Brexit day: next phase for cross-border financial firms begins

Three and a half years after the referendum, the UK ceases to be a member of the EU at 11pm tonight. The UK will enter into an implementation period until 31 December 2020, unless extended by common agreement of the UK and EU member states to a later date.

During the implementation period, EU derived laws and regulations will still apply and financial service firms can continue with existing cross border arrangements in a way that would not have been possible under a no-deal Brexit. Andrew Bailey of the UK's Financial Conduct Authority (FCA) has said: "The work the FCA has undertaken, along with government and the Bank of England, ensured the financial services sector was one of the best prepared industries for any of the possible Brexit outcomes. The implementation period gives firms a period of certainty while negotiations are continuing on our future relationship with the EU."

While this is helpful in dealing with short term concerns, the financial services industry still has no certainty of the impact of Brexit after the implementation period and is still potentially facing a cliff edge at the end of 2020. The agreed political declaration between the UK and the EU offers little, making broad non-binding statements that the UK and the EU are "committed to preserving financial stability, market integrity, investor and consumer protection and fair competition"; while respecting both the UK's and the EU's regulatory and decision-making "autonomy" and their ability to take equivalence decisions in their own interest. There is an acknowledgement that "close and structured cooperation on regulatory and supervisory matters" is in the mutual interest of both the UK and the EU, but no detail on how this is to be achieved.

Financial services, a sector which represented almost 7% of total UK economic output in 2018, is one the main areas of negotiation for the future relationship between the UK and the EU. The UK government ruled out remaining a member of the single market post-Brexit and the EU has ruled out sector-specific arrangements, including any continued financial services 'passporting'. As a result, there has been a focus on equivalence instead, with this being the most likely outcome of the negotiations. The political declaration required the UK and the EU to begin mutual equivalence assessments immediately and for these to be concluded by the end of June 2020.

Equivalence is the process whereby the European Commission formally recognises that the regulatory or supervisory regime of a non-EU country is equivalent to the corresponding EU regime. This allows the EU to rely on supervised entities' compliance with equivalent rules in a non-EU country and may make certain services, products or activities of non-EU authorised entities acceptable for regulatory purposes within the EU. The UK has already started to push for an 'enhanced equivalence' regime for financial services, with the aim of ensuring that UK financial service firms will have continued access to the EU market after Brexit, with greater structure around the equivalence process to reduce the likelihood of sudden withdrawal of equivalence by the EU. It seems likely that the UK will continue with this negotiating strategy following exit day.

However, one difficulty in achieving this is that equivalence is assessed in relation to specific business lines, rather than as the whole of financial services, and is governed by individual directives. Although many EU financial services laws, including Solvency II and MiFID II, contain provisions for equivalence, notable ones do not - including the Insurance Distribution Directive, which governs the sale of insurance throughout the EU. Without a new equivalence regime for the sale of insurance, UK insurance brokers will not have access to the EU market without having a separately authorised EU establishment.

Even where there is an existing equivalence structure in place, equivalence agreements can take time to agree and may well be subject to conditions and ;time limits. For example, the agreement with US Commodity Futures Trading Commission took four years to agree and the equivalence agreement granted to Switzerland for stock market access was provided for one year only.

There can be no doubt that agreeing, and implementing a comprehensive and enhanced equivalence regime for all financial services by the end of 2020 will be highly challenging. Financial services will also be competing against other areas of interest for the UK and EU in what are likely to be intense negotiations over a relatively short period to December.

Although the implementation period provides a breathing space for the financial services industry, it is only the start of a new challenging period for financial services firms with cross-border business in the EU. Firms should therefore keep their no-deal project planning for cross-border business in place and continue to lobby the UK government and the FCA for comprehensive arrangements to try to avoid a further potential hard Brexit for financial services from 1 January 2021.