As the United Kingdom continues to drift interminably toward its decision on Article 50, a growing number of Leave campaigners have become steadily more vocal in their demand for a “hard” Brexit, commonly understood to mean an immediate repeal of the European Communities Act and, with it, the loss of membership of the Single Market. While the immediate impact of a “hard” Brexit is difficult to quantify without any detail, it seems clear that exiting the Single Market would have a profound impact upon London’s financial services industry.
Throughout the referendum campaign, some of the Leave campaign’s more technical arguments centered around the UK’s alleged loss of sovereignty and the imposition of EU regulations and directives. However, the pursuit of regulatory harmonization within the framework of the EU’s Single Market has brought obvious advantages among Member States, including the UK. That a firm seeking to offer services across the EEA might be able to do so on the basis of a single authorization within their home state and a single system of regulation has clear cost, operational and administrative benefits. Harmonized rules on capital requirements may also permit firms to establish themselves in a single Member State while operating (or “passporting”) through a system of branches throughout the EEA without necessarily being required to hold separate or additional capital in each.
Indeed, it would be difficult to argue that the UK has not been the primary beneficiary of the continuing drive towards the creation of a harmonized, standardized system of financial services regulation within the Single Market, with the provision of financial services currently representing somewhere in the region of 8% of the UK’s total GVA.
However, for those firms outside the EEA seeking access to this lucrative market, the existing umbrella framework presents a considerable barrier to entry for non-Europeans. Broadly speaking, firms based outside the EEA may be prevented from providing investment services or products within the Single Market unless the regulatory regime under which those firms operate are considered to be “equivalent” to the corresponding EU regulation.
Determinations on regulatory equivalence have thus far proven to be both complex and politically sensitive. For example, following the final introduction in 2014 of the Alternative Investment Fund Managers Directive (“AIFMD”) which allows EEA-based investment managers to market their funds within the EEA on the basis of a single, pan-European marketing passport, the European Securities and Markets Authority has only last month published their advisory opinion on the potential extension of this marketing passport to firms in third-countries, such as the US and Canada. An affirmative determination by the EU on equivalence is not expected before 2018 and is by no means guaranteed.
That the EU might be a little hesitant to allow third-country firms easy access to this multi-trillion Euro market is understandable and, inevitably, political considerations will dictate that European firms are granted preferential treatment. Even if, post-Brexit, the UK’s overall regulatory regime is considered to be equivalent, access to the Single Market is likely to be limited. For example, both the Undertakings for Collective Investment in Transferable Securities (UCITS) Directive and the updated Markets in Financial Instruments Directive (MiFID) do not contemplate the provision of financial services or the sale of financial products by third country firms to European retail consumers.
Consequently, UK-based asset managers could end up in a position where they can neither market their funds to European investors nor trade the funds underlying assets within the EEA.
The UK is therefore faced with an interesting dilemma. If political considerations dictate that membership of the Single Market is no longer viable, the UK will be required, not only to maintain its existing regulatory framework in the hope that a determination on equivalence is reached promptly (despite the obvious commercial disincentive for the EU not to do so), but to also ensure that it evolves and develops in line with EU regulation for the foreseeable future, putting paid to any notion that a more liberal, light-touch system of financial regulation could be adopted in the UK as a way of enticing foreign firms to maintain their London bases.
Any failure to maintain existing membership of the Single Market will inevitably present an existential crisis for London’s financial services industry. It is difficult to conceive how a London outside the EEA, any more than New York or Singapore, could hope to act as the gateway of choice in future for third-country firms seeking access to EU-based investors and consumers.
To paraphrase that great existentialist thinker, Jean-Paul Sartre, it seems clear that, in future, efforts by UK-based firms to offer financial services within the EEA without recognized regulatory equivalence “tous sont en principe vouée à l’échec…”