March 2017 – The General Council of the Bar recently published a second edition of the “Brexit Papers” which included new sections detailing their firm opinions on the importance of passporting in the eventual Brexit negotiations. The report, originally published in December of 2016, is a lengthy document which thoroughly details how the UK’s legal profession believes Brexit should be handled.

These new papers throw fuel onto the fiery arguments regarding how Theresa May, and the other legislators in charge of negotiating the terms of the UK’s departure from the EU, should go about particular nuances of the negotiations once Article 50 is triggered on March 29th. Although the number of topics which need negotiating is staggering, the millions of financial professionals in London are all focused on the future of the passporting issue in particular.

You Shall Not Pass(port)

A “passport” in the financial services industry allows any financial institution under the purview of one of the 31 European Economic Area (EEA) Member States to provide certain cross-border products and services from one Member State to another, as well as the ability to set up a separate branch in any of those member states to aid in providing those products and services.

As far as the financial industry is concerned, this ability is perhaps the most valuable aspect of being a member of the EU and is absolutely essential for London to maintain its reputation as a global financial center.

theresa may

Theresa May lays out her goals for the Brexit negotiations. (Source: Irish Independent)

Passporting is facing a major threat, however, as Theresa May, in her January 8th speech regarding Brexit, made it clear that her priorities in negotiations were regaining control of immigration and lawmaking in the UK, even if that means leaving the single market. According to Jens Weidmann, President of Bundesbank in Germany,

Passporting rights are tied to the single market, and would automatically cease to apply if Great Britain is no longer at least part of the European Economic Area.

Unfortunately for those within the financial industry, and ultimately the UK economy, the price of becoming a member of the EEA after leaving the EU directly contradicts what May looks to get out of the negotiations and could end up being red-line issues for both sides.

If something is not done to preserve the UK’s passporting rights during negotiations, numerous banks headquartered in London would have to transplant thousands of employees to other offices in the EU and would face a lot of turmoil whenever conducting business between it’s EU branches and any remaining UK clients.

It goes without saying that this outcome is undesirable for everyone involved but, as things stand today, what options are currently available?

What’s on the Table?

When a country is not in the EEA but still wishes to do business with EEA countries, there are only a couple of options available to them. Unfortunately for post-Brexit UK, neither of the off-the-shelf options are remotely reliable or convenient.

Equivalence

The most common option available is called “equivalence” and it basically boils down to whether or not the EU thinks your country’s business policies and oversight are up-to-snuff with their standards. For the time being, this option is fine for the UK, since their business standards will be identical to those of the EU at the time of their departure (~April 2019), but the looming issue of uncertainty remains.

The biggest difference between passporting and equivalence is that one is permanent and the other is not.

passport vs. equivalence

Equivalence can often be affected by politics and is therefore not nearly stable enough for the major financial institutions which call London home. The issue of being granted equivalency is also somewhat of a grey area since there isn’t a ton of transparency around what goes into the approval process. A recent example of how costly and time consuming these equivalency talks can be is found in the case of the U.S. Commodity Futures Trading Commission which dragged on for nearly four years, despite the fact that both sides “wanted to conclude it quickly,” according to Jonathan Hill, the EU’s former financial-services chief.

Perhaps Doug Flint, chairman of HSBC Holdings Plc, said it best when he stated it’s, “a little bit hazardous to rely on equivalence, particularly where the industry involved is such a significant part of the GDP as our financial industry is to the UK.”

Third Country Passport

The idea of a third country passport is that it would allow certain non-EEA countries to operate their businesses similarly to those in the EEA. Unfortunately, nothing is that simple.

First of all, the third country passport is a brand new concept which is not yet activated and its availability so far is extremely limited. Secondly, based on the precedent set forth by the Alternative Investment Fund Managers Directive (AIFMD), the firm applying for the third country passport may be required to comply with all relevant EU law requirements on a global scale.

Needless to say, this option is even more immersed in red tape than equivalency and does not seem like a viable option for the near future.

Hybrid/Bespoke Solution

The most likely and most favorable solution is the one put forth by the aforementioned General Council of the Bar, as well as numerous other financial professionals who would undoubtedly be affected by the issue, which entails a custom agreement combining certain aspects of the equivalence and third country passport options. This is a generalized proposal that would basically boil down to what Andrew Coombs, an analyst at Citigroup, dubbed “equivalence plus”.

The way the Bar Council has proposed the EU and UK negotiators go about this hybrid solution is by performing a complete audit of the current products and services which can and cannot be traded with full passport access, as well as everything that goes into the equivalence and third country passport options, in order to identify gaps which can’t be filled using existing mechanisms. By their estimation, “It is these gaps that a bespoke arrangement should seek to fill.”

Although you never know how politics could affect this kind of decision, it seems like both parties are on the same page regarding a workable agreement. European officials are well aware that the whole of Europe’s economy would feel the hurt if the UK’s financial industry is crippled. As Mark Carney, Bank of England Governor, put it, “If you rely on a jurisdiction for three-quarters of your hedging activity, more than three-quarters of your FX activity, half of your lending, half of your securities transactions, you should think very carefully about the transition from where you are today to where the new equilibrium will be.”


Things will begin to get very interesting starting next Wednesday, March 29, when Theresa May triggers Article 50 and the likely two-year negotiation process for the future of the separated UK and EU begins to take shape. It will be a long, and often times dull, negotiation period as we sit on our hands and wait to see what comes of the negotiations, but you can be sure we will keep you updated on any new Brexit negotiation information as soon as it is available.