No sooner has talk of a Greek exit from the Eurozone dropped off the front pages than another possible EU shake-up is hitting the headlines, with Prime Minister David Cameron announcing that a referendum on the UK's membership of the EU might take place as early as June 2016.
The European Union Referendum Bill, currently progressing through Parliament, states the all-important question that voters will be asked: "Should the United Kingdom remain a member of the European Union?"
Most business leaders think that UK should stay in the EU (84% of them, according to a 2013 MORI poll for CityUK), but the outcome is far from a foregone conclusion. In a YouGov poll of voters in September 2015, only 38% of those surveyed said Britain should remain a member of the EU, compared with 40% who said it should not. On both sides of the debate there is still everything to play for.
We consider below the impact that the UK's exit from the EU (colloquially known as a Brexit) might have on the financial services industry.
At the moment a range of authorised businesses, such as banks, insurance companies and asset managers, are able to operate across the EU as long as they have a base in the UK. This is called "passporting".
Passporting means that a British bank can provide services across the EU from its UK home. Importantly, it also means that a Swiss or an American bank can do the same from a branch or subsidiary established in the UK. Goldman Sachs and JPMorgan have both given evidence to the Parliamentary Commission on Banking Standards flagging up the importance of the UK's EU membership in providing a base from which non-EU businesses can passport across the EU.
Passporting into the EU from the UK would not be possible following a Brexit (unless a special arrangement could be negotiated). Financial services businesses wanting to continue to provide services across the EU would have to establish subsidiaries in mainland Europe.
According to CityUK, 37% of financial services companies say they are very likely or fairly likely to relocate staff if the UK left the EU. This would have a huge impact on London.
Financial services is a highly regulated industry. Much of this regulation emanates from Brussels. Perhaps, the argument goes, a post-EU UK would be less constrained by red tape.
In reality, regulation is unlikely to lessen in the event of a Brexit, and potentially it might increase. Regulation of financial services is also not unique to the EU - regulators and regulation have become a part of business life across the globe.
If the UK wants to continue to do business with the remaining EU Member States following a Brexit, it will almost certainly need to comply with EU regulations in order to do so. Yet if it comes out of the EU, it will no longer be able to negotiate, influence or challenge those regulations. Banks will be faced with having to comply with UK as well as EU legislation, which may well diverge over time or at minimum be applied inconsistently.
This would be a pity. In recent years, the UK has frequently exercised its influence within the EU in relation to banking matters. For example, it successfully called for the introduction of a double majority voting system in the European Banking Authority. This means that any European Banking Authority measure requires a majority both of Eurozone members and those outside the Eurozone. As a result, Eurozone states (which now form a majority of Member States) cannot take precedence over non-Eurozone states. It has also brought several judicial challenges to proposed EU financial services regulations (including in relation to bankers' bonus caps, plans for a financial transactions tax and the location of clearing-houses). The results have been mixed, but the UK has at least had a place at the table. This would not be the case from outside the EU.
Continuing the UK's relationship with the EU
Various models have been proposed for how the UK and the remaining Member States of the EU might manage their relationship following a Brexit. Could the UK be the new Norway (by becoming a member of the EEA and EFTA)? Or Switzerland (accessing the EU by way of bilateral agreements)? Or Turkey (which has a customs union with the EU)?
Much can be said about the advantages and disadvantages of these and other options. Focussing solely on the financial services perspective, however, none is appealing.
The EEA and EFTA States have struggled to deal effectively with financial services and the gulf between the EEA and the EU in the financial services area is likely to widen over time.
Switzerland's 120+ bilateral agreements with the EU require constant renegotiation. None of these agreements allows Switzerland full access to the EU's internal market for financial services. As a result, Switzerland tends to do banking business by passporting - often from the UK.
Turkey's customs union is limited to trade in goods. It does not extend to trade in services (financial or otherwise) and is intended as a pre-cursor to EU membership, not an alternative to it.
It is likely therefore that, if the UK does leave the EU, it will be looking to set up a bespoke arrangement going forward. The terms on which it will be able to negotiate such an arrangement is another question, particularly as other Member States may use the opportunity of a Brexit to strengthen their own financial services industries.
The UK's legal system has become tightly enmeshed with that of the EU over a period of forty years. The unravelling process would be a long and expensive one. Which European legislation and regulation does the UK like or need and therefore want to keep? What should be replaced? Where are the gaps? New UK legislation might also be incompatible with EU legislation. Over time, it is almost inevitable that the two banking environments would drift apart.
There will also be an impact on existing contracts. For example, contractual parties will be asking:
- Will a contractual requirement to comply with a particular piece of EU legislation still be binding following a Brexit?
- What principles of EU law will still influence English courts?
- How will a judgment from an EU Member State now be enforced in the UK?
- How will a choice of English law be interpreted if EU law was part of English law at the time the contract was made but not by the time of performance?
The Brexit debate is full of uncertainty. Will the UK be more prosperous or less following a Brexit? How far will GDP fall, if at all? Will the UK become more regulated or less? No-one can be certain. It may be that the outcome of the referendum is decided (like the Scottish referendum is said to have been) on the basis of this uncertainty, with voters choosing the status quo over fear of the unknown.
In the meantime, a 2015 survey by EY indicates that 31% of investors will either freeze or reduce investment until the outcome of a referendum is known. An investor currently reflecting on whether to expand in the UK may well consider potentially safer options elsewhere in the EU. Perhaps the only certainty is this - that a growing unease about the UK's future will soon become a highly relevant decision-making factor in business.
Click here to view table.