Brexit – what does it mean for the City?

The UK’s financial services sector generates around 7% of GDP, pays about £60bn per year in tax, directly employs about 1.1m people, and makes a significant contribution to sustaining another million jobs in associated sectors such as accountancy, management consultancy and law.

Of that £60bn in tax, about £15bn (more than Britain’s total contribution to the EU) is paid by foreign banks based in the UK.

What effect will Brexit have on financial services? At this stage, no-one is really sure. Seven months on from the referendum, though, some broad outlines, and potential options, have at least started to become clear.

The ‘Norway model’

The initial preference of most prominent bankers, some sort of Norway-style arrangement whereby the UK would be outside the EU but remain a member of the single market, appears to be off the table at present given the politics around free movement. In essence, Norway accepts free movement and gets to be inside the single market – the government appears not to be seeking this.

No deal – WTO rules and what they mean for the City and the EU

If, two years after Article 50 is triggered, Britain has no deal in place with the EU for market access – whether a final deal or some transitional arrangement – the default position is to fall back on WTO rules. For financial services, that would mean the General Agreement on Trade in Services.  That agreement provides that there must be “treatment of services and suppliers from other members [of the WTO] no less favourable than that accorded to like services and suppliers of any other country”. In practice, this creates no barrier to the EU imposing various licensing requirements on anyone seeking to provide financial services in the EU. Institutions based on the inside would be given the appropriate licences, but that would leave a Japanese bank with a branch in London in no better position, legally, to provide its services in Paris than it would be if it closed the London branch and traded entirely from Tokyo.

A leading City solicitor told the House of Lords’ EU Committee that it would be likely to take 2 years to move the substance of an investment bank’s business to another country. That is the same as the period of time from Article 50 being triggered to the UK leaving the EU. Without any commitment from the government to achieve at least a transitional deal, he said, banks acting rationally should therefore begin preparations to move the day Article 50 is triggered.

Assuming that some level of market access for financial services can be negotiated after the UK leaves the single market, the mechanisms for such access are likely to turn on the concepts of ‘passporting’ and ‘equivalence’.

‘Passporting’ for Financial Services, post-Brexit

Passporting has become something of a financial media buzzword in recent months, more used than understood. The FCA and PRA issue so-called ‘passports’ to financial services firms doing business in the EU, and to other EU firms doing business in the UK. There are around 360,000 passports at present, issued to around 13,000 firms, with 336,000 of these passports being issued to UK firms to do business in other EU countries.

How do these passports actually map on to business activities, though? Many major firms told the EU Committee that even they did not really know. Lloyd’s of London thought 11% of its business was at risk from a loss of passporting. One senior City lawyer said that firms “often discover that they need permission to do something and had not realised it”. Sir Jon Cunliffe, Deputy Governor of the Bank of England, told the EU Committee that “in some areas like insurance where passports are used, they are very cheap and easy to get. Passports are used for relatively small volumes of business such as selling travel insurance cross-border”.

EU regulation fits with particular business activities, so for instance insurance is subject to particular regulations, hedging of debt is subject to other regulations, etc. The crucial issue is therefore not how many passports will be able to be issued, but which sectors, or types of business, they will continue to be issued for. Passports are currently issued, in the main, under:

  • the Capital Requirements Directive (CRD IV), which covers capital adequacy standards for banks
  • the Solvency II Directive, which covers the solvency requirements for insurers
  • the Markets in Financial Instruments Directive (MiFID), which covers securities, funds etc. and was recently revised
  • the Undertaking Collective Investment in Transferable Securities (UCTIS) Directive
  • the Alternative Investment Fund Managers Directive

It is entirely conceivable that passporting could continue under some of these regimes but not others, which would mean that some areas of financial services provision into the EU would be able to continue from London while others move elsewhere, inside the single market. However, it is hard to see how passporting could carry on for long in any sector where the relevant EU regulation ceased to apply in the UK.

In any sector where passport-style access is not secured, the potential fall-back position may be for trade in financial services to continue based on ‘equivalence’ i.e. trade could continue on the basis that UK regulations were in some relevant sense equivalent to those applicable in the EU.

Equivalence: ‘mirroring’ EU and the UK financial regulations

Many financial sectors are, at least in theory, covered by equivalence provisions – for instance, cross-border provision of investment services to wholesale clients under MiFID and reinsurance under Solvency II. Other sectors are not, the most important omission being banking services such as lending and taking deposits. No passporting might well mean no lending, regardless of regulatory equivalence.

For those activities which do have third country equivalence rules, the principle is that services can be provided in the single market by any provider regulated in any third country whose relevant regulatory regime is ‘equivalent’ to the EU’s. In principle, the day that the UK leaves the EU, its regulatory regime is very likely to be ‘equivalent’ in practice, as the government’s plan appears to be to copy EU regulation lock, stock and barrel at first, then amend it later if it wishes to do so.

Equivalence is, however, unlikely to provide a complete solution for long-term market access, even in those sectors where it does apply. Firstly, the equivalence provisions remain largely untested. Under MiFID II, for instance, equivalence decisions are a matter for the European Commission, and there is no timescale for how long the Commission has to make them. If it wants to grant equivalence to a third country, that decision has to go to a committee of member states, then the European Securities and Markets Authority has to register each individual firm from that jurisdiction. Furthermore, the financial services sector is by its very nature dynamic. While the UK’s regulations may well mirror the EU’s the day after Brexit, unless the UK actively apes EU regulation year on year thereafter, equivalence is unlikely to be sustained in the future.

Equivalence may come to play an important role in securing access for UK financial services in sectors which are subject to globally agreed regulatory schemes. However, it is likely to prove a poor alternative to passporting.


So, what does Brexit mean for the UK’s financial services industry? The answer remains unknown. However, the possible building blocks for a transitional deal, in which the UK could mirror EU regulation for a period, aim to have its regulations formally declared ‘equivalent’ by the European Commission on the date of departure, and seek to maintain passporting arrangements in as many sectors as possible, are perhaps beginning to come into focus.

This article draws on the House of Lords European Union Committee’s report, Brexit: financial services, published on 15 December 2016. The EU Committee’s ongoing series of reports on the potential effects of Brexit are available here.


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