Despite the recent High Court decision to give Parliament a vote on the invocation of Article 50, financial service firms cannot rest easy. The final outcome of the legal battle remains uncertain and even Switzerland, which has a much softer version of Brexit than the Government initially seemed to pursue, does not have the access to the crucial passporting rights on which the City of London relies.
Since the vote, many have argued that the loss of these financial passports, which enables cross-border trade in financial services, can be substituted by Third Country Access under so called “Equivalence Regimes.” This is the process whereby a third country would maintain an “equivalent” regulatory regime and thus acquire the financial passport from outside of the Single Market.
Excitement about Third Country Access has been heightened by the introduction of MIFID II in 2018. For the first time, the MIFID directive includes articles specifying potential access for third country firms. Many have seen this as a life line for the City of London as it is one of the most important passports in use, with 45 per cent of all passporting firms using the MIFID passport*. However, it remains unlikely that equivalence can properly substitute full membership of the Single Market. Firstly, third country access in MIFID II is reserved for institutional clients, so services to retails clients would be lost. Secondly, the process to acquire and maintain the passport is fraught with political difficulties.
In order for a London-based firm to register for the MIFID third country passport the European Commission would need to make an equivalence decision in favour of the UK. The Commission has no imperative to do this before the end of the Brexit period and thus a dangerous “Cliff Edge” could force firms to restructure their legal entities and personnel before any equivalence decision has been made. What’s more, firms face the threat of this equivalence decision being revoked within just 30 days if equivalence is not maintained. Without a bilateral agreement to extend or modify this process, firms may find relying solely on their London passport too risky to stomach.
The alternative of “equivalence” is undermined still further when our eyes are widened. For whilst MIFID II may enable provision for third country access, other passports do not. Important passports such as the Insurance Mediation Directive (IMD) for Insurance Advisors, used by 55 per cent of passporting firms, and the Capital Requirements Directive (CRD) for commercial banking activities are simply not available for third country firms*. This would mean that certain activities and functions would need to be re-domiciled within the Single Market. It is, as of yet, unclear how much of these functions would initially need to be relocated but overtime it may prove inefficient to split functions between multiple locations.
Given the different availability of third country passports certain firms may find the transition to post Brexit London easier than others. Fund Managers, for example, may be the least effected due to the provision of the Alternative Investment Fund Managers Directive (AIFMD) passport, MIFID II passport and the EU domicile of their funds. (Blog post to follow) However, the nature and structure of financial firms means that many tend to rely on several different passports covering a wide range of services. This structure enables huge benefits in economies of scale as one entity in London is able to service all cross-border business. The loss of any one of these passports, depending on its relevant significance, could thus undermine the efficiency of basing many other functions in London.
Equivalence is no panacea.