In recent months we have watched as politicians and other prominent figures have battled it out over what Brexit really means. Even now, in the wake of Article 50 being triggered, so much remains unclear. In this article, Simon Deane-Johns discusses the future of passporting once the UK leaves the EU.
What is passporting?
Some types of financial institutions are able to ‘passport’ their regulated activities throughout the European Economic Area (EEA) on the basis of their home state authorisation, without being separately authorised in each EEA member state.
In spite of countless unanswered questions when it comes to Brexit, it is clear that size matters when it comes to trade negotiations. So, as the larger trading partner, the EU will dictate its own terms in any Brexit deals. While the application of logic seems to be prohibited in this 'post-truth' era, I recommend proceeding on the basis that the UK will not be able to negotiate mutual passporting rights for financial institutions on acceptable terms.
This poses a very significant challenge for the 5,476 of the UK firms relying on 336,421 'outbound' passports to avoid having to get authorised in every EEA member state. You will see that this works out at 61 passports per firm, but passports are counted separately under each directive that requires them (but only one if a firm has several under the same directive). Of course, Brexit is also a challenge for the 8,008 EEA firms passporting into the UK.
So, a total of 13,484 firms need to apply for 359,953 additional regulatory permissions over the next two years to cover their existing markets.
These 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.
How to prepare your business
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 - 350 UK firms rely on outbound passports and 142 EEA firms passport into the UK. According to a recent 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:
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 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, 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. There is no substitute for doing your own analysis.
It seems that we are embarking on a very long and expensive journey...