Appendix 5: The impact of Brexit on the financial services sector
The effect of leaving the EU on the financial services industry
1.Our previous inquiry into financial services, Brexit: financial services,384 considered the anticipated effects of withdrawal on the UK industry. The present inquiry has focused more narrowly on the regulatory and supervisory implications of withdrawal, but we have also received significant evidence from the financial services industry on the anticipated impact of Brexit more broadly. In particular, the industry is concerned about the cliff-edge withdrawal of the pan-EU ‘passport’, which underpins cross-border business within the Single Market.
2.The effects of Brexit will not be felt uniformly across the financial services industry. As Simon Lewis, Chief Executive of AFME, told us, there are “three broad business models: there are banks that have London as a hub from which they have been used to passporting their activities to the EU-27, and clearly for those banks there will be potentially quite significant structural and legal changes. There are those of our members who have a pan-European structure, who therefore should be able to deal with the effects of Brexit a little more easily. Then there are banks that are heavily concentrated locally in one market.”385 This appendix therefore briefly outlines the scope of the sectoral evidence we received on how Brexit will affect different parts of the industry.
Wholesale banks
3.The wholesale banking sector is perhaps the poster child for the impact of Brexit on financial services, due to its status as an issuer of cross-border loans under the CRD passport. The Loan Market Association identified “a risk in some jurisdictions that where the lender or loan owner is a UK passported bank, if that entity ceases to be passported whilst the loan is still outstanding, the loan itself may be legally vulnerable. Such legal uncertainty creates the potential for legal disputes.” In consequence, “UK-based lenders would begin as part of their Brexit implementation planning to work on the basis that they will not be able to meet obligations under some existing loan business”. As a result, “Many UK-based banks and investment firms have established branches in the EU27 using their passport rights under CRD and MiFID.”386
Retail banks
4.Exclusive providers of domestic retail financial services are generally less affected by Brexit. The EU’s regulatory regime has increasingly begun to cover the provision of retail financial services, but still leaves the majority of retail banking regulation, together with conduct issues, to domestic regulators. Clifford Chance argued that in consequence, any future agreement “might not extend to retail business”, as “National retail markets have distinctive national characteristics and, as a result, distinctive national regulations.”387 The Personal Investment Management and Financial Advice Association (PIMFA) did not, therefore, “believe that a Single Market for retail financial services products has been created”.388
5.Which?, the consumer organisation, noted however that EU initiatives on retail financial services have included: the right of access to basic bank accounts; deposit protection in the event of bank failure; development of an integrated payment services market; promotion of cross-border distribution and consumer protection for insurance, mortgages, and other consumer credit; and requirements for the disclosure of key information and charges for retail investment products (the Key Information Documents required under the PRIIPS regime). Which? were generally positive about the nature of the EU’s regime on retail financial products, and argued that the UK should largely maintain the existing regulatory framework.389
Asset management
6.The asset management industry is generally less materially affected by the need to relocate in light of Brexit, insofar as the EU’s current legislative framework permits third-country involvement. This may change in future: the sector is directly affected by specific EU laws such as MiFID II (which is only finally coming into effect in 2018) and the AIFMD (which is slated for review during 2018).
7.Deeper concerns lay with the continued ability to use delegation (which allows an asset manager to set up a fund in one country and outsource portfolio management to investment staff in another country).390 Delegation, the Investment Association explained, “is not derived from an EU passport. Rather, it is an international convention frequently used to offer, among other services, investment management expertise, and is a key enabler for efficient global capital markets.” They argued that “The UK’s departure from the EU is, however, raising important concerns within EU-27 Member States about the increased amount of portfolio management activity that will be carried out on behalf of EU clients post-Brexit”.391 They also observed that the EU was considering giving further powers to the European Securities and Markets Authority (ESMA) to monitor delegation.
Insurance
8.Bupa commented that “The insurance industry in the EU is globally successful, as evidenced by the fact that the majority of globally systemically important insurers (G-SIIs) are headquartered in Europe”.392 Furthermore, as the London and International Insurance Brokers’ Association (LIIBA) observed, the UK insurance market provides a range of specialist insurance and reinsurance services that are unique in the EU.393 Market access is a controversial issue for insurers: for large cross-border providers such as Lloyd’s, losing access to the EU Single Market would be detrimental,394 whereas institutions such as the Equity Release Council were more sanguine, asserting that “there is valid reason to question the size and (crucially) the profitability of the cross-border market for insurance”.395 Aviva noted that insurance differed from, for example, wholesale banking, in that “some of the firms that operate in a number of different EU markets tend to do so through separately capitalised subsidiaries”.396
9.Insurers are covered by two EU regimes: the incoming Insurance Distribution Directive,397 which as LIIBA noted, currently contains no concept of equivalence, and Solvency II, which contains provisions that were criticised by many witnesses as inappropriate for the UK market. Insurance may, therefore, be an area in which the UK would seek to make regulatory changes post-Brexit (see Chapter 7).
FinTech
10.FinTech—the incorporation of technology in financial services provision—generally makes less use of passporting than other sectors of the industry, but the small size of many firms, and their close relationships with other, larger firms, means that withdrawal may still be disruptive. Funding Circle told us that although they did “not benefit from EU passporting, we work closely with a number of financial institutions (for example, as participants on our direct lending platform or that provide services to us) that rely heavily on passporting”. There would be a “clear business and relationship disadvantage if those institutions felt compelled to move all or a substantial portion of their operations out of the UK”.398
11.The London Stock Exchange Group (LSEG) raised further concerns regarding access to “data, services, capital and talent”.399 Funding Circle also focused on capital, arguing that withdrawal from the European Investment Bank (EIB) “would have the adverse effect of preventing thousands of small businesses from accessing large amounts of capital from an institution that has provided substantial support to our economy over the years”.400
Central Counterparties (CCPs)
12.Central counterparties—clearing houses—are a vital part of the global financial market infrastructure, and a large amount of this business is currently concentrated, for reasons of efficiency, in London. CCPs interpose themselves between counterparties to a trade, becoming buyer to every seller and seller to every buyer, thus reducing costs through netting, and concentrating counterparty risk in a single institution that can be supervised accordingly.
13.Perhaps the most salient concern for UK CCPs and their clearing members is the Commission’s current proposal to revise the European Market Infrastructure Regulation (EMIR). As well as effecting positive changes to the clearing obligation in order to introduce more proportionality, the proposed revisions would increase oversight of third-country CCPs (a move made directly as a result of Brexit), with the potential to force them to seek re-authorisation inside the EU in instances where risks were deemed too severe by EU regulators.
14.LSEG were “very much concerned by the proposal of the European Commission to impose the location of the most substantially important third country CCPs in the EU as it would necessarily create additional artificial costs and systemic risks, due in particular to a market fragmentation (EU and international markets being dislocated)”.401 Graham Bishop, a financial consultant, was however sympathetic: “The sheer magnitude of a potential CCP failure could de-stabilise the EU-27’s financial, economic and eventually political systems.”402
Payment systems
15.Mastercard explained that the payments sector:
“Comprises the wide array of means by which individuals or organisations can transfer funds between each other. It encompasses cash, cheques, ATM transactions, credit and debit cards, as well as a variety of inter-bank transfer mechanisms including direct debit, Faster Payments (used for mobile and online banking) and CHAPS (used for high value transactions).”403
16.Payments systems are an area in which the UK has a strong lead, and the current domestic regulatory structure for payments systems incorporates both the Treasury and the Payments System Regulator, instituted in 2014. Payments systems are affected by the EU’s Interchange Fee Regulation (IFR) and by the second Payments System Directive (PSD II), the latter sitting alongside the UK’s parallel Open Banking initiative, which in some cases generates conflicts with the maximum harmonising PSD II. Mastercard were concerned that PSD II “will have an enormous impact on the payments sector, but yet its status in the UK following Brexit remains unclear”. Which? concluded that “the potential opportunity to diverge from PSD II after Brexit may allow the development of a more effective UK market in payment services”.404
384 European Union Committee, Brexit: financial services (9th Report, Session 2016–17, HL Paper 81)
390 George Parker, Peter Smith, and David Keohane, ‘Britain braced for Brexit raid on £8tn asset management industry’, Financial Times (3 January 2018): https://www.ft.com/content/d2cde5e6-f095-11e7-b220-857e26d1aca4 [accessed 18 January 2018]
397 Directive (EU) 2016/97, 20 January 2016 on Insurance Distribution (recast) (OJ l 26/19, 2 February 2016)