How to Brexit - a Financial Institutions point of view

By John Flexer & Bengt Bjorkberg



In the week of the Conservative Party conference, Theresa May announced that she intends to initiate Article 50 in March 2017 which could lead to UK leaving the EU as soon as 2019. In the wake of this announcement the language of the UK and EU governments has hardened, with the EU stating that “there is no guarantee of access to the Single Market” and May responding that she will “prioritise curbs on immigration over the single market”. These may just be statements for public consumption, and while we cannot pretend to know what the UK and EU officials are really discussing behind locked doors, we cannot ignore that the UK may no longer be a member of the EU by summer 2019. So how do we go about preparing for Brexit in these uncertain times?

 




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Potential timeline

For the UK to formally leave the EU, it must invoke Article 50 of the Lisbon Treaty. Once invoked, a two-year time frame commences during which time it is envisaged that the UK and the EU will complete exit negotiations to establish the UK’s position outside of the EU.

So when will the UK government invoke Article 50?

Teresa May has indicated this week that she will kick it off in Q2 2017. If that happens the UK could be out of the EU as soon as Q2 2019. But will two years be sufficient time to unravel 43 years of treaties and agreements covering thousands of different subjects? Furthermore, will it be possible to create new deals during those two years. The terms of the UK’s exit will have to be agreed by 27 national governments, a process in itself that will take time.

Article 50 was only created in 2009 and consequently has never been tested. It has been suggested that the UK would be in a stronger negotiating position if it commenced negotiations prior to invoking Article 50 and Philip Hammond suggested that it could take up to six years for the UK to complete exit negotiations.

What happens if negotiations are not completed within the two-year time period?

Negotiations could be extended beyond the two-year time frame but this can only happen if all 27 remaining EU countries agree. If not the UK could be in a possition where they exit the current treaties without having new ones to rely on. 

The points raised above lead to a potentially longer period of uncertainty and volatility in the markets, while making it difficult for companies to make informed decisions and define their strategy going forward.

We also have the question, will the UK have access to any of the “four freedoms” or “single market” following Brexit? As can be seen in the diagram below, if we wish to have access to the full single market we must negotiate access to three of the four pillars, with the EU needing to accept that we have access to three but not the fourth, freedom of movement.

John Flexer has spent over 30 years in the City, initially with Merrill Lynch and then with Scotiabank. His career focus has been within Corporate Banking as a Senior Relationship Manager. In his most recent role at Scotiabank, he was tasked with establishing the European Strategy Office which quickly developed into an analysis of the impact of Brexit on the UK financial markets. John Flexer hold an MBA from the American Graduate School of International Management and a BA in Accounting & Finance from Nottingham Trent University.
Bengt Bjorkberg is DBFS appointed Regulatory Consultancy Programme Manager, managing the expansion of their regulatory practice. Prior to taking this role, he worked for some of the world’s largest IT and financial corporations, specialising in managing change and implementing efficient structures to meet the organisations’ requirements. Bengt is also an active member of the professional community and has written articles on subjects such as regulations, corporate efficiency and outsourcing.

The EU has granted such access before, but have indicated that they will not do so again, and in the case of Switzerland, only temporarily.  



Markets and Industry


UK Finance Market, the rebel market


The UK Finance Market has long been considered a rebel market where anything goes and anything can be traded. Be that advanced and complex instruments created and traded, or less regulated markets, there are few other markets that allow the breath and plethora of services and products that the UK does.

The question is,will the UK continue to be able to provide these? Our government has in the past successfully blocked a number of moves by the EU to regulate the square mile and level the playing field; One example of this is the UK not participating in the EU Financial Transaction Tax.

If the UK is no longer a member of the EU, we may be forced to adopt such regulations as a requirement to trade with the EU or to allow the sale of services to customers located within the EU. This would be similar to how FATCA forces Participating Financial Institutions to comply with the regulation group wide, including entities outside of jurisdictions directly affected by the regulation.

The upside is of course that there may be room for new products, specifically targeted to allow customers from within the EU to access the UK market and potentially allowing customers to gain access to such instruments.

EU protecting their market


The European Union is an economic union (technically a politico-economic union), and one of their primary objectives is to guard and further the economic interests of its members. So if the UK ceases to be a member, is the EU likely to put obstacles in the way to ensure that it is better to trade with EU Financial Institutions rather than UK based ones? And if so, what would such potential obstacles be?

This question is probably more relevant if we end up in a position where Article 50 has completed but no trade agreement has been reached. If the EU keeps their current line where no negotiation on trade agreements will be initiated prior to the triggering of Article 50, this may be inevitable as trade agreements are notoriously complex and take over two years. As an example the CETA (Comprehensive Economic and Trade Agreement) between the EU and Canada took ten years to negotiate.

There is also the question of the EU's priorities during the negotiations, and how the interest from EU members to continue trade with the UK is weighted against the EU's interest in staying united. The EU may use such negotiations to discourage other EU members from leaving, and if their choice of chief Brexit negotiator, Michael Barnier, is anything to go by, we cannot disregard the possibility that they will take a very hard line.

Passporting 

 

Potentially the biggest risk facing the City of London following the Brexit vote is the loss of passporting rights. Why are passporting rights so important?  Passporting currently allows financial services firms which are authorised in the UK to operate throughout the European Economic Area. With the UK’s stated intention to leave the EU, financial service businesses based in the UK could lose the automatic right to market and transact business within the EU. Much of the logic for basing European operations in London would be lost.

Depending on the outcome of negotiations, Financial Institutions are faced with the prospect of having to relocate some or all of their operations to a new location within an EU country. The problems facing financial institutions today is not only whether that decision will indeed need to be taken but also when it needs to be taken, given that as we prepare this paper we do not know what the outcome of the negotiations will be. Further, if a firm takes the decision to move some or all of its operations away from London, where is the best place to relocate to?

Relocation options


If passporting rights are lost, where should financial service companies relocate to? Is there another European city that can offer all that London currently does?
 
There are a number of cities vying for the crown with Amsterdam, Dublin, Frankfurt, Luxembourg and Paris topping the list.

Amsterdam

  • Market-friendly policies
  • Population with excellent English language skills
  • Good transport link
  • 12% office vacancy rates
  • New Zuidas financial centre has limited office vacancy

Dublin

  • Well established financial centre
  • Close ties with the UK and USA, linguistically as well as economically
  • Flexible labour and tax laws
  • Geographic location not ideal
  • While transport links to European capitals is good it is more limited with other major cities

Frankfurt

  • Well-established financial district
  • Well-located within mainland Europe
  • ECB, Bundesbank, Deutsche Bank and Commerzbank already located there
  • 12% office vacancy rates and City preparing for influx of 10,000 bankers over the next 5 years
  • Does not have cultural attractiveness of other cities

Paris

  • Good transport links
  • Large capital city with cultural heritage
  • Many major banks and asset management firms already located in Paris
  • It’s reputation for rules and regulations dims its appeal
  • Reluctance to speak English (“the global working language”)

Luxembourg

  • Convenient location
  • Favorable tax laws
  • Not part of the EU
  • Population of only 500,000 might feel overrun by influx of City workers
  • Only 4 million square metres of office space with 4% office vacancy rate

In summary, taxation and labour, laws as well as cost of living, will need to be considered when taking a decision.

Another possibility is that the markets split up and we see a concentration of industries occurring in specific cities. For example we might see that Frankfurt becomes the Insurance center of the world, Amsterdam the exchange traded instruments, Dublin becomes the foreign exchange capital, Luxemburg the rare metals exchange and Paris gets fund management.

What To Prepare For

 

Regulations carry on.


 On the assumption that we are not going to cave in the Euro tunnel and stop talking to Europe, we can be fairly certain that we will have to comply with most EU regulation if we wish to trade with the Euro block. We can also make the assumption that UK will not be considered “third country” or similar, but will have a status closer resembling that of Norway, Switzerland, Lichtenstein as examples.

Using those countries as templates, we can with some certainty state that all the currently inflight regulations such as MIFID II, EMIR, MAD/MAR and other EU regulations are unlikely to change. Furthermore only if the UK Government or EU strongly objects to aspects of the regulation would there be any changes to current implementation of those.

Other international regulations such as FATCA and OECD CRS are driven by non EU regulators and are unlikely to change whether or not UK is in the EU. In the case of OECD CRS, the UK was actually one of the driving forces within OECD behind the regulation.

For future regulation not yet released, it would need to be assessed on a case by case basis whether or not it is likely to be incorporated in UK Law.  

Risk of losing key non-UK staff


With all the uncertainty surrounding Brexit, EU nationals working in the UK may decide to remove the risk of uncertainty and take an early decision to relocate to an EU country. It is important, therefore, for companies to identify key “foreign staff” and put in place favourable packages to retain these staff. Further, if companies take the decision to relocate their offices to other European capitals, finding people with the right qualifications and background in those capitals may be challenging.

Data, law and jurisdictions


This is an area that could cause numerous issues during the transition. A lot of our current contracts are dependent on EU law. If you want to check, search the contract for lines that reads “where applicable according to EU law”. In theory, any contracts that contain such language would no longer be admissible in the UK post Brexit.

The second matter to bare in mind is “data passport”. Presently we can hold and process data pertaining to EU citizens in the UK, and vice versa, as a result of our EU membership. Following a Brexit this may no longer be the case. It is highly unlikely that the UK would instigate a regulation similar to  the Russian data privacy regulation 242-FZ, which prohibits storing and processing data on Russian citizens outside of Russia. However, from a legal perspective there is no guarantee that the EU will allow data on its citizens to be held in the UK as a non EU member. This could raise similar issues to those seen when the EU and the USA failed to reach an agreement on transatlantic data transfers prior to the Safe Harbour agreement expiring.

This scenario may actually be the most likely, if an aggressive Brexit is initiated, there may be a number of areas where the industry have to stop certain processes because the UK and EU have just not been able to reach an agreement in time.

As a biproduct of this, we could also see a reduction in available data for UK institutions. Currently a UK Financial Institution has access to numerous databases and records throughout EU because of the EU membership. Only if the Brexit negotiations covers such data exchange would we continue to have access to that data. In fact, continuing using such data post Brexit could potentially be a failure to comply with data privacy laws.

Keeping the client informed


Given all the uncertainty over the outcome and timing of negotiations, it is important to keep the client informed but what message should financial institutions be giving their clients?

With no clear sight on the outcome of the negotiations or when these negotiations will be completed, it is difficult to provide clients with any definitive information. Clients will, however, be concerned and will need to make their own decisions, based on the information they receive. Therefore financial services organisations will need to provide regular updates on their plans following Brexit, even if it is a “wait and see” approach but at the very least advise clients that their business is important and will continue to be serviced. The risk is that if clients are not kept informed, they may move their business to institutions who do.


How can DBFS help


We appreciate that our clients have the capability to research, assess and quantify the impact of regulatory and business change. However, there are times when additional experience, background information or a third party perspective is required.

Our advice is based on years of accumulated experience in the City garnered by our consultants. We are able to offer advice around a diverse range of topics encapsulating ourmarket coverage from basic operational improvements right through to strategic programs of work. We pride ourselves in only offering this advice where we believe we have the expertise or capability and at a level that is compatible with our client’s requirements.

Our in-house experts look down the tracks at the changing landscape of the financial markets, ensuring we understand our clients’ challenges and objectives. We ensure we understand opportunities and challenges on the horizon, how our clients can prepare for such impacts and leverage those opportunities and also ensures DBFS contribute towards improving the market place. We deliver advice through various channels including complementary knowledge papers, ‘by invitation’ peer-to-peer events and engaging our consultants for specific supplementary advice.

DBFS have a number of articles, whitepapers and tools available free of charge. Visit our Tax Treaties portal for more information on UK DAC/CRS, OECD/CRS, FATCA and CDOT. We also publish a number of whitepapers on other regulations, all of which can be found in the news section of our webpage http://www.dbfs.co.uk

You can also contact us on +44 (0) 207 332 0300 or on email enquiries@dbfs.co.uk


This article is available as PDF download here.

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