Big financial groups in London are losing faith in a quick fix to get access to the European Union after Britain leaves the bloc and are instead drawing up contingency plans to avoid becoming hostage to Brussels politics.
In the aftermath of Britain’s vote to leave the EU, legal experts said banks, insurers and asset managers in London using so-called EU passports allowing them to sell services across the bloc should keep their access because regulations in Britain would be equivalent to those within the trading zone.
Foreign Secretary Boris Johnson also said in July he expected financial firms in the country to retain rights to sell within the EU, given the desire of European firms to have reciprocal access to London.
But many in the City of London, Europe’s biggest financial center, are having second thoughts about relying on such an equivalency fix as it will be Brussels not Britain that decides whether the rules are the same.
Having equivalent rules is a condition for market access and Britain would almost certainly comply on Day One of Brexit, simply because it would have been enforcing EU-wide financial services regulations up to that point.
But what worries financial firms is that equivalence could, in theory, be withdrawn by Brussels at a month’s notice, which is an element of risk some are not prepared to shoulder.
“There is not a very clear structure for how equivalence is granted, and it’s likely to be at best a highly politicized environment,” said Mark Hemsley, chief executive officer of Bats Europe, the region’s biggest share trading platform.
“While on the face of it equivalence appears to be a very attractive route because it implies very little work, when you get down to the first level of detail there are unanswered questions,” he told Reuters in an interview.
European heavyweights Germany and France have played down hopes of an easy deal to keep London’s financial hub intact and Frankfurt, Paris, Dublin, Luxembourg, Milan and Amsterdam are all vying to woo UK-based firms that need watertight EU access.
Hemsley said barring a clear signal that Britain would have full access to the single European market, Bats would start work on a second base next year, with Dublin being one of the more attractive locations in the EU.
The EU passporting arrangements have been central to Bats success. Founded in 2005 in the United States, Bats first took on the main U.S. exchanges before expanding to Europe in 2008.
Centered in London with an EU passport, allowing unhindered trade across the bloc, Bats Europe has been able to snatch large chunks of share trading from centuries-old national European stock exchanges to become the market leader.
Other firms such as British insurers Admiral Group and Beazley Plc have also said they may shift some operations to Dublin, or elsewhere in the EU to have guaranteed passporting rights following Brexit.
U.S. banking giants Goldman Sachs and Bank of America both rely on EU passports for their London-based European operations and have said they may restructure some businesses when Britain leaves.
The passport so cherished by financial firms throughout the European Union is granted under a law known as the Markets in Financial Services Directive, or MiFID.
An updated version called MiFID II that comes in on January 2018 includes an equivalence provision for firms in countries outside the bloc that want to do business with EU customers.
“MiFID II is critical because of the need for continuity in global securities trading, but equivalence on its own is unworkable,” the head of regulation at a foreign bank in London said, referring to the lack of guarantees that equivalence would be maintained.
High Risk Strategy
The EU’s executive, the European Commission, is the body that decides if the financial rules in a country outside the EU are equivalent, and allow market access.
As Britain would almost certainly leave the EU after MiFID II came into force it should be compliant initially. But if the EU amended MiFID later, that would force Britain to make similar changes, or risk having equivalence withdrawn.
There is no set timeline for equivalence decisions and they not only cover countries but every firm wanting recognition from Brussels to trade across the bloc.
“That is not a very satisfactory environment. They can just switch you off,” Hemsley at Bats Europe said.
Besides the lack of guarantees, it could also take time for Brussels to make a ruling, adding another layer of uncertainty and risk. For example, it took Brussels about four years to decide that a U.S. rule for clearing derivatives was equivalent, and allow European banks to continue using U.S. clearing houses.
“It would be difficult to make long-term business decisions in the hope that the UK’s laws and regulations will be deemed equivalent to EU rules,” Vishal Vedi, banking and capital markets Brexit lead partner at Deloitte, said.
“So, placing sole reliance on equivalence is a high risk strategy.”
Bankers say the MiFID II equivalence regime could be a stop-gap from when Britain leaves the EU until new trading terms with the bloc come in.
The head of regulation at the foreign bank said there could be a bilateral arrangement that includes the equivalence regime, plus an overlay to address issues such as the short notice period for withdrawal and future changes in EU regulation.
“It’s a choice between being some sort of rule-taker or having some sort of bespoke arrangement, and that probably won’t be MiFID II on its own,” the banker said.
Hard Brexit Risks
EU leaders have said that as a matter of principle, Britain would only get complete access to the single market if it in turn allowed EU citizens to work there, a condition many Brexit backers oppose.
Deloitte’s Vedi said this was why many banks were planning for the World Trade Organization (WTO), or “hard-Brexit,” scenario which assumes Britain gets no preferential treatment and will rely on the WTO’s global system of trade tariffs.
“That is the scenario involving most change compared to the current set up. Then they can always peel back from there,” Vedi said.
For now, the contingency plans are just that. For Britain to leave the European Union, the government has to trigger Article 50 of the EU Treaty to start two years of divorce negotiations. British Prime Minister Theresa May has said that will not happen before the end of this year.
But when Article 50 is triggered, financial firms based in London with business in Europe will have to make a decision, Vedi said.
For Hemsley at Bats Europe, that would probably mean applying for an EU passport from a country such as Ireland, to avoid the regulatory uncertainty that the equivalence regime, bilateral deals or the WTO approach would all hold.
He expects others to follow suit.