What would Brexit mean for the UK financial services industry?

I just discovered a really interesting legal view of the implications of the Brexit vote on the UK Financial Services sector.  It was in a magazine by Mayer Brown, a law firm, written by legal eagles Alexandria Carr, Mark Compton, David R. Sahr and Guy Wilkes and, as the vote takes place tomorrow as to whether Britain will Brexit or Bremain, I thought I would post a summary of this note here.  Here are the conclusions:

The result of the EU influence on UK financial services legislation is that the UK legislative framework for regulating financial services is entwined with EU regulation both because it has implemented directives and because it relies on regulations. Further, a large proportion of EU legislation implements international obligations or guidelines (ie those agreed at global level with countries other than just the EU), albeit the EU may “gold-plate” those obligations or guidelines for the purpose of its internal market.

Accordingly, it would be a huge challenge for the UK to revoke or repeal its existing legislation and, if it were to do so, it might be faced with a need to replicate the EU legislation in order to meet global standards. It is likely that the UK might revoke or repeal certain discrete EU-specific obligations with which it does not agree, such as the cap on bankers’ bonuses, but the vast majority of the corpus of financial services regulation would be likely to remain post-withdrawal, at least for the near future.

Indeed if the UK wished to maintain a relationship with the EU, which seems necessary in the financial services sector, it is likely to be best served by mirroring EU legislation as closely as possible.  The UK is the leading global financial centre and the financial centre of the EU. Its status is at least helped by, if not dependent on, its position in the EU, as many non-EU financial services players see the UK as the gateway to Europe.

The loss of the passport, which would be inevitable (at the very least going forward) should any of the post-withdrawal options be adopted, would be highly problematic for financial services institutions established in the UK and elsewhere in the EU. It would mean that financial institutions established in the UK could not provide services to customers in the EU from the UK. Equally, financial institutions established in the EU could not provide services to UK customers from the EU.

If existing passports were revoked and new/extended passports were not available, financial institutions would be required to seek a new or additional EU or UK base for operations if they wished to provide cross-border services. Thus a financial institution established in the UK would require an establishment in an EU country if it wished to service EU clients in a number of EU Member States, as that establishment would enable it to obtain another passport. Equally, EU financial institutions which wished to service UK clients would need a UK establishment.  A financial services institution which establishes itself in a jurisdiction has to apply for a licence to operate as a provider of financial services and subject itself to the regulation of and supervision by the competent authority in the State in which it establishes itself. Accordingly, establishment in a jurisdiction is a costly and time-consuming exercise with far-ranging consequences: hence the value of a passport. Whilst the need to seek establishment in a new EU Member State would be a highly resource-intensive exercise for financial services institutions, it would not be without problems for those Member States which would be considered as new headquarters. It is also questionable whether, even given the attempts to break the link between banks and their sovereigns, any one Member State, or even the Eurozone, could afford to do so.

There is a mechanism for recognition of non-EEA Member States which gives financial services institutions established in their jurisdictions certain rights within the EEA, although such rights are in no way equivalent to the passport and the type of right is developed on a case-by-case basis in individual pieces of legislation. This process is known as equivalence. There is not a prescribed process but it typically involves an assessment of whether the third party legislative regime is equivalent to that in the EEA.

Given the close relationship between Switzerland and the EU, Switzerland is often one of the first non-EU jurisdictions to be granted equivalence. Other jurisdictions, including jurisdictions such as the US, which might be assumed to have similar legislation to the EU as they have implemented the same international obligations, can struggle to obtain equivalence, perhaps because the process is often politically influenced.

A need to benefit from equivalence decisions post any withdrawal may encourage the UK to maintain and develop legislation in line with that of the EU. Indeed, as noted above, much of the UK’s domestic financial services legislation has an EU source but that EU source in turn often implements international obligations. This provides another reason why UK financial services legislation post any Brexit is unlikely to diverge significantly from EU legislation, save perhaps where the EU has gold-plated international obligations as it has, for example, with capital requirements for banks and large investment firms. A further reason why UK financial services legislation is likely to mirror EU legislation, at least immediately post any Brexit, is that UK existing financial services legislation has been a principal source of EU legislation in recognition of the pre-eminence of the UK as a global financial centre. As a result of this pre-eminence, the UK’s domestic legislation has historically been amongst the most sophisticated in the world.

Thus it appears unlikely that the legislation that would govern UK financial services institutions, at least immediately post any Brexit, would differ significantly from that of the EU. This means that the main concern for those financial services entities would be access to the internal market.  The loss of the passport would be a great concern but there are arguments that existing passports could be preserved or that the loss should not be immediate on the UK’s withdrawal from the EU.

Greenland’s negotiations for withdrawal involved the agreement of transitional provisions during which Greenlanders, non-national residents and businesses with rights acquired under EU law retained such rights. A large part of the negotiations for the future relationship between the UK and the EU would concern such acquired or vested rights. The Greenland experience thus provides a precedent. There is also an argument that international law23 protects rights acquired or obligations exercised under treaties prior to withdrawal from them. Article 70(1)(b) of the Vienna Convention on the Law of Treaties provides that, unless the treaty provides, or parties to the treaty agree, otherwise, the termination of a treaty “does not affect any right, obligation or legal situation of the parties created through the execution of the treaty prior to its termination”. Law23 Articles 65 – 72 specify the procedures to be followed and the consequences of termination or suspension of treaties.

As with much of what might happen post a decision to leave the EU, whether and how much such acquired rights would be protected cannot be predicted: the Greenland example does not bind the EU and it is by no means certain that the principles of international law can be applied to EU rights and obligations. Further, such arguments could not be used going forward. They would not permit the extension of existing passports to new jurisdictions or new services nor the acquisition of new passports to permit the outward provision of financial service from the UK nor the inward provision of financial services to the UK.

You can read the full 8-page analysis in a PDF if interested.