Maintaining open financial markets between the UK and the EU should be a ‘win-win’

Maintaining open financial markets between the UK and the EU should be a ‘win-win’

Open Europe today published How the UK’s financial services sector can continue thriving after Brexit

Some light has been shed on the Brexit timeline over the past few weeks, but the terms of the future UK-EU relationship remain largely unclear. Given the importance of the financial services sector to the UK’s economy, speculation about what life for the industry might look like after Brexit has taken centre stage – particularly the ability to provide services to clients across Europe from a base in the UK, known as ‘passporting’.

Open Europe’s analysis finds that, while the passport has real value for some important business lines, it is an exaggeration to claim that London’s place as a global financial hub is entirely reliant on it or that there are no alternatives. Firstly, it is important to note that there is not one single passport that will be turned off like a tap if the UK leaves the single market. Financial market access between the UK and the EU relies on a patchwork of regulations and principles, where different sectors trade on different terms.

For asset managers, for instance, it is already quite common to domicile funds in another European hub, mostly Dublin and Luxembourg, and then delegate their management to the UK. In theory, this kind of arrangement could continue after Brexit – limiting the exposure of the asset management industry. As far as insurance is concerned, this is a globally diversified business and it is fair to say there is no real single market in the EU. The large majority of firms operating in the EU currently do so via separately capitalised local subsidiaries, which are not reliant on the passport.

The impact of losing the passport would be biggest for wholesale banking. Around a fifth of the UK banking sector’s annual revenue is estimated to be tied to the EU. For some products and business lines sold into the EU, there is currently no alternative to the passport and therefore many banks are making contingency plans for a worst-case scenario. This could include setting up new subsidiaries in the EU, which could involve significant costs in terms of moving capital, staff and infrastructure.

With formal Brexit talks under Article 50 fast approaching, how can the Government best reassure those financial firms that feel most vulnerable and secure the best outcome?

Regulatory ‘equivalence’ is a fall-back option for some sectors and the UK should seek this where possible. This would allow certain London-based business to continue across the single market if UK regulation is deemed ‘equivalent’ to the EU’s. However, it is, at best, a partial solution – it does not cover the full range of EU financial services regulations. Therefore, the UK should also seek bespoke agreements – covering, for instance, a passport for wholesale banking and the Lloyd’s of London insurance market – in order to secure the broadest possible access to the EU market.

However, the Government also faces a race against time. The financial services sector will need time to adjust to whatever the new post-Brexit reality is. This is by definition a fluid industry, and without assurances over what new arrangements will look like, some firms may put their worst-case contingency plans into action if uncertainty drags on.

Therefore, the Government should aim to offer the industry maximum certainty as early into formal talks as possible. One way would be to ensure that the EU deems UK financial regulation as equivalent from day one of Brexit – we could call it ‘pre-emptive equivalence’. This should be possible, since the UK already implements the full range of EU regulation. The option of a transitional period extending beyond the Article 50 two-year timeframe also warrants serious consideration.

In order to secure these objectives, the UK needs to convince the EU of the mutual interest in keeping financial markets open. Firstly, the UK’s financial services sector is Europe’s financial centre. Undermining the financial ‘ecosystem’ in London would lead to fragmentation which ultimately means higher costs of funding for European consumers, companies and governments. Furthermore, the passport is a two-way street. A number of large EU banks make significant proportions of the revenue in London – Deutsche Bank, for instance, gets 19% of its revenue in the UK.

Secondly, this is not a zero-sum game. If business moves out of London as a result of Brexit, it is far from obvious that it would relocate to another European hub. To mention but one example, the UK’s financial services sector employs anywhere between 1.1 million and 1.9 million people. Such a large pool of highly-skilled human capital is not easy to replicate elsewhere in the EU. The entire city of Frankfurt has a population of around 725,000. This means other non-EU financial centres – think New York, Hong Kong or Singapore – would be just as, if not more, likely to reap the benefits. It is therefore in the wider European interest to keep markets and trade open.