Banks without passports: How deep is the Brexit cliff?

Following the decision of the British electorate to leave the European Union (EU), the concerns of the UK-based banks are focused on the critical issue of “passporting” rights, which allow UK-licensed financial institutions to provide financial services directly to customers in other EU Member States. In a previous post, we have already sketched out the baseline scenarios for the UK banking sector. We are now turning to the potential impact of the loss of the EU “passport” on the balance sheets of the UK-based financial institutions and at large on the UK banking sector.

How does the EU “passporting” regime work?

The so called “passport” for the provision of cross-border financial services is not a single passport but a complex legal regime comprising of a series of sector-specific passports established by a number of different EU regulations. Most relevant for the the purposes of this analysis are two key pieces of EU legislation – the Capital Requirements Directive (“CRD IV”) and the Markets in Financial Instruments Directive („MiFID“). CRD IV allows banks to provide deposit taking, lending and payment services, while MiFID allows them to provide advisory services, investment services and portfolio management across the EU from a base in London. In practice, CRD IV regulates wholesale banking, while MiFID covers investment banking. Broadly speaking both directives allow financial services firms from one EU Member States to provide financial and professional services to clients, established in other EU member states.

In particular, the banking passport under CRD IV consists of several elements: First, CRD IV specifies the licensing requirements for activities of credit institutions, mainly consisting of authorization by the home supervisory body. Second, based on the fundamental freedoms of establishment and provision of services within the EU, the directive provides that, once licensed in one member state, a credit institution may establish a branch (as compared to a separate capitalised subsidiary) in or directly provide services to customers in any other EU or EEA member state – without prior approval. The credit institution should only notify the host country supervisor. Third, the CRD IV sets out the principles of prudential supervision, which predominantly gives powers to the home supervisor with some very limited powers for the host supervisor in the area of liquidity supervision. As a result the EU „passport“ avoids the need to set up a separate subsidiary in a EU/EEA Member State, to obtain a license from a EU/EAA regulator and subject its activities to overlapping supervision by the home and host state of the financial institution.

What does loosing the EU “passport” mean for the UK-based banks?

In case of a “hard” Brexit, the UK will become a third country from the perspective of the single market and the UK-based banks will need an extra licence from an EU or EEA member state to provide financial services to EU clients. Since the referendum, HSBC and RBS already have already established a subsidiary and a licence on the continent: HSBC in France and RBS in the Netherlands. Barclays operates mainly through branches and might therefore need an extra licence following Brexit (Schoenmaker for Bruegel, Jun. 2016). Respectively, EU-based financial institutions such as Deutsche, BNP Paribas and Societe Generale will also need to apply for a licence from the Bank of England. In any case, Brexit is very likely to leave a profound impact on the business models, market shares and balance sheets of the largest British banks and, through their London bases, of the international financial conglomerates that have based their European business in London.

According to data released by the Financial Conduct Authority (FCA) in September 2016, 5,476 UK firms make use of the financial services passport to provide services across the EU. 8,008 firms from across the European Economic Area make use of the passport to provide financial services in the UK (see Letter from FCA Chief Executive Andrew Bailey, Aug. 2016).

In the wake of the Brexit referendum, the British financial sectors was dependent on the EU passport for a significant part of its revenue. An Oliver Wyman study estimates that in 2015 the UK-based financial services have generated about 25% of their overall revenues (UKP 40-50bn of a total of around UKP 200bn) from “international and wholesale business related to the EU”. It further suggests that a potential loss of “passporting” rights may put at risk around 20% of the bank revenue in the UK (Sants et al for Oliver Wyman, Oct. 2016).

Particularly exposed to a post-Brexit shock to their financials are large US investment banks, which have concentrated in London their activities in Europe, the Middle East and Africa (“EMEA”). According to their most recent financials, the top five investment banks (Goldman Sachs, Citigroup, JP Morgan, Morgan Stanley, BAML) made up to 14.5% of their revenue in EMEA through their London bases (Sants et al for Oliver Wyman, Oct. 2016).

It is worth noting that the wholesale and investment banking remains, relative to other sectors within the financial services industry, one of the most vulnerable sectors to shocks resulting from the loss of „passporting” rights. For example, prior to the referendum the insurance sector was perceived as significantly less prone to suffer loss from loss of EU passports, because it uses subsidiaries as a main vehicle for its business in other EU Member States in order to contain the “insurance” risk in separate legal entities (see. e.g. Schoenmaker for Bruegel, Jun. 2016). Another example is retail banking which according to a recent consultation paper of the European Commission, remains largely domestic, particularly in the UK. As of 2015, cross-border loans within the Eurozone amount to less than 1% of total household loans (European Commission, Green paper on retail financial services, COM/2015/0630, Dec. 2016).

Atanas Sabev is an LL.M. candidate at Harvard Law School (class of 2017) and a Senior Consultant at PwC. This is a part of a series of short posts dedicated to the consequences of Brexit on the UK banking sector.

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