No-deal Brexit? – Implications for the financial services sector

As of 11pm on Friday 29 March 2019, the UK will officially cease to be a member of the EU. Britain’s Brexit Secretary has said the chance of the UK crashing out of the EU without a trade deal is “unlikely”. However, with the cliff edge fast approaching, it is a very real possibility; a view echoed by The Governor of the Bank of England, Mark Carney, who said the risk of a no-deal Brexit is “uncomfortably high”. In preparation for a no-deal Brexit HM Government has published a series of technical notes detailing the consequences. Among the papers is a notice (Notice) for the financial services sector on the potential no-deal impact and the government’s approach to ensuring that we have a “functioning financial services framework in any scenario”. Below is a summary of the Notice.

Background

The UK-EU financial services sector is highly integrated, supported by common rules and standards, and extensive supervisory cooperation. Financial services firms authorised in any European Economic Area (EEA) country can carry out activities in any other EEA country through a process known as “passporting”. Passporting allows entities authorised in one member state to deliver services in other member states without requiring authorisation from the local regulator.

These principles extend to banks providing wholesale clearing services, insurers / insurance intermediaries, derivative traders, investment managers and wealth management firms who currently benefit from access to retail and institutional clients from across the EU – whether these financial services businesses are headquartered in the UK or are part of an international business using the UK (and London in particular) as its gateway to the EU market.

No-deal

In a no-deal scenario, passporting rights would end and the UK will be outside the EU’s framework for financial services. UK firms’ position in relation to the EU would be determined by relevant member state rules and any applicable EU rules that apply to third countries (countries outside the EU). Similarly, the UK will generally treat individual EEA states and EEA firms largely as it does third countries. In other words, harmonised regulatory cooperation would end and different rules would apply to different elements of the financial services sector and different jurisdictions.

In an attempt to mitigate the effects of such a scenario the Notice sets out a series of measures that HM Government would take. Specifically, the Notice states that the government will:

• introduce a Temporary Permissions Regime that will allow EEA firms currently passporting into the UK to continue to do so for 3 years after Brexit while they apply for permissions from UK regulators;
• introduce a Temporary Recognition Regime allowing non-UK central counterparties to provide clearing services to UK firms for a period of up to three years;
• introduce legislation to ensure that contractual obligations between EEA firms and UK customers not covered by temporary permissions can continue to be met;
• provide financial regulators with a general transitional tool that will allow them to phase in post-exit regulatory requirements for firms, giving firms the necessary time to adjust and avoid the cliff edge on the point of exit;
• continue to work with stakeholders to ensure a fully functioning financial services regulatory framework at the point the UK leaves the EU.

Implications

How customers and financial services firms will be affected will depend on where they are based and under what regulatory framework they operate. Nevertheless, based on the proposals in the Notice; the implications are likely to be as follows:

• UK-based customers accessing domestic services in the UK provided by UK-based providers are unlikely to be affected.
• For UK-based customers and businesses who access services with EEA firms currently passporting into the UK, the temporary permissions regimes will enable these firms to continue to provide those services to UK customers for up to three years after exit.
• By contrast, EEA-based customers and businesses of UK firms currently passporting into the EEA, may lose the ability to access existing services due to UK firms losing their rights to passport into the EEA. This could impact these firms’ ability to continue to service their existing products and could have implications on their abilities to meet contractual obligations.

Thus the general conclusion with a no-deal scenario appears to be that the UK can safeguard the import of services into the UK, however, it is in no position to protect the outward flow of financial services to the rest of Europe.

Comment

Whilst it is reassuring that HM Government is planning for all eventualities and is making a concerted effort to ensure the continuity of the UK-EU financial services sector, the stark reality is that there is a limit to what the government can do unilaterally. Many of the measures proposed would be blunted by a failure of the European Authorities to offer some form of reciprocal commitments.

It is hard to conceive the EU stonewalling the UK financial services sector in the event of a no-deal. After all, the UK is a global financial centre and of paramount importance to EU companies. A failure by the EU to act would have profound implications; the ability to execute trades and clear derivatives would become an issue, EEA clients may no longer be able to use the services of UK-based investment banks, and UK-based investment banks may be unable to service existing cross-border contracts.

The consequences alone suggest that some form of arrangement will be put in place; nevertheless the government is quite rightfully setting out its position in the event of a no-deal scenario. A failure to do so would be negligent and would give leverage to EU negotiators. Whilst the government is taking a pragmatic approach to a no-deal scenario, what can be seen clearly from the Notice is that the trade of services involves two parties and therefore, mutual cooperation is needed to ensure the continuity of UK-EU financial services following a no-deal Brexit.

To discuss how Michelmores’ Finance and Investment group can help you or your business prepare for Brexit, or if you would like more information on this topic in general, please contact Jonathan Kitchin, Head of Michelmores’ Commercial & Regulatory Disputes team.