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Friday, 20 January 2017

Post-Brexit Outlook For Passported Financial Services

Well it's been a dismal six months watching the politicians shadow-box among themselves over what Brexit really means. There's no shared vision of the big picture, let alone any grip on the detail. What is clear, however, is that size matters in trade negotiations. So the larger trading partners like the EU will dictate their own terms in any deals. And while the application of logic seems to be prohibited in this 'post-truth' era, I intend to proceed on the basis that the UK will not even be a member of the EEA (or the Customs Union) - and that it certainly won't get a better trade deal with the EU than it has today. That means the only real job left for UK politicians is to figure out who gets pork-barrelled compensated by the UK taxpayer for being worse off for having to treat the EEA as a separate market (where they can't pass those costs onto their UK/EEA customers more).

While the car makers got in first, ejecting from the EU/EEA poses a very significant challenge, in particular, for the 5,476 of the UK firms relying on 336,421 'outbound' passports to avoid being authorised in every EEA member state. This works out at 61 passports per firm, which is somewhat strange given there are 31 EEA countries, but passports are counted for each separate directive that requires them (only one if a firm has several under the same directive). Brexit is also a challenge for the 8,008 EEA firms that hold 23,532 passports (about 3 each) to cover their UK offerings.

In essence, a total of 13,484 firms need to apply for 359,953 additional regulatory permissions over the next two years if they want to continue to make sure they can cover their existing markets.

Such applications don't come cheaply or quickly, and involve significant ongoing management and administration costs following authorisation. And because most of the work will be required abroad, the lion's share of the related fees and expenses will be charged outside the UK, worsening the UK's trade deficit even further. The UK can also kiss goodbye to the tax revenues on the earnings of each foreign firm, as well as the incomes of its management and staff...

But that's all water under the bridge (or out the English Channel, if you will).

During the next two years, any financial services firm based in the UK/EEA that relies on a passport for cross-border activities or ambitions involving the UK will need to pursue the following options, either organically or by acquisition: 
  • Retain/obtain authorization for an entity established in the UK, if it wishes to serve the UK market;
  • Obtain/retain authorization for an EEA-based entity to take advantage of the EEA passport regime for the remaining EEA countries;
  • Seek to rely on any passporting arrangements that the UK may agree with non-EEA countries (these could only be formally agreed post-Brexit, but might be planned in the meantime);
  • Obtain/retain authorisations in any non-EEA countries it wishes to target - as is the case today, but the cost/benefit of targeting some of these countries may now have changed, given the extra cost of authorisation to serve EEA markets, and perhaps jockeying among countries wishing to take advantage of the situation.
So where would you base your EEA-passport firm?

The relevant analysis, if not the outcome, will vary significantly depending on the type of financial services and markets involved. Most of the relevant passports relate to general insurance intermediation and trade in various securities/markets, but payment and e-money services represent the third most popular category with perhaps greater retail significance - here 350 UK firms rely on outbound passports and 142 EEA firms passport into the UK.  According to a report commissioned by the Emerging Payments Association, the 350 UK firms have six countries to choose from as a potential base for their EEA passport entity, based on criteria including the ease of making an application, supportive regulatory approach/attitude, ease of setting up and doing business, jurisdictional reputation and sovereign/political risk:
  • Cyprus 
  • Denmark 
  • Ireland 
  • Luxembourg 
  • Malta 
  • Sweden
While not wishing to disparage any of those fine jurisdictions, you will see from the commentary in the EPA report why the UK is walking away from a (literally) golden opportunity to continue its role as the preferred EEA passporting hub for financial firms (many of which are managed or staffed by people who moved to the UK for that reason).  Yet, while that commentary is very helpful and a useful lens through which to view options, I know from personal experience that it does not always reflect reality on the ground or capture all the criteria that are relevant to the decision for each firm - and the authors don't pretend that it does.

We are only at the beginning of a very long and expensive journey...

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