Brexit: financial services Contents

Chapter 2: Passporting, equivalence and market access

Possible trade agreements: existing models

11.Much of the debate about the UK’s future trading relationship with the EU has been cast in terms of various main models of access: full European Economic Area (EEA)9 membership (the ‘Norway model’); membership of the customs union; a bespoke free trade agreement (the ‘Canadian model’); EFTA membership and a series of bilateral agreements (the ‘Swiss Model’); and the ‘WTO model’. Our report Brexit: the options for trade10 considers these models in more detail. Boxes 1 to 5 below contain brief descriptions of each of them, focusing on their impact upon financial services.

Box 1: The EEA, or ‘Norway’ model

As a member of the European Economic Area, Norway must accept the ‘four freedoms’—freedom of movement of goods, services, persons and capital—as well as the authority of EU law. 11

It must also make contributions to the EU budget, albeit on different terms from full EU members.

EEA-authorised firms are eligible for the financial services passport in the same way as EU-authorised firms, although EEA states have little say over the rules governing the single market.

Box 2: The customs union

Under the customs union individual Member States are prevented from introducing charges which have an effect equivalent to that of customs duties on goods; nor are they permitted to impose quantitative restrictions or quotas. The customs union also has a Common External Tariff, imposed on all goods imported from third countries.

Turkey, though not a member of the EU, takes part in the customs union through an association agreement covering all industrial goods, but excluding agriculture (except processed agricultural products), services or public procurement. The Turkish arrangement does not provide access to the EU market for financial services, but does exclude free movement of labour.

Box 3: A free trade agreement

The most current example of a free trade agreement is the Comprehensive Economic and Trade Agreement (CETA) between the EU and Canada. This contains a financial services chapter and provides, in principle, for trade in financial services under the four ‘modes of supply’ contained in the General Agreement on Trade in Services (GATS). However, it is possible for a party to impose terms and conditions and restricts the ability of firms from one party to do or solicit business in the other’s territory. Firms may have no greater access than under the current third country equivalence regime.

These terms reflect a specific deal between the EU and Canada, and the UK could attempt to negotiate something more favourable. Experience suggests, however, that negotiating a free trade agreement with the EU is likely to be difficult and time-consuming.

Box 4: EFTA membership and bilateral agreements ‘The Swiss model’

Switzerland, through its membership of the European Free Trade Area (EFTA) and a series of bilateral agreements, has secured market access in a number of areas. Its access to the market for financial services is, however, limited to an agreement on the supervision of non-life insurance services and it is largely reliant on WTO GATS terms (see below). As a third country, Switzerland has been deemed equivalent under Solvency II and under the European Market Infrastructure Regulation (EMIR) in respect of central counterparties (CCPs). Equivalence determinations under the Alternative Investment Fund Managers Directive (AIFMD) and the Markets in Financial Instruments Directive (MiFID) are in train.

Box 5: WTO terms

In the absence of a deal with the EU the UK would fall back on WTO terms, and in particular the General Agreement on Trade in Services (GATS). Under GATS, WTO members must ensure “treatment of services and suppliers from other members no less favourable that that accorded to like services and suppliers of any other country”. GATS divides trade in financial services into four ‘modes of supply’:

  • Cross-border supply—the supply of a service from one state to another;
  • Consumption abroad—the consumer of a service being in one state and consuming the service in another state;
  • Establishment—the supply of a service from one state to another through the incorporation of a commercial presence in that state;
  • Presence of natural persons—a service supplier sending individuals from one state to another to supply a service.

Commitments to market access vary depending on the mode of supply. Typically, GATS members make limited commitments with respect to cross-border supply and consumption abroad of financial services. Under GATS, members are able to impose licensing or other requirements that make it difficult for a non-resident supplier to conduct business. GATS also includes a ‘prudential carve-out’, which enables members to take measures for prudential reasons: this could lead to the retention or introduction of measures which effectively reduce cross-border supply.

12.There is general agreement that EEA membership, the Norway model, would replicate most closely the access to the EU market currently enjoyed by UK-based firms. However, the price would be acceptance of the ‘four freedoms’, including the free movement of people, and of the jurisdiction of EU law through the EFTA institutions. A bespoke arrangement, along the lines of the comprehensive Canadian agreement, could provide a degree of market access. Membership of the customs union would provide no access for services, and the UK would have to fall back on WTO terms in this regard. Under WTO terms the UK would be treated as any other third country, with more limited market access, accompanied by significant drawbacks.

Passporting and equivalence

The legislative framework

13.By virtue of the UK being in the EU, financial services firms authorised in the UK are able to provide services into and within other EU Member States without the need for further authorisations. This is commonly referred to as ‘passporting’. The ability to passport services means that a firm can either provide its services directly on a cross-border basis or can establish a branch in another Member State, having received authorisation from its home state regulator and without the additional requirements and costs associated with establishing a subsidiary in that Member State. Subsidiaries, in contrast, may be subject to local governance and regulatory requirements, and may require separate capitalisation, both of which increase costs.

14.Passporting rights are set out in several pieces of EU legislation, most of which regulate particular activities or services. An individual firm can provide more than one of these services, so the extent to which a firm relies on passporting will vary depending on the range of its activities, with the result that the legislative regime governing a particular business can be difficult to untangle. As Simon Gleeson, Partner, Clifford Chance, told us:

“Our attempts to take businesses apart passport by passport have proved to be extremely difficult because we are now aware in a way that I do not think we were beforehand of just how poorly the passporting and legal structure maps on to the commercial business of the banks.”12

This echoed a comment by Peter Snowdon, Partner, Norton Rose Fulbright, who said that firms “often discover that they need permission to do something and had not realised it”.13

15.European legislation also allows for ‘third-country’ access to the market in respect of specific activities. The difficulties associated with the current arrangements for gaining third-country equivalence, where it is available, are discussed in paragraphs 40–59. Following Brexit, unless the UK were to join the EEA or negotiate an alternative arrangement allowing full single market access, it would be classed as a ‘third country’ and its firms would be subjected to those provisions. Market access in such situations is based on demonstrating regulatory equivalence between the third country and the EU.

16.Box 6 describes some of the more important pieces of legislation providing passporting and equivalence regimes. A table in Appendix 3 sets out the situation in more detail.

Box 6: EU Legislation granting passporting rights

Capital Requirements Directive (CRD IV)14

CRD IV and the accompanying Capital Requirements Regulation came into force for banks in 2013, bringing into EU law the capital adequacy standards agreed at international level in the Basel III regulations. The CRD regime covers banking services, including deposit taking, lending and other forms of financing, financial leasing and payment services, some corporate finance advisory services and some trading services. There is no third country regime under CRD IV.

Solvency II Directive 15

Solvency II sets the prudential framework for insurance and requires insurers to hold enough capital to have 99.5 per cent confidence that they could cope with the worst expected losses over a year. It allows an EEA firm to provide insurance or reinsurance services either cross-border or by establishing a branch in another state. Third-country insurers can provide services by establishing a branch within the EEA, authorised in the member state in which it is established. A third-country equivalence regime exists under Solvency II for reinsurance but not for direct insurance.

Markets in Financial Instruments Directive (MiFID) 16

MiFID has been applied in the UK since 2007 and was recently revised. MiFID II and the accompanying Markets in Financial Instruments Regulation (MiFIR) will come into force in January 2018. Under the MiFID regime, banks and investment firms can passport services related to securities, funds and derivatives, including trade execution, investment advice, underwriting and placing of new issues and the operation of trading facilities. MiFIR will introduce a third-country regime, allowing firms from third countries to offer these services cross-border to wholesale customers and counterparties.

Undertaking in Collective Investment in Transferable Securities (UCITS) Directive17

The UCITS regime has been in place since 1985 and was most recently updated in 2014. Investment funds that meet the rules set out under the UCITS Directive may be sold freely, including to retail investors, throughout the EEA on the basis of single national authorisation.

There is no third-country regime under UCITS, so were the UK to become a third country UK-based asset managers wishing to continue marketing these products would have to re-domicile—though there could be scope for a re-domiciled management company to delegate day-to-day management of the fund back to the UK. Alternatively, funds could be marketed from the UK as alternative investment funds (AIFs).

Alternative Investment Fund Managers Directive (AIFMD)18

The AIFMD sets the rules for alternative investment fund managers. It created an EEA-wide passport for EEA fund managers to market those funds across the EEA. A national private placement regime (NPPR) exists to allow non-EEA fund managers to market funds in EEA jurisdictions to professional investors, depending on the specific rules in those jurisdictions. AIFMD envisages that the NPPR will be phased out: it does, however, contain third-country equivalence provisions, which could enable UK firms to market their funds.

The extent of passporting in the UK

17.Many UK-based firms use the passporting rights granted under the legislation outlined above. The Financial Conduct Authority provided the figures in Tables 1 and 2 to the House of Commons Treasury Select Committee.19

Table 1: Number of inbound and outbound20 passports issued by the Financial Conduct Authority and Prudential Regulation Authority




Number of passports in total




Number of firms using passporting




Table 2: Number of firms with at least one passport under each directive




Alternative Investment Fund Managers Directive (AIFMD)



Insurance Mediation Directive (IMD)



Markets in Financial Instruments Directive (MiFID)



Mortgage Credit Directive (MCD)



Payment Services Directive (PSD)



UCITS Directive



Electronic Money Directive



Capital Requirements Directive IV (CRD IV)



Solvency II Directive



18.As we have noted, it is possible for a firm to have more than one passport in order to provide different services under different directives. It is also possible for a firm to hold more than one passport under the same directive. In reality, more EU companies than UK companies hold passports, but more passports in total are held by UK companies.

19.The figures provided by the FCA indicate very broadly the extent of passporting and the scale of the job of unpicking exactly how much use is made of it by UK businesses. The analysis published by Oliver Wyman, summarised in Table 3, provides a further indication, in cash terms.

Table 3: Sectoral breakdown of UK financial services revenues 2015, segmented by source of revenue


Domestic business earned from UK clients

International and wholesale business not related to the EU

International and wholesale business related to the EU


£65–70 billion

£20–25 billion

£23–27 billion

Asset management


£15–18 billion

£5–6 billion

Insurance and reinsurance

£27–29 billion

£7–10 billion

£3–5 billion

Market infrastructure and other


£13–15 billion

£9–12 billion

Source: Oliver Wyman, The impact of the UK’s exit from the EU on the UK-based financial services sector, October 2016, p 6.

20.These figures suggest that around a quarter of revenues in banking and asset management, and nearly half of revenues in market infrastructure and others, are related to the EU.23 Insurance is less reliant on EU revenues. In total, Oliver Wyman estimated that a ‘low access’ scenario following Brexit would result in a loss of £18–20 billion in revenues.24

The impact of passporting

21.Notwithstanding the analysis published by Oliver Wyman, witnesses urged caution, suggesting that it was difficult to read much into these bare numbers. As Sir Jon Cunliffe, Deputy Governor of the Bank of England for Financial Stability, told us:

“It is quite difficult to go from the number of passports and firms to the amount of what I would call economic activity. In some areas like insurance, where passports are used, they are very cheap and easy to get. Passports are used for relatively small volumes of business such as selling travel insurance cross-border.”25

22.The extent and complexity of passporting add to the difficulty in assessing the impact of Brexit. Douglas Flint, Group Chairman HSBC, told us that “Everyone is affected by passporting rights to a greater or lesser degree”,26 while Elizabeth Corley, Vice Chair, Allianz Global Investors, told us that, in the asset management sector, passporting was variable and only part of the equation.27 Sir Jon Cunliffe, while acknowledging the Oliver Wyman estimate of the impact of a ‘low access’ scenario, said that firms needed to be asked: “Which of your business lines, which of the transaction chains and which of the bundles of services you operate use some or all of the passporting permissions?”28

23.Anthony Browne described some of the activities that relied upon passports:

“If a German company was trying to raise €500 million for an investment to build a factory, it might do so by raising a bond with, in addition, a syndicated loan, and then hedge that in respect of foreign exchange payments, currency risk and interest rate risk. Those are three different products. The company would come to London for that. All of that is based on passporting rights. If passporting rights were lost, the company would not be able to come to London for bonds, for a syndicated debt or for hedging foreign exchange or interest rate risk. If we got equivalence, under MiFID and EMIR, it might be able to come for the bond and to get some hedging, under EMIR, but it would not be able to get the syndicated debt, because there is no provision for lending under any of the existing regulations. So banks based in London would only be able to provide a narrower range of services. They would not be able to be the sort of one-stop shop that they are at the moment.”29

24.Huw Evans, Director General, Association of British Insurers, said that the extent to which his members relied on passports was still being worked out: “it is not something we have ever had to know before, or overanalyse”. He warned that any estimates of the value of passporting were “either rubbished as too low or viewed as not specific enough in what they can actually relate to”. This situation may not apply across the wider insurance sector and Mr Evans pointed to a recent announcement by Lloyd’s of London, that about 11% of its revenues were at risk from the loss of passporting, but noted that it was “a very big deal for the firms it affects [but] does not have that big an impact on others”.30

25.Sir Charles Bean, Professor of Economics, London School of Economics, said that reliance on passporting would depend on whether “the firm in question is mainly operating in wholesale financial services where it can sell its services crossborder or whether it needs to connect with retail consumers. If you need to connect with retail consumers, you basically need to physically operate in the member state, and the loss of passporting rights will essentially mean that firms will need to set up subsidiaries over there.” He added that many major non-EU banks headquartered in London already had subsidiaries in other parts of the EU. The question was the extent to which those banks needed to transfer activities to another Member State.31

26.In written evidence, the Association of Foreign Banks noted that banks were more or less concerned, depending on their country of origin. UK branches of EEA banks, providing both wholesale and retail services, were concerned about the loss of passporting (more so for retail services) while UK branches of non-EEA banks and UK-incorporated subsidiaries of overseas banks did not view passporting as a central issue.32

Conclusions and recommendations

27.The legislation underpinning access to the EU market is based largely on the regulation of activities, and does not map easily onto the business structures of many firms. A better evidence-base is needed, and it is imperative that the Government gains a detailed understanding of how firms are likely to be affected by changes to their rights of access to EU markets, building where possible on the work undertaken by the firms themselves.

28.It is striking that some firms do not themselves appear to be aware of their reliance on the current passporting arrangements. It would be in the interests of the firms themselves, as well as in the national interest, if they were to cooperate with the Government and the regulators to determine the true extent of such reliance, so as to inform the Government’s negotiating position.

9 The EEA comprises the 28 EU Member States and the three members of the European Free Trade Agreement (EFTA) that have signed the EEA Agreement––Iceland, Liechtenstein and Norway. Switzerland, while an EFTA member, is not a member of the EEA. Following Brexit the UK could seek to become a non-EU member of the EEA. In this report, unless otherwise specified, references to the EEA should be taken to include both EU and non-EU EEA members.

10 European Union Select Committee, Brexit: the options for trade (5th Report, Session 2016–17, HL Paper 72)

11 Enforced by the EFTA Surveillance Authority, which has been given powers corresponding to those of the Commission in the exercise of its surveillance role, and the jurisdiction of the EFTA Court, which largely corresponds to the jurisdiction of the Court of Justice of the European Union over EU States.

14 The CRD IV package comprises Directive 2013/36/EU, 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC, OJ L 176/338 (27 June 2013) (CRD IV) and Corrigendum to Regulation (EU) No 575/2013, 26 June 2013, on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012, OJ L 321/6 (30 November 2013) (CRR)

15 Directive 2009/138/EC, 25 November 2009 on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II), OJ L 335/1 (17 November 2009)

16 The MiFID II package comprises Directive 2014/65/EU, 15 May 2014, on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU, OJ L 173/349 (12 June 2014) (MiFID II) and Regulation (EU) No 600/2014, 15 May 2014 on markets in financial instruments and amending Regulation (EU) No 648/2012, OJ L 173/84 (12 June 2014)

17 Directive 2014/91/EU, 23 July 2014 amending Directive 2009/65/EC on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS) as regards depositary functions, remuneration policies and sanctions, OJ L 257/186 (28 August 2014)

18 Directive 2011/61/EU, 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010, OJ L 174/1 (1 July 2011)

19 Letter from Andrew Bailey to Andrew Tyrie MP, Chair of the House of Commons Treasury Select Committee, 17 August 2016:

20 An ‘outbound’ passport refers to a passport issued by a UK competent authority to a UK firm. This allows it to do business in one of more EU or EEA member states. An ‘inbound’ passport refers to a passport issued in an EU or EEA member state to a firm from that state, enabling it to do business in the UK (or other Member States).

21 Portfolio management for UK client funds included in the international and wholesale business not related to the EU.

22 All ‘market infrastructure and other’ is considered potentially internationally portable. There is £10–14 billion of UK client business included in the International and wholesale business not related to the EU category.

23 Taking the higher figures for non-EU related business with the lower for EU, and vice versa, this works out as 19–24% for banking, 22–29% for asset management, 7–13% for insurance and 38–48% for market infrastructure and others. Domestic revenue for asset management and market infrastructure is included in ‘international and wholesale’.

32 Written evidence from the Association of Foreign Banks (BFS0004)

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