The UK exit from the EU is likely to have a significant impact on the financial services sector in the UK. The nature and extent of that impact will depend on the model of EU-UK co-operation adopted as an alternative to EU membership and the nature of the UK’s access to EU markets after the UK’s exit. Since the UK Prime Minister ruled out remaining in the Single Market in her speech on 17 January 2017, the likelihood of this sector facing substantial change has become high. Businesses will need to prepare before the UK actually leaves the EU.

The Financial Conduct Authority (FCA) made a statement on 24 June 2016 reminding firms and consumers that currently applicable financial regulation continues to apply until any changes are made by Government or Parliament. The statement said “Firms must continue to abide by their obligations under UK law, including those derived from EU law and continue with implementation plans for legislation that is still to come into effect” and reassured consumers that their rights and protections are unaffected by the result of the referendum. There is no suggestion that the UK will not continue to implement EU law and the Government has announced that existing EU law will be implemented into UK law in the Great Repeal Bill. So the UK should leave the EU with its domestic financial services law very closely aligned with that of the continuing EU.

The Government has also confirmed in its White Paper that the UK will continue to support and implement international standards, and that it will seek to establish strong cooperative oversight arrangements with the EU.

Access to European markets

Currently, a UK authorised firm has the right to carry on business in another EEA State, with or without a branch, provided the requirements of the Single Market Directive under which the activities will be carried out are met. This important “passporting” right allows UK authorised firms, including banks, investment firms, asset managers, (re) insurers, insurance intermediaries, payment services providers and E-money firms, free access to EU markets.

Depending on the nature of the exit, leaving the EU could mean either restricted EU market access for the UK, with “third country” status following an exit, or continued access to EU markets but without the ability to vote on financial services legislation eg as an EEA/EFTA member. It is now clear that the UK may well have no more than third country status after Brexit, unless either a new long term trade agreement covering services provides for a closer relation or the Government is able to negotiate a phased process of implementation that preserves the status quo until such an agreement comes into effect.

Given the risk that the UK does not retain continuous market access for its institutions, businesses will need to consider how to use their existing EU operations – with good planning this transition could be effected relatively smoothly – or whether new subsidiaries are needed. Without a transition period the timeline will be challenging, most particularly for those firms wishing to continue serving customers across the EU, but have hitherto passported out of London; it is also unclear whether regulators in continuing EU Member States will be able to process a potentially very significant increase in new authorisation applications.

What “third country” status means in practice will need to be considered on a legislation-by-legislation basis. As an example, looking forward, the Markets in Financial Instruments Directive II (MiFID II) allows EU Member States the option to require third country firms to establish a branch in that State before being permitted to provide services to retail clients and certain professional clients. This means that UK firms wishing to provide services to these clients across the EU may be required to set up branches in different Member States before being able to do so. Access to EU eligible counterparties and certain professional clients may be possible under MiFID II without establishing a branch, but this may be subject to uncertainty as it will depend on a European Commission decision on equivalence of the relevant UK legislation.

The outcome of an equivalence assessment would depend on the extent to which the UK chooses to replicate MiFID II provisions; the closer the UK stays to those requirements, the more likely it is to be assessed as equivalent: the approach that the UK Government has outlined for the Great Repeal Bill indicates a close correspondence of UK and EU financial services regulation will be maintained. Equivalence assessments are rarely at the top of the EU bodies’ priority list, and risk being deprioritised when resource is constrained. The assessment process can be slow, and there are numerous assessments to be performed for many jurisdictions – a table produced by the European Commission scopes out 30 distinct types of equivalence decisions which have or could be considered in respect of 33 countries (not including the UK) as at the end of 2015. It may conceivably be possible to negotiate some form of interim registration process.

The EU granted the USA’s Commodity Futures Trading Commission equivalence in relation to the regulation of central clearing counterparties (CCPs) under EMIR (the European Market Infrastructure Regulation on over-the-counter (OTC) derivative transactions, central counterparties and trade repositories) in March 2016, some two years after the Regulation came into application. If the UK were to be a third country under EMIR, in the absence of some other negotiated arrangement, UK CCPs would need recognition from ESMA (the European Securities and Markets Authority) in order to continue offering services to EU financial institutions. The EU also is considering legislative measures to move London’s euro-clearing business to the Eurozone after Brexit.

To maintain full access to EU markets, and specifically to carry on deposit taking, lending and payments in the EU, some firms would need to set up subsidiaries in the EU – subsidiaries will be able to apply for the EU passport but being a subsidiary comes with capital implications which are particularly burdensome for some activities, eg banking. For other firms, it could be necessary to move parts of the firms’ operations out of the UK into the EU.

Some firms will be able to use existing subsidiaries, but again there may be capital implications.

EEA firms

EEA firms currently passported into the UK or which would like to gain access to the UK market after the UK’s exit from the EU will face similar uncertainties as those described above. In terms of recovery and resolution planning, and depending on the extent of the UK commitments under the WTO GATS, EEA firms might find the UK regulators are more likely to insist on subsidiarisation and additional bail-in capital. The UK has traditionally accepted branches of banks from third countries and cannot discriminate against banks from EEA countries when their countries become third countries, so blanket subsidiarisation requirements would involve a significant change in the UK’s approach to third country banks in general; although the current view of the Prudential Regulation Authority (PRA) is that new non-EEA branches will focus on wholesale banking, and at a level that is not critical to the UK economy.

In addition, if the UK left the EU, then Article 55 of the BRRD (Bank Recovery and Resolution Directive (2014/59/EU)) may require EEA banks to insert clauses recognising bail-in powers into their UK contracts, unless otherwise agreed. The precise scope of this requirement is under review at EU level and may become less wide-ranging.

Amendments to rules and legislation

Almost the entirety of UK financial services legislation over the past 10 years has EU legislation as its source. The move towards the European Single Rulebook has also meant that many EU rules are now directly applicable in the UK. Much of this law, however, is closely modelled on earlier UK law.

Existing rules and legislation

The starting point of the Great Repeal Bill is the transposition of existing EU law, which will then be considered for adaption or amendment. While it is not difficult to imagine the swift repeal of particular UK “bugbears”, such as the bonus cap imposed by the Capital Requirements Directive IV (CRD IV), and various other tweaks to rules and legislation, it seems unlikely, although not impossible, that the UK exit will trigger a mass overhaul or repeal of EU-based financial services legislation, especially in cases where implementation is recent – or imminent – (eg Solvency II – January 2016; MiFID II – January 2018) and would involve costly systems and operational changes. Thus UK law is likely to continue to incorporate most current EU law in this field. The PRA and FCA handbooks will need to be amended to take into account the UK’s exit.

Directly applicable EU Financial Services Regulations

When the UK leaves the EU, unless otherwise agreed with the EU, alternative provisions will need to be made to retain a financial services regulatory regime in the UK. As described above, the Great Repeal Bill will incorporate directly effective EU law into domestic law and preserve the validity of implementing UK statutory instruments for other EU law. For example, UK implementation of the Market Abuse Regulation (in operation from July 2016) required changes to the current legislation, which will need to be maintained or reversed on a UK exit (see the section entitled Replacing EU law: the Great Repeal Bill above). Factors to consider, in relation to possible changes after incorporation, will include whether or not the measures are necessary for the financial stability of firms and the UK financial system, or are necessary to ensure the UK’s competitiveness or to meet an international commitment (eg CRD IV partly implements Basel III; EMIR is Europe’s response to the G20 commitment to have standardised OTC derivatives cleared through a central counterparty). The UK is independently committed to these measures and will remain so after it leaves the EU.

If UK regulatory policy begins to diverge significantly from the EU approach, this will create additional burdens for firms with cross-border interests who would need to comply with yet another set of regulatory requirements. It might also lead the EU to review equivalence in those areas of divergence.