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What will happen to passporting rights post-Brexit? Nicolas Groffman, partner and head of international, Tim Littler, partner and head of banking, and Harry Bengough, senior associate, at Harrison Clark Rickerbys Solicitors, consider the current issues involved in post-Brexit passporting in the financial services sector.
Passporting rights give British financial institutions the right to offer their financial services anywhere in the EU and in the European Economic Area (EEA) by virtue of being based in the UK, and therefore, regulated by UK regulatory bodies. This right is known as a ‘passporting’ right.
A UK financial institution can do this either by offering its services under an ‘establishment’ passport, that requires it to establish a branch in the relevant country, or by offering services without setting up a branch under a ‘services’ passport.
The debate about the significance of passporting rights stems from the importance of the financial services sector to the UK’s economy. Around 10% of the UK’s exports are financial services, and around one-third of those are to the EU. Given that around half of the UK’s financial services output is exported, the significance of any unhelpful adjustment to the existing model should not be downplayed, although we should avoid the implication that the exporting of financial services to the EU would simply cease if passporting rights were lost. It is also important to point out that the export of financial services is only partly carried out under the passporting arrangements.
Option 1—remaining in the EEA
Even the term ‘hard Brexit’ isn’t completely clear as passporting rights are part of an EEA agreement, not an EU agreement. This is the so-called ‘Norway Option’ whereby the UK joins the EEA and operates outside of the common agricultural policy and fisheries policies. However, this would entail the UK still having to contribute almost as much to the EU budget, retaining free movement of people, and enacting EU regulations without having any say in how they are decided. This seems almost impossible.
Option 2—bilateral agreement
If the UK leaves the EU and retains no EEA membership then it would still be possible to set up bilateral agreements for passporting. The other option would be an end to passporting.
The UK is the world’s foremost provider of financial services and it is unlikely that the EU would reject its services. It is likely, however, that the arrangement would not allow for ‘services’ passports—in other words, UK institutions would be required to set up branches in the countries where they wish to do business. It is also possible that some forms of services will not be passported.
The type of agreement reached is likely to depend on whether Europe’s own financial institutions are allowed to argue their case. While European businesses in general benefit from UK financial institutions, and would suffer if passporting rights were diminished, Europe’s banks might spot an opportunity to develop their business at the UK’s expense and push for reduced rights.
Option 3—no agreement of any sort
It is impossible to say what the impact of this would be. If the UK leaves the EU with or without a trade agreement, but no agreement to allow passporting, then access to EU financial services markets would have to be negotiated on an individual basis. It would be hard to say how long this process would take and what the outcome would be, as this would cause significant uncertainty within the City.
One likely outcome would be depending on ‘equivalence’ provisions, allowing third-country financial firms access to the EU if their home country’s regulatory regime is deemed ‘equivalent’. Equivalence provisions are found in regulations such as those governing clearing houses and securities trading, but many financial sectors are not covered.
Switzerland, despite not being an EEA state, has negotiated limited passporting rights. To operate under these rights the Swiss must adopt equivalent regulations to those in the EEA. If the regulations change then they must act swiftly to adapt their own regulations. The result of this is that the Swiss can be left out in the cold, with their banks unable to operate in the EU, until they adopt amendments to EU law.
Success in this regard would be limited to what can be negotiated with the EU on the UK’s departure. With both France and Germany set to hold elections this year, and Brexit being very much on the agenda, there may be some reticence to formalising any agreement swiftly. Both the governor of the Bank of France and the president of the Bundesbank have indicated that in their view, the UK should not be allowed to continue using passporting rights post-Brexit unless it becomes a member of the EEA under the Norway option.
There is a risk that the UK government will be unable to legislate swiftly enough to maintain UK equivalence with EU regulations, and that the EU will use this as an excuse to bar the UK. Yet at the same time Canadian banks are allowed to operate in the EU, despite having arguably less ‘equivalence’ than UK banks, so the EU would risk looking foolish and losing credibility if it took this hardline approach.
There are some potential differences which could be cited as reasons for not accepting ‘equivalence’—eg the EU currently caps bonuses paid out to bankers. If the UK sought to raise this cap they would fall foul of the EU regulations, possibly causing any passporting rights to be rescinded.
While passporting is a useful tool, losing it will not signify the end of cross-border banking for the City. Moody’s have recently announced that the ‘impact of losing ‘passporting’ rights under EU law would be manageable for rated banks’. They do not consider it likely that the UK will lose all its passporting rights and instead look towards the incoming rights within the Markets in Financial Investments Regulation (MiFIR) Regulations and the Markets in Financial Instruments Directive 2014/65/EU (MIFID II).
Under MiFIR, the UK may be deemed a ‘third country’ to the EU, and thereby provide firms with an alternative means of accessing the single market. In order to be eligible for third country rights under MiFIR a firm must be regulated and supervised in its home country by the relevant authority, for instance the Financial Conduct Authority (FCA), and they must receive a positive equivalence determination from the European Securities and Markets Authority (ESMA) that the legal and supervisory facilities of the third country are equivalent to those required under MiFID II. Cooperation agreements must also be in place covering methods for exchange of information and for notifying breaches of the regulation to ESMA. Once the above has occurred, the firm must register with ESMA.
The FCA has confirmed that financial regulations from the EU will remain applicable until any new UK legislation has been enacted.
This could provide a smooth transition out of the EU, however, it relies upon a European Commission judgment that is a political decision over which the UK will no longer have a say. The process under MiFID II can also take up to 210 working days (30 working days for ESMA to confirm that the application is complete followed by a further 180 working days to determine whether the registration should be granted) the process of which may not be enacted until the UK has left the EU.
The UK’s position as recently voiced by the Prime Minister appears to lean towards a hard Brexit. If the UK failed to reach any agreement with the EU then the City would face challenges in Europe until other negotiations are concluded. There has already been some suggestion by the chief of the British Bankers Association, Anthony Browne, last year that banks will move some of their operations out of the UK. The French finance minister has also reportedly made moves to entice American banks to move operations to Paris. So far, however, the moves are relatively small (HSBC and UBS stated they will move 1000 roles from their UK-based investment bank to Paris, though HSBC added there was ‘no rush’ to do so).
A more blunt calculation may simply be that the banks do not have a great deal of choice. No European city is as globalised as London, and while UK-based banks may have been using Brexit as leverage for concessions from the government, the UK government may believe they are bluffing, and that the UK’s prime role as a trader for Asia, the US, and the wider world is fixed, with or without Brexit.
Under Solvency II Directive 2009/138/EC (Solvency II), insurance and reinsurance companies could operate within the EU under equivalence provisions. In some areas the UK is judged ‘super-equivalent’ for Solvency II, and this is unlikely to change post-Brexit so it should be in a position to achieve equivalence under Solvency II.
Until the UK government sets out a clear plan for Brexit negotiations, whether that means a hard Brexit or otherwise, it remains unclear what the future holds. This is further compounded with elections across Europe which could see the furtherance of the populist movements that have been witnessed both in the UK and US which could render the issue academic should additional countries leave the EU causing the entire house of cards to collapse.
Interviewed by Tracey Clarkson-Donnelly.
The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.
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Chris is a member of the New York Bar with more than two decades of experience as a financial services and capital markets lawyer in London. Before joining LexisNexis in 2016, Chris worked as a Senior Professional Support Lawyer at Linklaters LLP, supporting the firm’s market-leading Financial Regulation Group, with a particular focus on MiFID II. Chris also worked as Legal Analyst at Bloomberg, where he drafted analytical articles on EU, UK and US financial services law and regulation for Bloomberg journals and developed practical guidance content for the award-winning Bloomberg LAW legal research platform. Prior to that, Chris was a partner in the U.S. law group at Allen & Overy, advising issuers and underwriters on a wide range of capital markets and corporate finance transactions including SEC-registered and Rule 144A debt and equity offerings and mergers and acquisitions, as well as providing general U.S. securities law advice. He also co-founded the firm’s Microfinance Working Group and advised on a variety of matters including two landmark securitisations of loans to microfinance institutions.
Chris has written extensively on legal and regulatory issues for numerous publications and lectured on financial regulation, microfinance and capital markets.
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