The long-term prospects for the UK's financial services sector outside of the European Economic Area (EEA) continue to be a contentious topic. In the near term, firms face the disruption and uncertainty of new rules and regulations, including several temporary measures designed to ease the transition to the new state.
The financial services industry contributed £132 billion to the UK economy in 2018, according to a 2019 parliamentary briefing paper. Recent ONS statistics show that the sector employs over 1.3 million people - around 3% of all UK jobs. With 43% of UK financial exports heading to the EU, concerns surrounding the potential negative impact of Brexit on the sector and the UK economy are understandable.
The end of the transition period on 31 December 2020 marked the final stage of a long and often painful journey following the UK's vote to leave the EU in June 2016. On the face of it, the financial services sector has had plenty of time to prepare, but the absence of a trade agreement until the eleventh hour has required firms to plan for various outcomes.
UK banks and financial services firms have worked hard over the last decade to adapt their businesses to take advantage of the EU passporting system. Passporting allows firms to trade freely throughout the EEA with minimal additional authorisation. However, from 1 January 2021 the UK is no longer part of the scheme and reverts to 'third country' status. Third countries can apply for 'equivalence' status which, once granted, allows firms to operate in areas where the UK's rules meet the same standards as EU regulations.
It might seem logical to assume that passporting rights could be transformed seamlessly into equivalence in most areas, on the basis that UK and EU regulations are fully aligned. However, obtaining an equivalence ruling is typically a slow process and can take several years. In the meantime, firms that wish to trade within the EEA must do so through an authorised entity based in the EEA - a requirement that will add complexity and cost. Some relief has been granted - EEA firms passporting into the UK on 31 December 2020 can continue to operate in the UK for a limited period under the Temporary Permissions Regime (TPR). UK financial regulators have the power to make transitional provisions for a limited period, known as the Temporary Transitional Power (TTP). The FCA will apply the TTP to modify the application of the MiFIR derivatives trading obligation (DTO) to avoid conflict between EU and UK DTO rules.
UK firms will not benefit from reciprocal equivalence from the EU, although the European Securities and Markets Authority (ESMA) has granted temporary third country recognition to three UK CCPs including LCH and to one UK CSD. Firms face the combined challenges of planning for the end of temporary reliefs while adapting booking models, trade processing and regulatory reporting to meet the new requirements from 1 January 2021. The FCA has stated that it won't take enforcement action against firms not meeting all requirements immediately as long they have taken reasonable steps to prepare before the effective date. The regulatory spotlight on trade and transaction reporting is unlikely to fade. Firms will need to adapt trade capture, reconciliation and reporting systems quickly and effectively to avoid reporting gaps and errors that have led to large fines in the past.