A clearer path on Brexit, but what next for financial services?
19 December 2019
The Conservative Party’s resounding victory in the general election means the EU Withdrawal Agreement is now almost certain to be passed in the House of Commons, with the UK leaving the EU on 31 January 2020. The impact of the UK leaving the EU without a deal in January would have been damaging for the financial services sector, despite the huge amount of work that has gone into preparing since June 2016. So the fact that there is likely to be a Brexit agreement will be greeted with relief in board rooms across Europe and beyond. But what does this latest twist in the Brexit saga actually mean for financial services firms?
The first answer is more time - but not a great deal. The withdrawal agreement includes a transition period which will run until the end of 2020. There is the option to extend this period if both the UK and EU-27 wish to (and the request is made before the end of June 2020), but the Prime Minister has stated he will not extend beyond the end of 2020, so firms should plan on the basis that it will end as currently envisaged. Regardless, the extra time is welcome. Many firms will need the time to be operationally ready.
The UK leaving the EU without a deal on future relations has not been taken off the table - if a trade agreement is not reached by 31 December 2020 then the UK will leave the transition period without a deal and revert to WTO rules. So firms should expect the pressure from EU-27 regulators to build capability in EU entities to continue, but firms should also use the time to take a step back and apply a more strategic lens to their Brexit strategies. The short time frames associated with Brexit have necessitated a tactical approach to preparations, especially as the sector has been grappling with other profound challenges such as transitioning from LIBOR, dealing with the Insurance Distribution Directive, alongside increased regulatory scrutiny and technological change, at the same time. It may be tempting to push Brexit back down the list of priorities, but those firms that use these extra months to consider in more detail what a sustainable operating and business model looks like in post-Brexit Europe are likely to reap the benefits in the longer term.
The second answer is a bit more certainty, perhaps. The political declaration on the future relationship which accompanies the withdrawal agreement commits both sides to supervisory cooperation and that they will strive to undertake equivalence decisions by June 2020. So at this stage, firms should focus on understanding what is possible under the EU’s current equivalence framework. Positive equivalence decisions would give some financial services firms an important level of optionality. But equally the political declaration does not absolutely guarantee that these decisions will be taken by June. The European Commission also communicated on 29 July 2019 about its future intentions for managing equivalence with third countries, making clear that in future, equivalence will need ongoing monitoring, and can be withdrawn. Much will also depend on the negotiations on the future relationship, but despite the patchy nature of the EU’s current approach to equivalence (under which activities such as deposit taking and insurance can not be provided on a cross border basis) the framework could provide a basis for continuing to carry out some pan-EU activities from the UK. Here's a summary of the EU’s approach to equivalence.
The UK authorities have been very active in putting in place measures to reduce the cliff edge risks for the financial services sector from a no deal Brexit, including creating a temporary permissions regime for EEA firms that passport into the UK and providing clarity on what new regulations EEA firms would have been subject to in the event of no deal. These measures will no longer take effect. In the short term, a delay in some of these new regulatory requirements, such as UK-specific transaction reporting and third country branch regimes will come as a relief. But for EEA firms there is less clarity, for now, on what the UK regulatory regime will look like for them after 2020. It is likely that many of the policy decisions already taken by HMT and the regulators on how to tailor EU regulation to the UK context will apply, but others are likely to change.
The financial services sector and its regulators have been clear since the referendum that a no deal Brexit would be bad for the sector and wider economy. Now this eventuality at the end of January seems to have been avoided, focus can turn to the next stage of the process. For policy makers this should mean crafting a future framework for financial services which avoids the worst effects of financial fragmentation. For firms the focus should be on balancing the need to complete preparations with undertaking longer term strategy. If the past week has taught us anything it is that the political climate remains unpredictable - be prepared for more Brexit bumps along the road.