UK/EU financial services after Brexit – how will this impact UK firms?

Overview

Single market mutual recognition (such as passporting) will cease to apply as between the UK and the EU/EEA at the end of the current transitional period. In this article, we look at the opening salvos in the negotiation of the new EU/UK relationship and consider how this will impact financial services firms. On 3 February, the European Commission published a draft of the negotiating mandate for the future EU/UK partnership. The UK prime minister also published a less detailed statement (to Parliament) on the UK position on the same day.

When will the UK leave the single market and how does the UK opposition to a transitional period extension impact the financial services negotiations?

The UK’s departure from the single market is currently scheduled for the end of this year but the terms of the Withdrawal Agreement allow for the EU and the UK to agree (prior to 1 July 2020) a one-off extension of the transitional period for a maximum period of two years (i.e. to 31 December 2022 at the latest). The EU negotiating mandate says that it would not be possible to agree an extension to the transitional period after 30 June 2020.

The Government’s position is that it will not seek, or agree to, any extension, and the transitional period will therefore expire on 31st December this year. Of course, this may prove to be no more than a negotiating tactic, but most commentators expect the Government to stick to its position as the 30 June deadline approaches. This is also the date under the Withdrawal Agreement for completion of the fisheries agreement (see below).

The prime minister’s statement describes two alternative outcomes: (i) a deeper relationship along the lines of the Free Trade Agreement the EU has with Canada; or (ii) a relationship based ‘simply on the Withdrawal Agreement deal agreed in October 2019, including the Protocol on Northern Ireland/Ireland’. The latter is a somewhat Orwellian way of describing ‘no deal/no-Free Trade Agreement’ and trading only on the basis of World Trade Organization multilateral commitments (which offer very little for the financial services sector). The Government seems less concerned about achieving a smooth transition and prepared to exit the single market even if some (or all) of the UK/EU treaty envisaged under the Political Declaration is not in place.

Recently there have been suggestions from the EU side that the UK’s insistence that the transitional period cannot be extended means that negotiations this year must be concentrated on priority areas such as goods, so that the services sector negotiations will have to wait until after the UK has left the single market. There is no sign that the Government is particularly alarmed by this prospect. The EU negotiating mandate is more circumspect but talks of achieving ‘as much as possible’ of the negotiations during the transitional period and continuing with the ‘negotiations on any remaining issues after the end of the transition period’. The EU negotiating mandate says ‘We will work on all topics in parallel. We will be particularly vigilant to progress in areas where the risk of disruption at the end of the transition period is particularly high, in case no agreement has been reached.’

In the goods sector there is a big difference between the Political Declaration plans for tariff and quota free access and the alternative of introducing tariffs under respective World Trade Organization multilateral commitments. In financial services, the gap between the Political Declaration plan for the treaty and a no-deal/no-Free Trade Agreement scenario is not that great. Financial services is therefore unlikely to be a priority. For many financial services firms, there will be large-scale disruption at single market exit but this is, to a large extent, the plan under the Political Declaration anyway.

Taken in isolation, it would be relatively easy to convert the limited Political Declaration provisions on financial services regulatory cooperation into full treaty terms, but it may be impractical to think this element would be agreed outside the broader services negotiation. It may be that any Free Trade Agreement negotiated to take effect from 1 January 2021 will need to be restricted to GATT and goods sectors. It might be restricted to areas where the EU has exclusive competence, so as to avoid the need for member state national ratification processes. All services liberalisation, including financial services, might be covered under a later GATS Free Trade Agreement.

This outcome might prevent a trade off in the negotiations between goods and services sectors. Without an extension of the transitional period, this might mean an initial agreement which is focused on limited emergency measures, in the hope that deeper (and broader) arrangements can be negotiated after the UK has exited from the single market. At least one German politician has suggested this approach, with an initial treaty simply seeking to avoid the worst areas of ‘mutual harm.’

Limited ambition for financial services liberalisation confirmed by both EU and UK statements

The apparent consensus on the limited ambition for financial services in the Political Declaration text (see our article on the story so far) is readily apparent and confirmed as common ground in the EU negotiating mandate and the prime minister’s statement.Indeed, the only obvious tension, or area for negotiation, evident from these statements is the different emphasis on process and procedure for the withdrawal of equivalence decisions. The EU is dismissive, but the UK is holding out for a bilateral element to the process in the hope that more transparency and procedure might provide greater certainty for UK firms and restrict the EU’s ability to use the withdrawal of equivalence as a political/trade tool.

Fish for financial services? Is there a route to a closer financial services deal?

In contrast to the consensus on financial services, there is a gulf between the EU and UK in many other areas; with access to UK fishing, level playing field obligations, Gibraltar, ‘alignment’ and ECJ involvement being just some of the more obvious examples. There seems to be something of a turn round; while Mrs. May sought to persuade the EU to accept a closer relationship with the UK, the roles are now reversed with the EU seeking a closer deal from Mr. Johnson. Some see the outcome as depending as much on how the domestic UK dialogue unfolds as on the negotiation process with the EU - despite the UK’s bravado at this stage, will Mr. Johnson, under pressure from the business lobby, swerve at the last minute towards the EU to avoid the economic fall-out of his hardline approach?

It is tempting to think that in that scenario, the UK might achieve substantive bilateral market access/mutual recognition in financial services, well beyond what the Political Declaration envisages. In theory, the UK might seek to change or supersede current EU law by agreeing a more favourable or objective basis for equivalence determinations and/or greater scope of mutual recognition. Many commentators still seem to entertain this possibility, but we believe this assessment is misplaced. There seems to be a lack of appreciation:

• as to just how little, in general, Free Trade Agreement provisions deliver in the financial services sector; and
• of the minimal practical impact of the financial services treaty provisions envisaged in the Political Declaration and the extent to which the UK has already accepted the EU’s equivalence-based approach.

Moving completely away from the Political Declaration text would be a huge concession by the EU, which remains adamant that its autonomy should not be fettered, and would also run contrary to the UK’s increasingly hardline against so-called ‘rule-taking’ in financial services. Recent commentary from the UK side seems to confirm that this is not even on the Government’s shopping list for the negotiations.

Leo Varadkar was recently quoted in the Financial Times as saying – ‘you may have to make concessions in areas like fishing in order to get concessions from us in areas like financial services. That’s why things tend to be all in the one package.” Some see this as evidence that access to UK fishing could be matched by substantive access in financial services.Even in the scenario of a last-minute UK/EU deal of this sort, we think that, while this might well result in a closer outcome in some sectors, it is very unlikely that a substantive closer deal on financial services would emerge. Much more likely, is the possibility that the EU will seek to link, say fishing, with a best terms/outcome implementation of the Political Declaration text on financial services including the granting of equivalence decisions and enhanced cooperation procedures (under a Joint EU UK financial services forum) on prospective rule changes, identification of threats to equivalence and the process for withdrawal of equivalence.

The UK will presumably be seeking to ensure that a full set of equivalence decisions is in place at the end of the transitional period and some security, at least on a transitional basis, that these would be maintained – for example until the final financial services Free Trade Agreement is in place.

In our view, financial services firms would be well advised to write-off any hopes of a dramatic ‘rabbit out of the hat’ outcome for financial services and assume that the ‘best outcome’ from the negotiations is for equivalence decisions supported (sooner or later) by a Free Trade Agreement with some level of transparency and process on future changes to their status.

This is the third in a recent set of articles on UK/EU financial services after Brexit. In our first two articles, we looked at the background to the Political Declaration, which accompanied the Withdrawal Agreement, and at the regulatory framework for UK/EU financial services after the UK leaves the single market.