The UK’s referendum on EU membership is almost upon us, and the country has got itself in to something of a tizz. Just one of many industries likely to be affected by a British exit from the political and economic union, the financial services sector is arguably in line to be one of the hardest hit, with uncertainties surrounding everything from regulatory scope to the fate of Europeans employed in The City.
Ronald Gould, European chairman of governance, risk management and compliance solutions provider Compliance Science, and a former senior adviser to the UK Financial Services Authority (now the Financial Conduct Authority), argues that a so-called ‘Brexit’ would inevitably lead to “some negative fall-out” for the UK financial services sector, at least in the short to intermediate term. While acknowledging that the long-term effects are harder to call, he says: “For the first couple of years, I think an exit vote would work to the disadvantage of the UK financial sector.”
There is no contention that a vote to exit would bring considerable change to the market. One major issue to arise is that of passporting rights. While UK-based service providers currently benefit from the right to conduct business in other member states, in the case of an exit from the EU, this would potentially cease to be the case, meaning firms would have to apply for a passport in order to continue their business with mainland providers and clients.
While Gould notes the convenience of being able to access the broader European community “without having to go through a lot of time-consuming and costly regulatory hoops, country-by-country”, Nikolas Xenofontos, director of risk management at the online trading service provider easyMarkets, expands on this, suggesting that if they find themselves outside of the EU, UK firms may have to prove themselves to the EU authorities, often for the first time, in order to gain permission to continue trading on the continent.
Xenofontos says: “Firms wishing to operate in the EU would be required to conduct an ‘equivalence’ test to prove to Brussels that the UK’s new rules are in line with the EU’s structure.”
According to Gould, while some would argue against the importance of passporting, they are fooling themselves. There is a major risk that other countries with significant financial centres could take advantage of the uncertainty brought by a UK exit, and that other financial centres may not necessarily make it easy for the UK to negotiate new agreements.
While acknowledging the business that the UK gets from the EU is “not such a large proportion of the total that it becomes debilitating”, he goes on to warn: “You’re taking a pretty optimistic view if you think the loss of easy access is going to leave firms in the UK unscathed.”
Taking the opposite view, however, while speaking to financial services professionals at the SWIFT Business Forum event in London in April, John Redwood, the current Conservative Party member for Wokingham and chairman of the Conservative Parliamentary Economic Affairs Committee, suggested that after an exit from the EU, The City would actually look very much the same.
He said: “We have a set of perfectly good arrangements at the moment for dealing with our trade. I would suggest that we don’t change anything, and it would be up to [the European counterparties] to suggest what changes they wish to make.”
Arguing the other side of the debate at the SWIFT event, Vince Cable, former secretary of state for business innovation and skills within the previous coalition government cabinet, said: “The underlying principles of passporting, which are critical to the operation of financial institutions, have worked very well for the City.”
“I think the vast majority … are comfortable with the status quo.”
Similarly, Xenofontos notes that some 5,300 financial businesses in the UK operate across the EU, and that for these firms, it is the loss of the passporting facility that could prove to be the most costly.
He says: “This would necessitate creating European subsidiaries throughout the EU rather that operating additional branches. This could require significant restructuring, not to mention operational costs.”
Another oft-cited sticking point in the debate is that of regulation. Legislation from the EU falls into two categories: regulations that are applied throughout the EU with immediate legal effect, and directives that are developed by European authorities and passed on to local legislators to be transposed. The latter can be interpreted, to some extent, before new rules are enshrined into domestic law.
The Market Abuse Directive, for example, was produced and developed by EU regulators and transposed into law through the legislative process in the UK.
The Market Abuse Regulation, however, due to come in to effect in July 2016, will supersede the directive without the need for transposition into UK law. If the UK was to vote to leave the EU, then once that split is effective, the regulation might, in theory, cease to apply.
“This is where we will require some explanation from the authorities,” says Gould. “If an EU regulation is in place and we are
already operating under it, local authorities are likely to continue operating under those same rules. But that’s just an assumption at the moment.”
Redwood dismisses concerns such as these, suggesting instead that the UK will be free to make its own rules and to take up a place on international bodies such as the World Trade Organization, playing a bigger part in creating the rules with which UK banks must comply.
He told SWIFT London delegates: “We will be on world standards bodies who often inform the very European directives and rules which end up on your desks for you to have to comply with.”
“So we will be leap-frogging the mezzanine level and we will be there at the top table.”
Gould expresses the opinion, however, that the EU’s regulatory regime may not have been all bad for business in the UK.
He says: “There are a lot of arguments that some of the regulations are over the top or too difficult to implement, and in individual cases that might be true. But in general, EU regulation has improved the climate for investors and for consumers, and it has given the public more comfort that some of the historic abuses in the industry are better under control. That has to be a good thing.”
Comment from the industry sees the same words repeating: uncertainty, unsure, hard to call, division, disruption. With no real clarity on what might happen for the financial services sector in the case of an exit, it’s a difficult eventuality to prepare for.
A lack of preparation, however, has been noted by the Leave Campaign as an undermining of its position, placing the industry again in the spotlight of the mainstream media.
According to Xenofontos, London’s financial sector is divided. He suggests that British exports of financial services accounted for £20.2 billion in 2014, equivalent to almost 1 percent of the country’s GDP.
An exit from the EU could complicate London’s relationship with the EU, he says, but it won’t necessarily derail the industry completely.
“Several large institutions, including HSBC and Goldman Sachs, have declared they would like to avoid Brexit.”
“However, as one of the world’s largest financial services centres, London’s competitive advantage is unlikely to be harmed in any significant way due to Brexit.”
Despite the strength of The City, Xenofontos goes on to note that several analysts have cited a two-year period between vote to leave and the UK effectively withdrawing from the EU, and that it is difficult to predict what will come about in that transition time.
He asks: “Will there be any transitional structures or provisions that would protect existing arrangements within the EU? What new regulatory, fiscal or trade measures will the UK adopt in the event that it leaves the EU? Likewise, how will the EU respond?”
Building on this, Gould suggests that, without knowing what to prepare for, the financial services industry has instead been acting on an assumption that Brexit simply won’t happen. This means “the amount of preparation has, until recently, been fairly modest”.
Gould says: “If we are going to deal with the challenges, it will require a huge amount of preparation and advanced planning, which, so far, we haven’t really seen evidence of.”
“Whether it’s an ‘in’ or an ‘out’ vote, institutions have a responsibility to consider how they would manage an exit.”
With those in favour of Brexit working on the assumption of more regulatory power and relying on the strength of The City as a standalone financial centre, and those opposed to an exit fretting about the various great unknowns, it appears the one thing that everyone can agree on is uncertainty. And, as Gould points out: “Uncertainty makes banks nervous.”
He says: “Uncertainty could make firms postpone anything they’re planning with the UK, and if institutions are stopping their business plans with UK firms, that will not be a good thing.”
At the SWIFT London conference, Cable expressed a similar view, calling a potential exit a “leap in the dark”.
Cable commented: “In a world which is currently massively uncertain, where there is a large amount of risk, why take the additional leap into the unknown, with all the potential dangers involved in that?”