Summary

The UK is proposing to leave the EU Single Market in financial services when it leaves the EU. Cliffedge risks will arise when passporting rights between the EU27 and the UK cease. The UK originally proposed to the EU27 that there should be mutual market access when passporting rights cease. This approach was rejected by the EU27. One alternative for firms in the UK is to make use of EU provisions for regulatory equivalence for third countries. This is currently a patchwork. If it is not possible to rely solely on regulatory equivalence, the other option is to ensure that, before passporting rights cease, firms are authorised to provide financial services in both the EU27 and in the UK. It appears that, when passporting rights cease, firms will in general be able to carry out contractual obligations already agreed between EU27 and UK entities on cross-border financial contracts. But specific cliff-edge risks will still arise when passporting rights cease. The best way of avoiding these risks is by agreement between the EU27 and the UK. Agreement is needed as soon as possible.

Introduction

1 On 22 June, ICMA sent an open letter to senior political leaders in the EU27 and the UK on Brexit cliff-edge risks in international capital markets.1  The open letter explained the concern of ICMA and its members about the risks of a cliff edge on Brexit, which would fragment international debt capital markets and damage business in the real economy and financial stability. ICMA’s open letter gave examples of cliff-edge risks and argued that ways of avoiding them needed to be agreed between the EU27 and the UK as soon as possible ahead of Brexit. The Vice President of the European Commission replied on 19 July;2 and the UK City Minister replied on 6 August.3 The purpose of this Quarterly Assessment is to set out possible steps that market firms can take, and help needed from the authorities in the EU27 and the UK, to avoid cliff-edge risks in international capital markets, despite the remaining uncertainty about the terms of Brexit.4

Cliff-edge risks: background

2 Given that the UK is proposing to leave the EU Single Market in financial services when it leaves the EU, cliff-edge risks in international capital markets will arise when passporting rights between the EU275 and the UK cease. Passporting rights allow firms authorised in one EU Member State to provide services in other EU Member States without requiring authorisation or supervision from the local regulator.6 The European Commission explains the loss of passporting rights as follows: Many operators, including from third countries, have established themselves in the UK and operate in the rest of the Single Market based on the passporting rights enshrined in the EU financial services legislation. These passporting rights will cease to exist after withdrawal. This means that the provision of financial services from the UK to EU27 will be regulated by the third country regimes in EU law and in the national legal frameworks of the respective Member State of the EU customers. There will be no Single Market access.7

3 When will cliff-edge risks arise?

Cliff-edge risks will arise most immediately if the UK leaves the EU without an agreement on Brexit on 29 March 2019.

If there is an EU27/UK withdrawal agreement, as a result of which passporting rights continue during a transition period8 after Brexit, cliff-edge risks will still arise if there is no EU27/UK trade agreement at the end of the transition period at the end of 2020, unless the transition period is extended.

And, even if there is an EU27/UK trade agreement, there will be cliff-edge risks if the agreement does not preserve existing passporting rights.

The British Government's proposals in the White Paper

4 The EU (Withdrawal) Act, which will take EU law into UK law on Brexit, was passed by Parliament in the UK in June. Shortly after receiving Royal Assent, HM Treasury started publishing secondary legislation on the first financial services statutory instruments, including temporary permissions and recognition regimes. These regimes are intended to enable firms currently authorised to operate in the UK to continue to be authorised for a limited period after Brexit. However, no equivalent has
yet been proposed by the EU27.9

5 The British Government also published a White Paper in July.10 Its main objective is to set out the British Government’s proposals to remain aligned with the EU27 after Brexit on customs arrangements and EU regulations relating to goods. In addition, these proposals are intended to address the UK’s commitment to avoid a hard border between Northern Ireland (in the UK) and the Irish Republic.

6 Although trade in goods is its main focus, the White Paper also covers services, including financial services. The British Government recognises that “the UK can no longer operate under the EU’s passporting regime, as this is intrinsic to the Single Market of which it will no longer be a member.”It argues that “the UK and the EU will wish to maintain autonomy of decision-making and the ability to legislate for their own interests. … The decision on whether and on what terms the UK should have access to the EU’s markets will be a matter for the EU, and vice versa. However, a coordinated approach leading to compatible regulation is also essential for promoting financial stability and avoiding regulatory arbitrage.”11

7 It is not yet clear to what extent the EU27 will be prepared to accept the UK proposals in the White Paper: the main EU27 criticism so far has been that the UK proposals “cherry pick” from the four EU freedoms (people, goods, services and capital), on the grounds that the four freedoms are indivisible.12 Nor is it yet clear what the response will be in the British Parliament, both if the proposals are accepted by the EU27 and in particular if the EU27 does not accept them. A framework for a future trade agreement, in the form of a political declaration, needs to be reached this year in order to give sufficient time for ratification of the EU27/UK withdrawal agreement by the British Parliament, European Parliament and EU27 Member States before the deadline of 29 March
2019, when Article 50 expires. Extending Article 50 would require unanimity in the EU27 and the agreement of the UK.The British Government is currently opposed to seeking an
extension, and also opposed to holding a second referendum on the outcome of its negotiations with the EU27.

Ways of avoiding cliff-edge risks in general

8 International capital market firms have known for some time that they need to prepare for the risks of a cliff edgeon Brexit. The question is: what is the best way of avoiding
cliff-edge risks? The UK originally proposed to the EU27 that there should be mutual market access when passporting rights cease. This would have involved mutual recognition of
each other’s regulatory standards, taking into account that EU27 and UK regulatory standards will be the same at the outset. Under this approach, the EU27 and the UK would have
recognised each other’s regulatory standards, so long as they were consistent with equivalent regulatory outcomes, which would have been agreed in advance; and there would have
been an agreed mechanism for resolving disputes. But this approach was rejected by the EU27, on the grounds that the EU27 needs to be autonomous in its decision-making.

1. Martin Scheck, Chief Executive, ICMA: Brexit: Cliff-Edge Risks in International Capital Markets: Open letter to President Juncker and Prime Minister May, 22 June 2018.
2. Valdis Dombrovskis, Vice President of the European Commission: Letter to Martin Scheck, 19 July 2018.
3. John Glen, UK City Minister: Letter to Martin Scheck, 6 August 2018.
4. The paper does not consider the pros and cons of Brexit, nor the political and economic implications.

5. And the rest of the European Economic Area (EEA) which also includes Norway, Iceland and Liechtenstein. The British Government has so far ruled out remaining within the EU Single Market by joining the EEA.
6. HM Government: Banking, Insurance and Other Financial Services if here’s No Brexit Deal, 23 August 2018.
7. European Commission: Preparing for the Withdrawal of the UK from the EU on 30 March 2019: Communication, 19 July 2018.
8. The British Government refers to the transition period after Brexit as an “implementation period”. The main change during the transition period after Brexit is that the UK will no longer have any say over new EU regulatory standards.
9. Bank of England Financial Policy Committee: minutes of the meeting on 19 June 2018, published on 3 July.
10. HM Government: The Future Relationship Between the United Kingdom and the European Union: Cm 9593, July 2018.
11. HM Government: The Future Relationship Between the United Kingdom and the European Union: Cm 9593, July 2018, chapter 1, paragraphs 60-61.
12. Donald Tusk, President of the European Council: “The suggested framework for economic cooperation will not work.”: Salzburg Summit, 20 September 2018.