

In relation to areas where the UK seeks EU access, there would be a process to be undertaken where the EU would need to be satisfied that the UK’s laws on the particular topic are equivalent in outcomes to the EU’s on that topic. And the same would apply for the EU seeking access to the UK.

The UK could at any point decide it did not wish to pursue equivalence on a particular area, and could ignore it, though of course there would be no required access on that area. The same would be true for the EU in applying for UK equivalence on each subject: they could decide not to ask for it on a specific matter. However, each party would retain the optionality to apply for equivalence across all financial services business lines if it wished to do so.

The UK would only seek access for EU-facing business. The laws for domestic and rest-of-world businesses would be left unaffected by the deal and we could take a very different tack for businesses servicing those markets.

Where equivalence has been declared, UK firms would have full access to the EU markets and vice versa. There would be no discrimination. The benefit which the City would obtain is direct and easy access to EU clients with no duplication of regulation. For business conducted cross-border from the UK into the EU, the UK regulators would be solely in charge and would apply UK regulations only. For UK-based businesses establishing branches in the EU, their head office here would be supervised by the UK regulators under UK laws and their EU branch would be supervised by the EU regulators under EU laws in respect of the liquidity of the branch and the day-to-day conduct of business conducted in the branch, but not for instance the capitalisation of the entire entity or the operations of the UK head office. This is the norm under the passport.

For retail business there would be additional local requirements for selling to consumers. UK-based businesses selling to EU consumers would have to comply with EU consumer protection requirements policed in the EU. EU businesses would similarly have to comply with UK requirements and be supervised by UK regulators when dealing with UK consumers.

Timetable and Next Steps

These arrangements could be implemented before Brexit, that is by the end of March 2019, by way of the normal EU legislative process, so that they could be voted on by the European Council under qualified majority voting (with the UK having a vote) and by the European Parliament by simple majority (where UK MEPs would have a vote). The arrangements are in conformity with WTO restrictions, although certain procedural steps may need to be taken to ensure that is the case. Existing equivalence decisions would be grandfathered into the new Regulatory regime so no new determinations would be required for those.

The evidence is that such a framework would be the simplest and most easily executable route to financial services Brexit which meets the needs of the UK and the EU, and also delivers in respect of the aims and needs of the City.

Other options? Should there be a visible Plan B?

As mentioned at the outset, however, the UK needs also to prepare properly for a no deal outcome. There are obvious economic detriments to the EU of no deal. Mrs Merkel is stressing free trade in discussions with the USA. It is to be hoped that she will do the same with the UK. However, we cannot count on that.

First, in a no deal scenario, the UK would make no exit payment to the EU for any period after Brexit. Such a payment is wrongly characterised by the EU as legally owing. It is not, and the legal analysis underpinning the Commission’s assertions on this is erroneous. It is clear that the EU will be subject to huge strains if the UK stands on its rights and exits without making an ex gratia payment.

Secondly, the UK should take steps now to announce changes and incentives to ensure that a no deal outcome will be obviously attractive for industry, even though of course the UK does not seek such a result. Such a step should enable industry to act with confidence and to avoid any precautionary moves which are being discussed amidst the uncertainties as to the outcome.

In a financial services context this means working now to reveal a more market-friendly legal and regulatory situation if there is no Brexit deal, from the moment of Brexit. UK laws and regulations have traditionally applied higher and safer standards, with fewer rules. Within the EU the UK has had to apply its higher standards, being accused of gold plating, but with all of the prescriptive detail of EU regulation. This chokes innovation and makes supervision by the regulators less dynamic. The Government should immediately set up a group of 8-10 people to re-think its legal and regulatory framework against the possibility of a no deal outcome. This body could work with industry to reduce friction costs on business and reclaim the UK’s traditional approach which has served it so well.

The output of such a group would also inform the UK’s thinking in defining its laws and regulations under an equivalence-based deal. In such a case fewer changes will be possible, but the UK will nevertheless wish to make clear up front what it has in mind so that there are no surprises when the UK makes its desired changes after Brexit takes place and we are not all back in the negotiating room talking again about equivalence.

In addition, the Government should consider tax breaks and incentives for UK financial firms, which would come into effect solely on a no deal scenario, so as to incentivise the financial industry to work to avoid moving business to the EU, thereby avoiding systemic risk from the resulting disruption. Such a move would help financial institutions to facilitate EU clients in establishing subsidiaries here. It would also compensate UK institutions for the frictional costs of finding ways to continue servicing EU clients cross-border from the UK after Brexit. Various techniques exist to do this and institutions would be incentivised to develop and use those techniques.

Conclusion: what the UK must now do and why

For those worried that such an approach is overly assertive, it must be remembered that the UK needs to protect itself and also to protect the financial markets that it hosts from systemic risks.

Other competitors have not been slow to act. France has announced a number of tax measures intended to lure away UK business given Brexit, including the abolition of the highest bracket of a payroll tax levied on each salaried employee and the cancellation of plans to increase France’s 0.3% tax on financial transactions. Frankfurt is offering “risk takers” an exemption from aspects of its labour laws in its own effort to lure international banks to move there after Brexit. These are pretty activist steps to take against an existing EU partner, particularly whilst the EU wrongly asserts that the UK cannot negotiate trade deals for a post-Brexit environment whilst still being an EU member.

The UK, therefore, like France and Germany, needs to behave with confidence and to take protective actions for the contingency that the EU does not wish to enter into an amicable post-Brexit arrangement with it.

The Government and the sector must remember that the position the UK faces now is in fact in a number of respects similar to the position that would have arisen had the UK not chosen to leave. Within the EU, under the deal David Cameron struck in February 2016, had it been implemented, the UK would have had to stand on its rights and negotiate over what the opt-out from ever-closer union – on which the EU is now moving rapidly ahead – actually meant. It would have had to stand up to protect itself against the effects of the eurozone becoming a single country, with a block vote, within the greater EU. It would have had to push for a proper implementation of the undertaking to make EU laws more competitive.

Now the need for the UK to reposition itself has been accelerated and can no longer be an iterative discussion within an ongoing EU. Instead the UK needs immediately to start behaving in anticipation of the complete sovereignty that is about to be reclaimed, since others are already doing so and it cannot ignore that development. This is a task that cannot be undertaken in fearfulness. It requires detailed work and pragmatic thought.

Only by the UK being more assertive will the benefits of the attractive proposition contained in this book become fully apparent within the EU. The object should in the first place be for such a win-win deal. It is to be hoped that the EU will accept the mutually beneficial proposition that I set out. Both the UK and EU would win if it does so. The deal is relatively easy to implement and would preserve the result of over 40 years of collaboration between the UK and EU to date, for the good of all.

But these proposals are not the only way forward. In an earlier volume, A Blueprint for Brexit: The Future of Global Financial Services and Markets in the UK, published by Politeia last November, I outlined the option of London becoming its own financial centre, with the attractions to businesses in the EU and globally of a competitive tax system and the incentives that the UK, outside the EU, would be free to offer as well as the effective regulatory framework which has put Britain at the heart of the sector’s rule-making internationally and in the EU. This arrangement would be to the UK’s advantage. It would cement London’s pole position as a world financial centre, rivalled only by New York. It would not, however, bring the same advantages to the EU as the equivalence arrangements I propose.

In order to optimise the UK’s chances of a mutually attractive agreement, to preserve its position and avoid any dangerous disruption in the markets, the UK must move forward with its hands outstretched for a deal whilst openly preparing for the possibility its offer is rejected. Institutions will then see that maintaining all of their business in the UK is win-win for them, and that it is in their interests to stick with the safe, flexible and profitable UK environment regardless of what happens.