U.K. politicians pushing for a post-Brexit trade deal on financial services are trying to stem an exodus of bankers from the City of London. For British banks, the stakes aren’t quite as high.
A U.K. withdrawal with no preferential access to the single market would result in declining tax revenue and the potential loss of 75,000 finance jobs as firms shift operations to the continent. Yet HSBC Holdings Plc, Barclays Plc and other British lenders would probably be no worse off than their rivals in the U.S., Switzerland and Japan.
After all, the home countries of global giants Citigroup Inc., Credit Suisse Group AG and Mizuho Financial Group Inc. have no free-trade deal with the European Union that covers banking. They nevertheless do business — a lot of it — in the single market by opening subsidiaries and branches in the bloc. Some services can even be sold to EU customers directly from the home office.
“Setting up in the EU just means things are more costly, more cumbersome for the big U.K. banks,” said Simon Adamson, an analyst at CreditSights in London. “They’ll have to stop doing some business out of the U.K., and there will be costs associated with that. A bigger risk will be the possible knock-on effects from a weaker U.K. economy, but the direct impact on banks will be limited.”
Douglas Flint, a former chairman of HSBC, said last year he wasn’t sure “what we would be looking for in a free trade agreement.” He pointed to the access U.K. and U.S. firms have to the other’s markets, facilitated not by a trade deal but by cooperation and exchange of information between supervisors. “One of the most solid regulatory cooperation agreements in our industry is between the U.S. and the U.K.,” he said.
The process of cementing such ties between the U.K. and the rest of the EU is already under way, and begins from a tradition of close cooperation within the bloc. Sam Woods, head of the U.K.’s Prudential Regulation Authority, has said he’s “extremely actively engaged” in talks with his EU counterparts on the immediate Brexit issues, such as the relocation of banks, and on their relationship after the divorce is final.
So if the politicians don’t come up with something better — Woods has proposed a middle-ground deal covering a limited range of services, such as investment banking and clearing — the U.K. banks will have the same avenues for single-market access that are open to rivals in other banking powers outside the EU.
The first option for non-EU banks is to open a subsidiary, an autonomous company legally established, authorized and supervised in one of the bloc’s countries. They must meet their own capital requirements. Crucially, a subsidiary has the right — known as a passport — to sell services throughout the European Economic Area, which comprises the EU plus Iceland, Liechtenstein and Norway.
Citigroup and Mizuho are required under U.S. and Japanese rules to split retail and investment banking operations at home and abroad, which means they have two main units in the EU.
The second option is to open a branch in an EU country. Branches — legally dependent parts of a larger company — are more limited than subsidiaries in the range of access they provide to the single market. A branch depends on its parent for capital, liquidity and funding, and is supervised mainly by its home-country authority.
Branches from non-EU countries are set up largely according to national law, and their activities are confined to that country. Branches aren’t eligible for the single-market passport.
The Bank of England in December came out with a policy proposal that would allow most of the 77 branches of EEA banks in the U.K., with assets of as much as 1.8 trillion pounds ($2.6 trillion), to carry on as before after Brexit. The plan was based on the continuation of “strong supervisory cooperation” with authorities in the EU.
“If we get no cooperation at all, which is not my expectation, ultimately we are not in the business of allowing branches, and firms would have to subsidiarize,” Woods said last month. Other EU supervisors have yet to respond with proposals of their own.
Non-EU firms can also sell services in the bloc via so-called third-country clauses in some EU financial-services laws. This option doesn’t cover a range of financial services, including deposit-taking, mortgage lending and payment services. It shouldn’t be sold short, however. Barclays has said that third-country arrangements such as those in the MiFID II market rules that kicked in on Jan. 3 “could cover much of the relevant parts of our EU operations.”
Most third-country access depends on a so-called equivalence decision, whereby the European Commission, the EU’s executive arm, recognizes that a country’s rules and oversight of specific business lines are as tough as its own. This allows the EU to rely on firms’ compliance with those frameworks, reducing overlaps on both sides as well as reducing capital costs for EU companies exposed to equivalent third countries. In some cases, it opens part of the single market to that country’s firms.
The potential downside of relying on third-country access is that the commission can withdraw an equivalence finding on short notice, closing off market access, and non-EU countries have little right to appeal. As a result, many in the industry say the arrangements are unsuitable for long-term planning.