Last month, the House of Lords European Union Select Committee published a report "Brexit: financial services" which sets out some initial findings on the impact of Brexit on the sector, which will be used by the House of Lords for further consideration and debate. The UK is the world's largest exporter of financial services and insurance, contributing more than 7% of UK GDP. Nearly two thirds of those employed in financial services in the UK reside outside London. Given the size of the industry, its importance to the wider UK and EU economies, and the potential impact of Brexit, the House of Lords says that financial services should be the first issue to be investigated. We set out a short summary of the report below.
- Financial services relocating from Britain as a result of Brexit are more likely to move to New York than elsewhere in the EU because New York has a highly evolved finance "ecosystem" like London, which would be very difficult to replicate in the EU.
- The extent to which UK financial services firms currently rely on passporting needs to be determined: some firms themselves did not have a clear idea of their reliance on passporting.
- If the current passporting regime is not maintained post Brexit, the UK Government should seek a deal to bolster the current equivalence framework, to cover gaps in that framework and ensure the continuation of equivalence decisions as financial services regulation develops.
- Avoiding disruption in financial services is a high priority. There must be a clearly defined and adequate transition period, avoiding a "cliff edge", both at the moment of withdrawal following the Article 50 process and as the UK and EU move toward a new relationship.
The report is structured via a number of chapters, with a more detailed assessment, some data, and input from participants who appeared before the House of Lords.
Passporting and equivalence
- The legislation underpinning access to the EU is based on the regulation of activities, and does not map easily onto the business structure of many firms. Better data and evidence needs to be collected to understand how firms are likely to be affected by changes to the rights of access to the EU.
- Some UK firms were not aware of the extent to which they relied on passports.
- The EU equivalence framework is narrow and potentially unreliable. The process of determining equivalence is complex and fraught with risk and uncertainty for firms. For example, there is currently no time limit within which the EU Commission must make an equivalence decision.
- Although the UK would lose direct influence in setting the EU regulatory regime post Brexit, the UK was, and would remain influential at the international level where an international framework was in place, and for those areas of the financial services sector subject to such a framework, this would mean the UK would still have influence over the direction of travel for the EU.
The UK financial "ecosystem"
- Such is the size, complexity and interconnectedness of the UK financial services sector, many have described it as an ecosystem: it is not possible to consider different parts of financial services in isolation – they need to be considered holistically.
- EU firms rely heavily on the services provided by the UK financial services industry and there are interdependencies between financial services and other EU businesses – efforts to draw services away from the UK to the EU could be as harmful to the wider EU economy as to the UK economy.
- Any assessment of Brexit on financial services must take this into account and it makes that assessment particularly complicated. The interconnectedness of the financial system presents serious difficulties in determining the impact of Brexit. The 2 year period of the Art 50 negotiations is insufficient. A considered and orderly transition is required.
- The UK has a number of advantages as a financial services hub – which allows for economies of scale and depth of capital market activity that cannot be easily replicated, except possibly in New York. Evidence submitted suggests it would be to the EU's advantage that such a system remains intact.
- In relation to euro clearing activities, the UK is dominant in this area. The ECB previously attempted to require euro clearing to be conducted within the Eurozone, which the UK successfully challenged. Post Brexit, there has been a renewed suggestion this activity should be conducted within the Eurozone, even though this would have an negative impact on both EU and UK firms. The question is whether any Eurozone location could provide the same benefits to the wider economy as London (or New York), and whether a politically driven attempt to "repatriate" euro clearing to the Eurozone would invite retaliation by other non-eurozone states, leading to a breakdown of the system of multi-currency clearing.
Free movement and Fintech
- The ability of the UK to continue to access highly qualified staff and transfer them between the UK and EU is a key issue for the financial services industry. Currently the UK financial services sector employs over 1,000,000 people of whom around 60,000 are EU nationals and 100,000 are non EU nationals.
- FinTech relies on foreign staff to a greater degree than the wider financial services sector and would be impacted by any restrictions on movement of people post Brexit.
- Access to data is vital for the FinTech sector. The UK would need to continue to observe similar data protection standards as those under the forthcoming General Data Protection Regulation (GDPR). The same applies to the account data and third party access requirements being introduced under PSDII.
- Although the FinTech industry has thrived in London, it could potentially move elsewhere.
The House of Lords considered what a bespoke deal for the UK's relationship with the EU might look like post Brexit. In the context of financial services, they assert that any agreement should supplement the current equivalence regimes. To negotiate effectively, the government should model the different scenarios as accurately as possible. This is still to be done.
In relation to planning and transition, the House of Lords observed that negotiations with the EU on the UK's new relationship are likely to take longer than the withdrawal negotiations under Article 50. A transitional period will be required in relation to financial services following completion of the Art 50 process. The length of that period may need to be extended in the light of subsequent negotiations on a new long term relationship with the EU.