Borders create obstacles for trade, and for London’s financial firms, they’ll create significant consequences. Custom controls between the European Union and the United Kingdom will become necessary for the flow of goods. And for services, the changes will be even more radical. European law currently allows financial firms in London to use more than 5,000 different passporting rights to serve clients on the Continent and in the Republic of Ireland. These rights will automatically fall away on March 30, 2019, the day after Brexit, or at the end of the transition period that might follow. There are only a limited number of substitutes to the passports at hand, and they are not nearly as good.

Equivalence Status

London firms could bet on equivalence. This status is granted to countries outside the European Union, provided that they fulfill certain conditions: their regulation and supervision of financial firms must be comparable to that of the European Union; they must cooperate with EU authorities in areas such as anti-money laundering or the fight against terrorism financing and tax evasion; and they must allow European firms reciprocal access to their markets.

The European Union has already granted equivalence status to a number of countries, including the United States, Australia and Canada, for certain types of financial services, such as derivatives trading. However, these privileges are relatively insignificant in comparison to the market access that British firms currently enjoy. Moreover, there is no legal right for claiming them. The European Commission might even be tempted to withhold a decision on equivalence in order to use it as a bargaining chip in discussions over a trade agreement or as leverage against the creation of a soft-touch jurisdiction outside its borders, a so-called “Singapore on the Thames.”

Equivalence also comes with strings attached. To illustrate, some such agreements require that disputes between the third-country firm and its client are settled in a member state and under EU law. Equivalence is also not permanent, but can be withdrawn at any time, for instance, when the quality of supervision is no longer the same as in the European Union.

Finally, equivalence as an entry ticket to the single market only works for selected categories of financial services providers, such as investment fund managers, securities firms and reinsurances, but not for others, in particular not for banks and primary insurances.

Establishing Subsidiaries

British firms could also access the single market through the establishment of a subsidiary in a member state. Such an entity could serve as a letterbox only, with most of the senior staff and value creation remaining in London. Member states have started to compete for the establishment of British subsidiaries on their soil, with some implicitly promising to turn a blind eye on capital and staffing requirements. Yet, the European supervisory authorities — the European Securities and Markets Authority and the European Banking Authority — have made it clear that they will not allow a supervisory race to the bottom. In particular, they will prohibit British firms from rendering services in the European Union through “empty shells” and with “dual hatting,” in which CEOs on the Thames would run the business of an EU firm.

Correspondence and Cross-border Services

In the internet era, UK firms could also try to serve their clients in the European Union via correspondence or cross-border services. The legal framework for rendering such services is largely in the hands of the member states. Some of them require the establishment of branches on their soil, with the operating conditions being determined by national law. Fulfilling the different requirements of 27 member states can prove to be very costly for British firms.

Reverse Solicitation

A final method could be reverse solicitation. Founded on the European citizens’ right to receive services in other countries, in a nutshell this means that the firms do not come to the clients, but the clients go to the firms. This so-called “passive use of freedom of services” also allows maintaining contact with a customer. Its precise contours are, however, uncertain. For instance, it is not clear whether a firm may sell or advertise a new product to an existing client.

No matter what route is taken, Brexit causes considerable headaches in legal departments across London. Leaving the European Union while continuing to be its financial centre is as impossible as having your cake and eating it too. While it is certainly an exaggeration to speak of Britain as a “vassal state” of the European Union, the truth is that many European rules have extraterritorial effects. They cover service providers even if they are established outside the member states.

London is going to lose valuable business to its EU competitors. This is corroborated by daily news of banks and other financial firms sending personnel from London to the remaining member states. Cities on the Continent and in Ireland are lining up to give them a warm welcome. 

It’s unlikely that the European financial centre will set up shop in Frankfurt, Dublin, Amsterdam or Paris, but rather a mixture of them. For some industries, banks might also shift jobs to New York or Asia.

Due to Brexit, Europe as a whole will lose. Financial services will become decentralized and, as a result, more expensive. Liquidity will be fragmented and not as easily accessible as it is now. This should worry the European Commission. It will certainly allow British firms to provide expert financial services to EU clients as long as they are needed. As a consequence, it is unlikely that Brexit or the end of the transition period will mark an abrupt end to cross-border financial services between the European Union and the United Kingdom. That said, the European Commission is holding the longer end of the lever. As the biggest market in the world, the European Union will keep the gate open for British financial services only as long as it needs them.

The opinions expressed in this article/multimedia are those of the author(s) and do not necessarily reflect the views of CIGI or its Board of Directors.
  • Matthias Lehmann

    Matthias Lehmann is a full professor and director of the Institute for Private International and Comparative Law at the University of Bonn. He holds doctoral degrees from the Friedrich Schiller University Jena and Columbia University, as well as a habilitation from the University of Bayreuth.

  • Dirk Zetzsche

    Dirk Zetzsche is a full professor and holds the Appui au Développement Autonome Chair in Financial Law (Inclusive Finance) at the University of Luxembourg, as well as a non-executive directorship at the Center for Business and Corporate Law at the University of Düsseldorf.

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