It was always a matter of when, not if, the attention of the media would turn to the future of the financial services sector after the UK leaves the EU. Will Brexit make no difference, or will the loss of the EU financial services passport – which allows UK-headquartered firms to do business across the bloc – put an end to London’s dominance as a global financial hub?
New research published this week by Open Europe concludes that, as is usually the case, the truth is more nuanced. For starters, there is not a single passport – but several sector-specific ones based on a number of separate EU regulations. Therefore, in the upcoming Brexit negotiations with the EU-27, the UK will not be facing a black-or-white choice – keep the passport or lose it.
Furthermore, the importance of the passport depends on the industry. It works best for banking, but is less relevant to asset managers and insurers. This is why we suggest that the UK government focus its efforts on retaining or replicating a passport-like trade arrangement with the EU in those sectors where it is most valuable, and where there are no obvious alternatives on offer under the existing rules.
One widely cited fall-back option, for instance, is to achieve regulatory “equivalence” after Brexit – that is, to make sure that the EU judges the UK’s financial regulations to be as good as its own. However, equivalence is only a partial solution. It is a more piecemeal approach, and while in theory the process for granting it is a purely technical one, it can easily trespass into politics – not least because the European Commission can take as much time as it wishes to adopt a positive equivalence decision.
Most importantly, the existing EU regulations envisage no equivalence at all in some sectors. Therefore, we recommend that the Government should seek what we have called “pre-emptive equivalence”, so that the UK is deemed equivalent by the EU as of Brexit Day and there is no regulatory limbo. However, we also believe this should be topped up with bespoke deals in areas where equivalence is not available – wholesale banking being the key one.
One question we are often asked is, “But why should the rest of the EU agree to all this? What’s in it for them?”
It will no doubt be a challenge, but we believe the UK has good arguments to convince its European partners that keeping financial markets open across the Channel is beneficial to everyone involved.
The point of having such a wide range of financial activities taking place in one big hub – what is commonly known as an “ecosystem” – is that it helps keep transaction costs down. In other words, one consequence of fragmenting London’s financial ecosystem would be to push up the costs of funding for consumers, businesses and governments across Europe.
From the EU’s standpoint, there might be political motivations to pursue this kind of outcome – but it would make little sense economically.
Furthermore, for all the talk of red carpets being rolled out for US bankers in Paris, there is (at least in the short term) no other European financial centre that can replicate what London has to offer in terms of infrastructure, business-friendly environment, and human capital.
This has at least two crucial implications.
First, non-European hubs – think New York, Singapore or Hong Kong – would be just as well prepared, if not better, to welcome business moving out of the City.
Second, given that relocating is not a cost-free exercise, if certain business lines did not look profitable from within the UK any longer, they might not be moved to Europe but simply be cut off altogether.
Under either scenario, not just the UK but Europe as a whole would end up worse off – something which should be in everyone’s interest to avoid.
