Brexit will never be done. Even if the end of the transition period can be navigated with minimal disruption, the lack of an institutional underpinning to the UK-EU relationship points towards decades of negotiation over dozens of policy areas, including financial services. Welcome to long Brexit.
Deal or no-deal by 31 December, there will be little short-term impact on the financial services industry. Although this sector is a key part of the UK economy, Her Majesty’s government has not sought to negotiate enhanced access to the EU market. Instead, a range of ad hoc arrangements have emerged to govern short term cross-Channel operations, and businesses have adapted accordingly.
Short-term fixes
For example, in asset management, the UK has taken a relatively liberal stance with the temporary marketing permissions regime (TMPR), announced in November. This gives EU-based UCITS and AIFs passporting access to UK investors of up until three years from the start of 2021, subject to regulatory approval.
The EU has not reciprocated. UK asset managers are required to take the same steps as their colleagues in countries like the USA and Switzerland. While this is an adequate temporary fix, over the longer term this is fraught with difficulty and thus is a potentially unstable foundation for future relationships.
Long-term question marks
‘Short term, a UK manager just needs to set up a Lux or Irish fund and appoint a Lux or Irish management company which will delegate portfolio management to the UK,’ noted Gilles Dusemon (pictured), a partner in the Private Equity & Real Estate practice of the law firm Arendt & Medernach. This would allow the fund to tick over, but the problems arise when new investment is sought, both for retail UCITS and alternative funds.
Under current rules ‘the UK manager would have to find a way to organise its distribution network within the EU, when previously this may have been organised from the UK,’ Dusemon added. This is a considerable problem, as much of the British asset management industry is built around serving the EU. This compares to Swiss and US players for which this market represents an additional extra.
Fish vs equivalence
He spells out two options for the UK. They could negotiate country-by-country access but Dusemon says this would be ‘burdensome and inefficient’. Alternatively the UK government could persuade the EU to grant ‘equivalence’ to UK players. After receiving political backing for this move, implementation would require EU authorities to be able to check or take it on trust that UK regulations are of an equal level to those on the European mainland. It remains to be seen if UK politicians are minded to grant this access, given the extent to which recent political manoeuvring has harmed trust.
There are over 40 financial sector ‘equivalences’ that the EU has in its power to grant or deny the UK. These could be decided either as part of wider negotiations, or case-by-case. ‘Trading fishing quotas for equivalence,’ is how Nicolas Mackel half-jokingly characterised this, when speaking to the virtual ALFI London Conference on November 23.
Those advocating openness and preservation of much of the status quo, point to the benefits for general economic growth from building pan-European and global financial markets. While those favouring protectionism tend to be distrustful of the financial sector, particularly when it features the prefix ‘Anglo Saxon’. Until January this year the UK was the leader of the EU faction working for openness, but as long Brexit unfolds, the way regulations are written and implemented will change.
Good early signs?
Those in the ‘open’ camp could be encouraged that in September the EU unilaterally agreed to allow EU-based banks to have continued access to UK-based clearing houses, at least until mid-2022. London is a global hub for derivatives clearing, with, for example, the London Stock Exchange Group’s LCH clearing about 90% of all euro-denominated interest rate swap transactions. Although eurozone policy makers are nervous about these key operations happening outside the EU’s regulatory environment, they are wary of disrupting this systematically important activity.
Also across the financial sector, there is a fund of goodwill to be built upon. ‘I think trust is there between regulators,’ noted Sheila Nicoll, Head of Public Policy with the asset manager Schroders, speaking at the ALFI London Conference. She suggested this is a good starting point, although she recognised that politics could intervene to put these bonds under strain. She called on all industry players ‘to develop, build and consolidate that trust by behaving sensibly ourselves, and reassuring regulators that we’re doing all that we can to make them feel comfortable.’
Politics is prior
Nevertheless, the spectre of political intervention looms. While some find the institutional, legalistic nature of the EU frustrating, it is that which serves to diminish political considerations in decision making. We live in a world where for reasons of electoral politics the interests of the UK fishing industry (€2.3bn of exports in 2019 says the UK government) appear to predominate over those of financial services (e.g. €735bn assets under management in UK funds domiciled in Luxembourg, according to the CSSF).
‘Negotiations between states are a test of power rather than a debating contest,’ points out Alexander Clarkson, a lecturer in German and European Studies at King’s College London. Given that the EU is about six times larger and thus six times more powerful than the UK, cross-Channel financial services providers should hope that Boris Johnson’s administration can adapt strategy quickly to this changed power dynamic. Failure to do so could see the cause of ‘openness’ harmed within EU decision-making bodies. Europe’s financial services sector could be caught in the crossfire as long-Brexit is negotiated over the coming decades.