If the City of London sneezes, Europe’s financial services industry will catch a cold. That is the message from newly-released data showing how mutually dependent the UK and EU’s mighty financial industries are.
The data, released by the UK’s Financial Conduct Authority, show that nearly 5,500 UK registered companies use “passports” to access the EU market, while 8,000 companies registered elsewhere in the EU use the system to access the UK. Passporting is the jargon for the way banks, insurers and asset managers are able operate smoothly across the EU from a regulated entity in any of the region’s 28 member states.
By allowing institutions based in London to sell products elsewhere in the bloc, passporting has become of paramount importance to financial services companies with regional headquarters in the City, including some of the biggest names in global finance.
“It’s hard to see how we can serve all of our European clients, and the European economy, without access to the single market,” said Daniel Pinto, chief executive of JPMorgan’s corporate and investment bank, which has its European headquarters in London and employs over 16,000 in the UK.
“Our clients will need us to have passporting ability, or something that achieves the same thing,” he said.
At present, finance and politics may be on a collision course. Senior executives and advisers suggest that 20 per cent of investment banking and capital markets revenue — some £9bn — could face disruption if Britain loses access to passporting without an adequate replacement. Theresa May, Britain’s prime minister, spent part of her trip to New York this week meeting heads of Wall Street groups, some of passporting’s chief beneficiaries. Unless passporting, or something like it, is maintained, big US banks could have to shift large chunks of their business to continental Europe.
Nevertheless, in the wake of Britain’s June 23 vote to leave the EU, the City’s use of passporting may soon become a thing of the past. So far, EU leaders have shown no appetite to grant the UK the kind of unfettered access that passporting provides, unless Britain in turn accepts the rules that come with membership of the single market, including free movement of people — a red line for many Brexiters.
Richard Eglin, senior trade policy adviser at law firm White & Case, described financial services passports as “the one thing where they [the EU] have the UK over a barrel”, adding: “They will extract a high price for whatever they give Britain on that.”
As a ranking official involved in the talks puts it: “After Brexit, the passport as we know it is dead. It cannot stay the same for the City.”
The finance industry has long maintained that London is too significant a hub to be left out in the cold. A report by the consultants Oliver Wyman, shows that 55 per cent of capital market and investment banking revenues generated in London in 2012 were paid by European clients outside Britain.
It added that almost 80 per cent of capital markets and investment banking activity in the rest of the EU was managed and executed in the UK.
But the new FCA data also highlight that with half as many more companies passporting into the UK than out of it, the EU has a lot to lose, too. Passporting is “truly a two way thing”, said Anthony Browne, chief executive of bankers’ group the BBA.
“The passport is incredibly widely used by European banks wanting to sell services into the UK or operate in the UK,” he said. “Losing the passporting provisions wouldn’t just be an issue for the City of London.”
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Many of the EU banks that would lose easy access to the UK are small. But there are a number of exceptions.
Passporting is important for investment banks, since they can run relatively large international businesses as “branches”, as Deutsche Bank and Commerzbank do in the UK, rather than as separately capitalised subsidiaries.
Retail banks still tend to set up national subsidiaries for large operations, as Santander UK has done. Some of the smaller banks that use passports to operate branches in the UK could probably continue with a branch structure even when the UK leaves the EU.
Insurers are the biggest users of passports.
Leading groups such as AIG and Tokio Marine have chosen London as a base for their European operations and use passporting to access other markets.
“[Brexit] has a substantive potential impact on our membership,” said Dave Matcham of the IUA, which represents international insurers operating in London. “The majority of them passport into the EU from London.”
The EU, he says, represents 17 per cent of the £16bn in premiums that his members wrote in London in 2014. Passporting into London from other parts of the EU is even more popular.
The asset management industry also uses passporting to enable UK-domiciled funds to be sold across the EU and vice versa. This has meant that until now, UK-based asset management companies have not needed a presence on the continent in order to sell funds to investors there. The vast majority of M&G’s fund sales, for example, are passported out of the UK. Man Group, Ashmore and Baillie Gifford, have no offices on the continent, despite EU-based clients accounting for 21 per cent, 28 per cent and 4.5 per cent respectively of their total assets under management.
Brexit has cast doubt over the future feasibility of these distribution arrangements.
Many finance industry insiders dismiss suggestions that alternatives to passporting could fulfil their needs. They point out that there is currently no fully-fledged substitute for passporting — something demonstrated by the keenness of global groups from the US, Switzerland and Asia to base EU operations in London.
Nonetheless, some consultants and lawyers believe there will be ways to short-circuit the most obvious restrictions. Seb Walker, of investment banking consultancy Tricumen, said banks could use booking systems that initially log trades in an EU location and then replicate the transaction in London. “It’s pretty easy to switch booking entities,” he said.
Brussels has rules on how overseas companies can gain access to specific parts of the EU financial-services market, but they are scattered across different laws and do not amount to a comprehensive system. It is a route, notably, that offers little in the way of market access for insurers and mutual fund managers.
The rules, known in EU jargon as “equivalence” standards, also have the disadvantage from Britain’s point of view of giving the whip hand to Brussels, as each kind of market access requires separate EU approval.
Many bankers are sceptical. “It only applies to a limited range of services,” said Mr Browne at the BBA. “There is no equivalence regime for CRDIV [banking rules] so corporate banking, including deposit taking and lending, isn’t included.”
A bigger challenge to the equivalence solution is European politicians’ preparedness to rubber stamp such an arrangement.
“It [equivalence] can be politicised because it’s granted by the European Commission,” said Mr Browne. “It can be withdrawn at short notice. It’s very difficult for business to plan . . . if their operation can be closed down in a month without any warning.”
A banker with a large international company said passporting was the best option for financial services groups. “Anything that moves away from passporting would deliver less optimal outcomes, higher costs for clients, lower operating efficiency and potentially negative impacts on the European economy.”
As Mrs May and her EU interlocutors move towards negotiations next year, the question is whether such concerns about interdependence will allow passporting to survive — or for an alternative or transitional scheme to be put in place — or whether instead politics and regional rivalries will prevail.
Additional reporting by Oliver Ralph, Madison Marriage and Alex Barker