HSBC London Håkan Dahlström/Flickr. (CC 2.0 by)
The result of June’s referendum on whether the UK should leave the EU has exposed limits in assumptions and concepts that strategic planners at financial services (FS) firms – from banks and insurers to dealers and asset managers – must recognise.
These challenges, and the inadequate analysis that can result if they are not acknowledged, have seen an evolution of labels, all trying to capture what sort of new UK-EU relationship a firm should plan for. The term Brexit had a brief legitimate role in tactical planning up to the first few days of market turmoil. Since then an early focus on retaining passport rights has been complemented with a more nuanced set of tasks at an industry level. But still, given that what is good for an industry (from a national viewpoint) may be detrimental at any particular firm, and the possibility that that the government will require a price for securing rights for FS firms, only adds to the huge challenges for strategic planning at the firm level.
In examining Brexit from the perspective of the financial services industry, we need to expose four persistent myths that have taken hold since the referendum.
Myth 1: Brexit means ‘Brexit’
The term ‘Brexit’ is a weak label for strategists to use. The wide deployment of the term Brexit in the referendum campaign to suggest that those voting to leave the EU were in fact voting for a clearly defined set of outcomes is debatable. But for those now involved at FS firms in strategic planning, the label Brexit adds nothing to analysis – it is merely shorthand for a decision to leave the EU membership.
In the first days after the referendum, the tactical responses of firms trading in the capital markets did not need to be overly concerned with what the opposite of EU membership might actually look like. During this short period of time, currency dislocations, volatility and liquidity challenges, as well as buying opportunities from oversold stock were probably driven more by news of the decision to leave than by any thorough analyses of the UK’s likely position after the eventual withdrawal from the EU. These events could be more or less well planned for by banks and asset managers – even if few expected to implement them.
Beyond this short period, however, the term Brexit loses worth. Any forward planning now has to consider a whole range of possible new types of relationship with the EU. This may be an obvious point, but even with the introduction of modifiers like ‘hard’ and ‘soft’, talking of Brexit as if it were a clearly defined thing only tends to perpetuate the notion that there are a suite of pre-existing options from which the UK must choose. It is as if, having decided not to use a vehicle to commute, it is just a matter of deciding which bicycle to buy.
Myth 2: replicating single market access is about retaining existing passports
Alongside those involved in strategic planning, senior management and lobbyists in financial services want to inform political opinion with their preferences for any new relationship. In light of the politically- yet not legally-binding referendum result, FS firms must express their preferences in ways which are consistent with not being a member of the EU (even if their preferred options sit more naturally with there having been a Yes vote). Whether the UK will eventually seek membership in European Economic Area (EEA), a recast “Swiss model”, or a bespoke arrangement: the financial services industry’s future will depend upon the precise articulation of a new treaty with the EU.
This recognition led many leaders of FS firms to concentrate on retaining existing passporting rights. As the UK’s Financial Conduct Authority explained in its 17 August 2016 letter to Andrew Tyrie MP, chair of the Treasury Select Committee:
“with a passport an entity’s authorisation to do business in one EU Member State (and under certain directives in EEA states, too) is recognised by all other Member States as an authorisation to do business in their territory as well. As such, a passport obviates the need to obtain separate authorisations from other Member States”.
And of course, the wide usage of passports cannot be underestimated. The FCA reported in that letter that 5,746 UK-based firms use 336,421 individual passports to do business in other EU and EEA member states. This equates on average to each firm offering two passportable services in every one of the EEA states.
There is a growing realisation that retaining passporting rights alone would not be sufficient to protect financial services’ interests.
More recent policy positions however now place this objective in a wider context of policy requests. The CityUK’s September 2016 Brexit paper seeks several outcomes, including access to the single market on “terms that resemble as closely as possible the access we currently enjoy, including through a bespoke British option, passporting and keeping euro clearing in London”. This reflects the growing realisation on behalf of the financial services firms that the retention of passporting rights alone would not be sufficient to protect their interests. There are at least three reasons for this:
Retaining passports alone does not ensure full and non-discriminatory access
First, passports are attached to various specified activities in the major financial services directives. For example, the Markets in Financial Instruments Directive (2004/39/EC) and Solvency II (2009/138/EC) provide the frameworks for investment business and insurance business across the EU. An activity might be dealing as agent in relation to financial instruments, portfolio management, or investment advice.
Clearly some actions are unarguably the giving of investment advice, but what of marketing or soliciting business beforehand? There is no consistent EU-wide recognition of the activity of visiting a country for the purposes of soliciting business, putting on roadshows, or for having follow-up meetings with existing clients. Additionally, as any business operating in the EU has experienced, there are a range of country-specific requirements that must be met for the practical business of servicing customers in that country.
The upshot of this is that a passport in the hands of a person from a third country would not today provide all the soft rights that UK-based firms currently enjoy. More importantly, provisions of equal access and non-discrimination amongst EU firms are deeply engrained in the existing EU acquis communautaire. Such provisions are the special privilege of EU member states. They will not be granted lightly in any new agreement with the UK, especially if the latter wishes to restrict the free movement of people. Accordingly, to maintain the UK’s FS firms status quo, the practical implementation of these provisions will need to be replicated. This represents a significant challenge.
Relying on equivalence to secure access not only binds the UK’s future choices, but it may not be retained as the test for access anyway
Secondly, the rights of third country firms to access the EU presently depend upon assessments of the equivalence of the third country’s regime by both the EU and national governments. Equivalence as a test only gained currency in the EU after the financial crisis, as a compromise between Fortress Europe policies – especially those then trying to keep hedge funds out – and those which are more open to US and Asian firms seeking to do business in the EU.
Much has been written on equivalence and how it may tie the UK to remain in step with the EU. But it is also possible, however, that future financial services directives will not retain equivalence as the test for third country firms but will rather demand different and more specific requirements to be met. Again, this suggests that any new agreement with the EU will need to secure some longer-term recognition that UK firms will be ‘equivalently’ regulated.
Some business depends upon being able to export (delegate) activities to the UK – rather than use a passport to access the EU
Thirdly, asset managers and others rely on rights to delegate core investment management services from Luxembourg- and Dublin-domiciled funds to portfolio managers sitting in the UK. These are not passport rights. In the future, the ability to delegate outside the EU may also depend upon both EU and national assessments of the equivalence of the UK’s regime. Therefore, unless the right to delegate is secured in any new treaty, it introduces a further layer of uncertainty in forward planning that presumes single market access.
Those charged with strategic planning have, in the five months since the vote, become acutely aware that the retention of passports may be necessary, but this will be far from sufficient to secure single market access.
Myth 3: what is good for industry is good for individual firms
The third area in which labels can mislead is in the use of the term industry, as in the financial services industry, or the banking industry. As any label, it has its uses, but it is vital to understand its limits as well. Within individual firms, the first questions asked by those tasked with working out the response to Brexit will not be about the health of the industry.
Rather, they will be concerned with how to minimise costs, retain staff and clients, and even how they may use the opportunity to out-compete their rivals. What matters to a global bank; to a challenger bank; to a vertically integrated insurer asset manager with all its business in the EU; or a fund manager mainly servicing US clients (from the UK) will differ on a case by case basis.
Stark clarity as to where the lines will be drawn is needed so individual firms can make their decisions about where to locate what business activities and where to expand or contract.
Again, this is not surprising. Many are asking for clarity from the government regarding their negotiation plans, and in the early days it was frequently characterised as being needed so as to reassure the FS firms. But as individual firms work out what changes would suit them best, and time passes, the strategic planners will read any announcements by the government as a sifting of the options available. In that sense, early calls to reassure the City are long past, what is awaited now is stark clarity as to where the lines will be drawn so individual firms can make their decisions about where to locate what business activities and where to expand or contract.
Myth 4: the presumption of priority
Finally, there appears to be an unspoken assumption that the UK government will negotiate a new treaty without expecting something in return from financial services. This may be a fair assumption. However, given the wider mistrust of financial services in the population, and the perception that it does not serve every region (or nation) equally, any administration will want to be clear to the electorate why financial services need to be protected in some way.
There are good economic reasons why they might be, but FS firms will want to plan how they can better explain what they bring to society or indeed how they might better serve wider society’s needs.
Strategic planning following the EU referendum is extremely complex. Several key existing models of single market access do not map easily onto a relationship where the UK is not a member of the EU. This article has described some of these conceptual and labelling challenges. It makes no assumption about the merits or demerits of any new relationship for Britain, either with the EU or the rest of the world. Rather, it seeks to dispel some simplistic (and, therefore, persistent) myths regarding the place of financial services in the forthcoming Brexit negotiations.