Brexit and its impact on the financial sector

At midnight (CET) on 31 January 2020, the United Kingdom left the European Union (EU). This marked the beginning of a transition period that will last until this end of this year. During this time, the United Kingdom will remain a member of the single European market but will lose its voting rights at the EU institutions. Negotiations on the future relationship between the EU and the United Kingdom are scheduled to begin in March 2020. The outcome of these negotiations will be key to determining how Brexit will impact the European economy and financial system following the end of the transition period.

Unless a corresponding agreement is reached, the UK’s withdrawal from the EU will mean that British enterprises will lose their free access to the single European market after the transition period has expired. Conversely, enterprises domiciled in the EU will then no longer be able to conduct business with the United Kingdom unimpeded. Any tariffs or other trade barriers resulting from Brexit could lead to reduced trade and prosperity in both the United Kingdom and Europe as a whole. The objective of the negotiations is therefore to conclude a comprehensive free trade agreement between the two partners.

What will change for banks?

It is foreseeable that Brexit will have far-reaching consequences for the financial sector and banking supervision, too. With the UK’s exit, the European Union will lose a part of its financial sovereignty, explained Bundesbank Executive Board member Joachim Wuermeling in an interview with the Frankfurter Allgemeine Sonntagszeitung. “London will no longer be subject to EU rules and could transform itself into an offshore financial centre of sorts,” he warned. Wuermeling, who is responsible for banking supervision, among other areas, at the Bundesbank, is concerned that the United Kingdom could again loosen the existing rules for banks. “London sees itself in competition with financial centres such as New York; there is therefore a great temptation to loosen the reins on its own banks.”

As a result of Brexit, the “passporting rights” for transactions between British counterparties and parties domiciled in the European Economic Area (EEA) will expire after the end of the transition period. These passporting rights allow financial enterprises that are authorised to provide financial services in one EEA country to provide these services in all other Member States as well. However, due to Brexit, financial enterprises that have so far been domiciled in the United Kingdom are now being forced to establish licensed branches in the remaining EEA Member States in order to retain their passporting rights and continuing serving their customers located in those countries. Conversely, enterprises domiciled in the EEA must apply for permission from the UK supervisory authorities in order to retain access to the UK financial market. Many international banks domiciled in the United Kingdom acted quickly and have already obtained these licenses – and overwhelmingly in locations that are covered by the European Single Supervisory Mechanism (SSM). The SMM is the component of the European banking union responsible for banking supervision and, since November 2014, has supervised the 120 most significant credit institutions in the 19 participating countries.

The long road to Brexit

Brexit, which was voted for by the UK public in a referendum in June 2016, was originally intended to be completed by March 2019. However, the UK House of Commons rejected the draft Withdrawal Agreement negotiated between the EU and the United Kingdom on multiple occasions. The European Council subsequently approved an extension of the Brexit deadline, first to spring and then to the end of October 2019. On 24 July 2019, UK Prime Minister Theresa May ultimately resigned and was succeeded by Boris Johnson. In mid-October, the EU27 and the new UK Government agreed upon a revised Withdrawal Agreement. This agreement included, in particular, changes to the provisions concerning the border issue between the Republic of Ireland and Northern Ireland as well as to the political declaration on the future relationship between the EU27 and the United Kingdom.

The amended agreement envisages that, in future, Northern Ireland will form a customs area with the United Kingdom. At the same time, however, EU customs law and all relevant single market legislation will be applied in Northern Ireland. To ensure an open border between the Republic of Ireland and Northern Ireland, the necessary checks will already take place at the entry points to the island of Ireland in Northern Ireland. In order for the agreement to be ratified in time, the European Council approved another postponement of Brexit, this time to 31 January 2020. On 12 December 2019, elections were held in the United Kingdom, which gave Boris Johnson a considerable majority. With the votes from the UK Conservative Party, the House of Commons finally approved the revised Withdrawal Agreement on 9 January 2020. Approval by the UK House of Lords and the European Parliament a few weeks later finally cleared the path to an orderly Brexit.