Brexit: what alternatives are there to passporting?

Financial passporting is one of the reasons behind London's success as a financial centre. Matthew Partridge looks at how the City will cope when it’s gone.


Passporting is one of the reasons behind London's success as a financial centre
(Image credit: © 2017 Bloomberg Finance LP.)

One of the big things keeping people in the City up at night is the loss of financial passporting. To recap, passporting allows people working in the UK to sell a nearly unlimited range of financial services to people and companies throughout the EU without having to get permission in each individual country. This is immensely useful for financial services firms in the UK, and one reason London is a major international financial centre.

However, with the PM insisting that Britain is going to leave the single market, it seems very likely that the UK is going to have to find an alternative model.

Since this is a complicated topic, we've decided to speak to one of the top legal experts in this area. Rachel Kent is Global Head of Financial Institutions at Hogan Lovells. As part of her job she works with a large number of top financial institutions, most notably advising the London Metal Exchange on the establishment of LME Clear. Rachel generously agreed to walk us through the various options, and give her thoughts on the legal and political implications, as well as some thoughts on their benefits and drawbacks.

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The Canada-EU free trade agreement (Ceta) has been cited as the sort of trade deal that the UK can expect to get given Theresa May's stated goals on immigration, the European Court of Justice and budget contributions, so it makes sense to start there.

Contrary to the common perception, Ceta does cover some services. Indeed, it allows Canadian firms not located in the EU to sell services to EU nationals provided they meet certain conditions. While only a few services, such as maritime insurance, are explicitly mentioned in the text, the fine print of the treaty at least leaves open the possibility that other services could be treated in the same way.

However, in practice Ceta grants only a very weak level of access. Firstly, countries are still allowed to restrict firms from doing or soliciting business, which is obviously a major practical barrier. Secondly, both parties are given a "prudential carve out", which allows them to impose "reasonable" restrictions that it considers to be in the interest of investors, firms or the financial system as a whole. This means that, after Brexit, the French regulatory authorities could ban a product sold by a British bank because they believed that it wasn't in the interest of investors, even if a French bank sold a similar (but not identical) product.

Overall, prudential carve-outs and the ability to ban firms from actively seeking (or even conducting) business allow national regulators "to take away with one hand, what they give with the other". While Ceta contains some vague aspirations towards regulatory harmonisation, these are also extremely weak, so again their practical use in helping British firms retain access to the single market is extremely limited. While it's uncertain what degrees of access would be retained, Kent predicts that in the best-case scenario, British firms would keep 20%-30% of access but in the worse case they could be left with nothing.

The second option is a "third country regime" (TCR) or "equivalence", as it is commonly known. These are agreements (including "non-EU passports") that allow firms in non-EU countries to gain automatic access to the EU market in certain areas where Brussels has judged that the regulatory regime in the host country is comparable to that in the EU. On paper this seems a more plausible approach because several countries have such agreements with the EU, or are poised to have such agreements come into effect. For instance, in the case of fund management a TCR is likely to be adopted that will give Canada, Guernsey, Japan, Jersey and Switzerland (along with possibly Hong Kong and Singapore) rights to sell funds to institutions across the EU.

However, there are several problems with this. Firstly, the countries have to follow EU regulations, which makes them "rule-takers". Third-country rights are purely at the discretion of the EU, and they can be revoked at a moment's notice without the right of appeal. They also are granted on a sector-by-sector basis, and usually come with restrictions. In the case of funds, foreign companies even in countries covered by the TCR will still be banned from selling to ordinary investors. They also take time to agree, while some sectors don't have any agreements at all. Overall, solely relying on equivalence without a wider trade deal would also result in a large loss of access.

Of course, there are other models beside a free-trade deal and relying on TCRs. Switzerland has a wide-ranging bilateral trade deal, which comes close to, but is not the same as, to single market access. Norway, and the other EEA countries also retain full access to the single market. However, apart from the potential political problem associated with these models (such as on immigration and contributions) Kent feels that Britain would lose most of its input into rule-making, which would be difficult given our longstanding ambition to be a regulatory leader.

Overall, Kent feels that there's no getting away from the fact that the degree of market access that British firms will enjoy will depend on two factors. These are: Brussels' need to "prevent us from being seen to enjoy the benefits of EU membership without the costs" and "the government's willingness to accept conditions such as continued freedom of movement and further payments to the EU budget". The only factor that might work in our favour is that "we're planning on incorporating existing EU law into UK legislation" which will mean that our regulatory regimes will start off very close together.

Dr Matthew Partridge

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

Follow Matthew on Twitter: @DrMatthewPartri