More than a million people are employed in the financial services sector creating over 7% of the value of the UK economy in the second quarter of 2017.

£27.3 billion of tax receipts was attributed to the banking sector by HM Revenue and Customs in the 2016-2017 financial year. The broader financial services industry, which includes insurance firms for instance – according to an estimate by the City of London Corporation – is credited with generating more that £70 billion in tax revenues in 2016, making up 11.5% of the national total.

Financial Services and its reliance on the EU.

A quarter of the financial services sector annual revenue, it is estimated, involves business related to the EU.  EU business is particularly important in banking and investment according to the Institute for Fiscal Studies. Over 40% of UK exports in this area heads to the continent. The UK’s position and because of its access to the EU market has meant that many overseas banks have their European headquarters here.

This is a two-way relationship. London is the world’s leading financial centre.  There are no alternatives in Europe able to match the efficiency and cost effectiveness found in the UK. PwC (PricewaterhouseCoopers) have emphasised that many businesses in Europe rely on the UK for their financial requirements.

This leads us to the question of trade options for financial services with the EU in the wake of the Brexit vote.

There are, basically, 4 broad models for financial services conducting trade with the EU.

Passporting:  Passporting is a system that allows Firms based in EU member states, and non-EU states that are members of the European Economic Area (EEA), to sell their services freely within the bloc.  It works as EU member states have agreed a body of shared regulatory and supervisory standards relating to financial services. Firms in one member state can apply to their national competent authority for a range of ‘passports’ indicating that they meet these standards in given areas, allowing them to establish branches elsewhere in the bloc and trade across borders with minimal further scrutiny. The UK financial services sector currently trades with Europe on this basis.

World Trade Organisation (WTO) terms:  States outside the EEA, or ‘third countries’, typically do business with Europe on the terms outlined in the WTO’s General Agreement on Trade and Services (GATS).   Trading on WTO terms entails significant limitations on cross-border trade compared to passporting, and stricter regulatory requirements and supervisory oversight of the EU branches of UK banks. Both sides are also able to impose measures for ‘prudential reasons’ such as ensuring the stability of the financial system, which can lead to further restrictions.

The UK financial services sector would trade with the EU on these terms in the event of ‘no deal’ on Brexit. The Bank of England has ordered firms to draft ‘Brexit contingency’ plans in the event of this scenario. The Chief Executive of the Financial Conduct Authority expects firms to act on these contingency plans and start moving staff and operations out of the UK by the end of the year – unless a transition deal is agreed before then.

Equivalence:  Some third countries receive preferable market access rights regarding certain services, on the basis that their laws and supervisory frameworks are deemed ‘equivalent’ to the EU’s by the European Commission and a committee of experts from member states. ‘Equivalence’ is based on an assessment of how far the laws of a third country have the same intent and outcomes as the EU

The House of Lords EU Committee’s report on financial services discusses the ways in which relying on equivalence determinations could prove problematic in practice: Equivalence is not negotiated, but requested from the European Commission – and the UK cannot technically apply until it has left the EU. Once granted, equivalence can be withdrawn by the Commission.

While the equivalence process is relatively untested, previous decisions have taken many years and been sensitive to political changes. Some financial services – including basic banking services, such as lending and deposit-taking – are not covered by existing or incoming equivalence regimes. Trade for these services would revert to WTO terms or need to be negotiated separately in bilateral agreements

Market access rights are much narrower than those under the passport system for services covered by equivalence,

Switzerland has been granted equivalence in some areas, but many Swiss firms still choose to conduct their European business from bases in EU member states for better access to the internal market.

Free trade agreement (FTA):  Other third countries have attempted to cover financial services as part of a broader FTA with the EU. The Comprehensive Economic and Trade Agreement (CETA) between the EU and Canada is the most recent example of this.

FTA’s covering financial services have recently been negotiated with the EU by a number of countries, including Ukraine, Canada and South Korea. It is, however, true that these FTA’s offer few provisions for trade in services. In CETA, for instance, the provisions for financial services fall a long way short of passporting.

It is possible, given the UK is in an unprecedented position when it comes to starting negotiations with the EU and given it has the same regulations as the EU and a higher degree of interdependence between them that an agreement offering greater access to the financial services market than previous FTAs might be possible.

However, the European Council emphasises in its Brexit negotiations guidelines   that no sector-by-sector membership of the Single Market will be allowed post-Brexit, so some restrictions on trade in financial services should be expected.

The extent of access will likely be determined by how far the UK decides to diverge   from EU regulations in the future. Establishing new arrangements for managing changes to rules on either side may prove crucial.

So, what is The Government’s position when it comes to financial services and Brexit. The White paper issued by the Government in May 2017 expresses a desire for “the freest possible trade in financial services between the UK and EU member states.” More specifically, the Prime Minister’s Article 50 letter envisages financial services being covered by a comprehensive FTA.

In her Florence speech, the Prime Minister, Theresa May, was adamant that the UK should push for a more ambitious, bespoke agreement. She also echoed calls from the financial sector for a transitional arrangement to be decided on before the end of the year, during which existing arrangements would be maintained.

According to David Davis, the Brexit Secretary, there will be regulatory divergence from the EU on financial services after Brexit, to secure a long-term competitive advantage for the UK.

Philip Hammond, the Chancellor, stressed, however, the importance of regulatory co-operation.  He has the support of both the Governor of the Bank of England and the Chief Executive of the FCA in this and they want to see the UK and EU maintaining equivalent arrangements as a way of preserving free trade and open markets.

The Chancellor has also reassured financial services companies  that they will continue to have access to global talent after Brexit, amid concerns that immigration restrictions could make it difficult to satisfy the industry’s demand for high skilled labour.

Brexit will also impact the UK’s financial services trade with the rest of the world.

It is not only the relationship between the UK and the EU that will change after Brexit. By leaving the EU, the UK will no longer be party to trade arrangements between the EU and third countries around the world. FTAs with the likes of Singapore and South Korea will need to be re-established, and the recognition of other third country regimes in EU regulation will require replication in UK law.

The UK could also attempt to go beyond the market access rights provided under these EU arrangements, as well as pursue new FTAs with other partners.