Sarah Hall / Oct 2020
As the Brexit trade negotiations reach their denouement, clarity is beginning to emerge in terms of the implications of different deal or no deal scenarios for financial services.
One of the most central decisions for financial services is the granting, or not, of equivalence by the EU to financial services based in the UK. Formally, equivalence decisions are not part of the trade negotiations. Equivalence is a unilateral decision made by the EU. However, in practice, the decision forms part of wider political calculations made on both sides of the negotiating table. This has been exemplified again recently with debates resurfacing about the extent to which the economically small, but culturally totemic issue of fishing rights will take precedent over financial services, and indeed services trade more generally in the trade negotiations and its outcome.
The EU has recently made clear that equivalence decisions that are needed for continued single market access for UK based investment firms are now not going to be concluded in the medium term. And there are some areas of financial services that are not covered by equivalence decisions at all. For example, single market access cannot be granted for non-EU banks. This reflects the fact that equivalence is by no means a like for like replacement for the passporting rights the UK used as an EU member state (and has continued to do so through the transition period).
In the absence of equivalence decisions and with the end of passporting in sight, financial entities continue to implement their own corporate strategies in response to the risk of a no trade deal Brexit. For example, in the case of retail banking, the London based fintech Revolut has recently announced that its Irish customers’ bank accounts will temporarily be migrated to its Lithuanian operations before the end of the transition period. This is because currently, Irish customer accounts with Revolut have been regulated by the UK Financial Conduct Authority using passporting rights. At the end of the transition, in the absence of such rights, the UK regulator will no longer be able to regulate accounts of EU citizens.
However, beyond these corporate responses, clarity is beginning to emerge regarding how financial services regulation may be approached by both the UK and the EU at the end of the transition. In many ways, this needs to be followed more closely than the more frequently commented upon job moves out of London because it is these regulatory decisions that will be vital in shaping Europe’s future financial services landscape.
On the UK side, a considerable degree of regulatory flexibility appears to be emerging. For example, through the Temporary Permissions Regime, a financial entity that is currently authorised to operate in the UK through passporting will be able to continue operating on that basis for up to three years from 1 January 2021 during which time they would be able to apply for UK licences.
On the EU side, a more cautious approach to the continued single market access of UK based financial entities appears to be developing. For example, regulatory changes by the EU are more permissive only in areas that are deemed to be central to financial stability. For example, in the case of clearing houses, London dominates EU market activity. LCH, owned by the London Stock Exchange clears around 90% of euro denominated interest rate swap transactions. The EU is planning to allow EU banks access to UK clearing houses until the middle of 2022 in order to allow the EU time to develop its own domestic clearing houses.
This approach reflects a growing sense that the EU is keen to onshore financial market activity currently undertaken in London at the end of the transition period. Although outside of the formal trade negotiations, the precise form this onshoring takes is likely to be shaped by the existence of a trade deal. As noted above, whilst activities in investment services seem very unlikely to be granted equivalence decisions, the level of cooperation between the EU and the UK on issues such as share trading is likely to be heavily influenced by whether a deal is truck or not. Equivalence in these areas may be more forthcoming if a trade deal is agreed.
As a result, even though some of the key decisions for financial services are beyond the scope of the trade negotiations, securing a deal, even if it is very thin in services for financial services would have significant implications because it would provide the basis for a future trust based relationship between the two parties. This, and its alternative of no trade deal, are likely to have significant implications as the EU and the UK work to implement a markedly changed approach to the practice and regulation of cross border financial services trade.