The City of London is Europe’s financial centre and has recently leapfrogged New York to become the world’s leading financial centre, according to think tank Z/Yen.
London is currently home to over 3000 securities firms regulated under MiFID – dealers, brokers and investment managers. Well over 50% of the EU’s MiFID firms are based in the UK, emphasising its primacy as the EU’s securities hub (EBA: Report on investments (December 2015).
What would be the impact on these firms, and the City of London, if the UK electorate votes to leave the EU, and in doing so the UK becomes – from an EU perspective – a third country state? There are parallels – think of Switzerland, and international financial centres such as Jersey. How do they fare outside the EU when their financial institutions need to do business or service customers in the EU? The short answer is, it’s not easy.
A loss of influence
At present the UK has a direct influence over the decision making process in the European Commission, Parliament and Council. Most recently the UK has been able to influence the development of AIFMD and ensure that the Directive provides protection for investors but without reducing investor choice.
As a third country state the UK’s ability to influence EU regulation would diminish. It can attempt to participate in the decision making process by raising points with a member state with which it has a favourable relationship, in the hope that any concerns or comments eventually get passed on at an EU level. Alternatively, it can try to find another third country ally, for example the US, with which it can engage with the EU and attempt to influence policy.
Generally, third countries such as Switzerland and the US are received well by the EU institutions, and the EU is keen to maintain a good working relationship with them. But cordial relations fall well short of a member state’s right to participate in discussions and to exercise a formal right of veto. Further, EU institutions can and do make politically motivated decisions that do not recognise the interests of third country states.
Currently, a UK authorised bank, insurer or securities firm (and others too) has the right to carry on business in another EEA state without further authorisation. This passporting right allows UK firms to access European markets and over 2000 UK investment firms benefit from a passport under MiFID; indeed nearly three quarters of all MiFID passporting is done by UK firms into the EU (EBA: Report on investments (December 2015).
UK firms will lose this right if it exits the EU, meaning that each right of access for insurers, fund managers or banks would need to be individually negotiated at Government level with the EU. The status quo will only last if the EU agrees and for so long as neither UK nor EU financial services law changes, which won’t be for long. Third countries’ experience is that these negotiations can be difficult and protracted – and will not necessarily replicate a member state’s unfettered market access. Under MiFID II, for example, third country firms will be able to access only professional clients and eligible counterparties within the EU on a cross border basis, but subject to the home state being recognised as providing EU-equivalent regulation. This falls far short of the current universal passporting rights and would require the UK to satisfy the EU on an ongoing basis that it was continuing to meet its requirements. This could be a real drawback for the City of London whose prosperity substantially depends on continued and unfettered free market access to the EU.
EEA authorised firms will lose the corresponding ability to operate in the UK, and consequently the UK will lose the advantages this brings such as increased liquidity, employment opportunities and tax revenue. London may additionally stand to lose some of its attractiveness to incoming third country firms. The Bank of England website currently lists 80 banks incorporated outside of the EEA who have established a UK branch; while not enjoying passporting rights, part of London’s attraction to such firms is its position within the EU.