Mr Carney, Governor, Bank of England, was asked by the Treasury Select Committee what would be the impact of Brexit on the City: “I would say a number of institutions are contingency planning for that possibility (i.e. to relocate business activities from the City in the event of Brexit). There would be an impact. I can’t give you a precise number in terms of institutions or jobs or activity, because we don’t know where we would be on that continuum between full mutual recognition or pure third country access.” The Governor was pressed on whether anything less than mutual recognition would result in some degree of loss of business in the City of London. His response was, “without question.”
The City of London is not only Europe’s financial centre – according to think tank Z/Yen, London has leapfrogged New York to become the world’s leading financial centre. To put some numbers to this, the City is currently home to over 3000 securities firms (dealers, brokers and investment managers) regulated under the Markets in Financial Instruments Directive (MiFID). Well over 50 per cent of the EU’s MiFID firms are based in the UK, emphasizing its primacy as the EU’s securities hub.
But how to assess the consequence for these firms and the City of London if the UK votes to leave the EU, and in doing so the UK becomes, from an EU perspective, a third country state? There are parallels – think of Switzerland and international financial centres such as Jersey. How do they fare outside the EU when their financial institutions need to do business or service customers in the EU? The short answer is it’s not easy.
At present the UK has a direct influence over the decision making process in the European Commission, Parliament and Council. Most recently, the UK has been able to influence the development of Alternative Investment Fund Managers Directive (AIFMD), and ensure that the Directive provides protection for investors but without reducing investor choice.
As a third country state the UK’s ability to influence EU regulation would diminish. It can attempt to participate in the decision making process by raising points with a member state with which it has a favourable relationship, in the hope that any concerns or comments eventually get passed on at an EU level. Alternatively it can try to find another third country ally, for example the US, with which it can engage with the EU and attempt to influence policy.
Generally third countries such as Switzerland and the US are well received by the EU institutions, and the EU is keen to maintain a good working relationship with them. But cordial relations fall well short of a member state’s right to participate in discussions and to exercise a formal right of veto. Further, EU institutions can and do make politically motivated decisions that do not recognize the interests of third country states.
Currently a UK-authorized bank, insurer or securities firm has the right to carry on business in another EEA state without further authorization. This passporting right allows UK firms to access European markets and over 2000 UK investment firms benefit from a passport under MiFID. UK firms will lose this right if it exits the EU without mutual recognition. This means that each right of access for insurers, fund managers or banks would need to be individually negotiated at Government level with the EU. Third countries’ experience is that these negotiations can be difficult and protracted – and will not replicate a member state’s unfettered market access.
Under MiFID II, for example, third country firms will be able to access only professional clients and eligible counter-parties within the EU on a cross border basis, but subject to the home state being recognized as providing EU-equivalent regulation. This falls far short of the current universal passporting rights and would require the UK to satisfy the EU on an ongoing basis that it was continuing to meet its requirements. This could be a real drawback for the City of London, whose prosperity substantially depends on continued and unfettered free market access to the EU.
EEA authorized firms will lose the corresponding ability to operate in the UK, and consequently the UK will lose the advantages this brings – such as increased liquidity, employment opportunities and tax revenue. London may additionally stand to lose some of its attractiveness to incoming third country firms. As stated in its October 2015 report EU membership and The Bank of England: “Around half of the world’s largest financial firms – ranging from commercial and investment banks to insurers, asset managers and hedge-funds – have chosen to have their European headquarters in the UK.”
Feature Image credit: Flagging Support, by Dave Kelham. CC BY-SA 2.0 via Flickr.