Vol. 38 Associate Editor
As financial service firms consider what kind of future may lie ahead in a post-Brexit market, one word has taken on a prominent role in the ongoing discussion: passporting. Under passporting, financial services firms authorized in one E.U. member state can offer cross-border services and open branches across other member states, without needing to obtain additional regulatory approvals from local authorities. Moreover, this benefit is not limited to U.K. firms; rather, many foreign firms maintain operations in London so that they too may gain passport rights to access the E.U. market. To say that the city of London has prospered under this regime would be a gross understatement, as access to the E.U.’s single market has led London to become not only the financial center of Europe, but one of the largest financial centers world-wide. However, whether the London will continue to maintain its dominant position in the global financial market will likely depend heavily on the nature of the U.K.’s post-Brexit trade relationship with the E.U. In a report published on November 3, 2016, Barnabas Reynolds, partner and head of the global financial institutions advisory practice at Shearman & Sterling LLP, outlined four possibilities for potential post-Brexit trade relationships between the U.K. and the E.U. and the consequences of each: maintaining the passport; a new, major bilateral deal between the U.K and E.U.; equivalence-based access; and, a “financial centre” model.
The first possibility, maintaining the passport, would likely entail some form of transnational agreement that would keep existing passport arrangements in place, at least until such time as a new system could be developed. While many banks believe that maintaining the status quo in this regard will be the best course of action, Reynolds highlights four significant drawbacks to such an arrangement. First, under a post-Brexit passporting arrangement, the U.K. would become a “rule-taker” to E.U. passporting laws, the development and enforcement of which it would no longer be able to moderate and influence. Aside from the sovereignty concerns regarding such an arrangement, this “rule-taking” position would also hamper the U.K.’s ability to tailor important rules to its own financial markets, potentially resulting in the U.K.’s financial markets being subject to more onerous rules than they otherwise would be under a domestic regulatory structure. Second, and related to the first point, is that the U.K. would be subject to the authority of various E.U. supranational agencies, the governance of which the U.K. would have no part in following Brexit. Third, because the passporting framework has been associated to a degree with the E.U.’s four freedoms (the freedom of movement of goods, people, services, and capital), it is likely that the continuation of passport rights would entail the continuation of free movement of people and payment towards the E.U. budget. Considering that immigration and budget contributions were some of the primary policies rejected in the Brexit referendum, it is unlikely that a continuation of passporting would be politically supported if it also meant retaining some form of the freedoms of movement and payment. Lastly, in relation to the aforementioned points, current U.K. Prime Minister, Theresa May, has already ruled out the possibility of any post-Brexit arrangements “which do not involve controls over E.U. immigration and a return of sovereignty.” From these points, the possibility of a continued passporting arrangement post-Brexit, while advantageous to the extent that it maintains the status quo, does not appear to be a feasible solution.
The second possibility Reynolds identifies is that the U.K. enters into an extensive bilateral deal with the E.U. to preserve access to the single market. Some advocates of this type of arrangement view it as preferable to an equivalence-based system, while still replacing the existing system of passporting. However, the negotiations for such an arrangement would likely involve the U.K. cherry-picking a number of benefits from the E.U. package to retain post-Brexit, with the E.U. requiring the U.K. to accept significant concessions in turn. Because such concessions would likely implicate the U.K.’s sovereignty and the freedoms of movement and payment, it is unlikely that a bilateral agreement would be politically supported within the U.K. Moreover, given the rhetoric of many E.U. politicians in the wake of Brexit, there will not likely be political support for a bilateral arrangement within the E.U. due to fears that such a “sweetheart deal” would “pave the path to exit” for other member states. Therefore, for similar reasons as to why the continuation of passporting itself would not be politically feasible, the bilateral deal would likely not be possible.
Outside of maintaining passporting or a bilateral deal, another potential post-Brexit arrangement would be the use of an equivalence-based system of access. Equivalence-based access enables firms outside the E.U.’s regulatory sphere to service member states, provided the E.U. deems that the applicable non-E.U. regulatory regime is at least as effective as the E.U.’s regime. In the case of the U.K., this may enable firms located in London to continue providing services within the E.U. without importing any of the four freedoms or other sovereignty concessions. Furthermore, an equivalence-based system would potentially provide a higher degree of regulatory flexibility for the U.K., as they would be able to tailor regulatory requirements to match domestic market conditions more closely, and avoid some of the more burdensome E.U. regulations. Lastly, an equivalence-based arrangement may generate mutual benefits for the E.U. as well because equivalency decisions may be granted on a reciprocal basis, thereby enabling E.U.-based financial firms to continue providing services in the U.K.
However, unlike passporting, access under an equivalence-based determination would not be a right; rather, it would be a privilege, subject to potential revocation by the European Commission on short notice. Equivalence determinations are also more limited with respect to the scope of financial services that they cover, and may take a substantial length of time to negotiate. For financial services firms seeking certainty in their ability to continue providing services to E.U. customers from London, such an at-will arrangement would likely be viewed with significant skepticism. Furthermore, U.K. regulatory policy would still be subject to influence from E.U. authorities, albeit in a more indirect fashion. Rather than retaining true sovereignty in its regulatory decisions, the U.K. would merely retain the illusion of sovereignty under an equivalence-based arrangement because, if its regulatory rules do not track the policies of the European Commission, then access to the E.U. market for U.K.-based financial services firms may be unilaterally revoked. While the flexibility and potential mutual benefits of an equivalence-based arrangement are apparent, the tenuity of such an arrangement may undermine the confidence of financial services firms looking for a higher-degree of certainty that they will be able retain adequate and uninterrupted access to the E.U. market.
The fourth potential post-Brexit arrangement is described by Reynolds as the “financial centre” model. Under the “financial centre” model, the U.K. would rebuild its entire regulatory framework, seeking to replace it with a more market-friendly regime by replacing more burdensome and inefficient rules with tailored, common law approaches. Through this arrangement, the U.K would seek to build a reputation as “an attractive, market-friendly, well-respected place to do business,” thereby incentivizing financial services firms to continue their operations in the U.K. while also attracting new firms to come to London. As the “financial centre” model would entail a more radical post-Brexit separation from the E.U., Reynolds’ view is that this model should only be pursued in the event an equivalence-based arrangement is not possible or becomes overly burdensome. However, the success of this model will likely hinge on whether financial services firms in London, particularly foreign firms running their European operations from the city, will acquiesce in the U.K.’s regulatory reforms, and the potential reduction in access to the E.U. market for these firms. For many firms, the short-term increase in business costs due to reduced access to the E.U. market may be too great to justify continuing their London operations for the prospect of a long-term benefit in the U.K. as a “financial centre.” Cost considerations will likely play a substantial role in the decision of a firm to remain in London or move, especially given the reduced profitability of the financial services sector in the wake of the 2008 Financial Crisis, and for some firms the potential benefits of the “financial centre” model may simply be too speculative.
In addition to the “financial centre” model, the other three potential post-Brexit arrangements are also vulnerable to the possibility that increased costs financial services firms will lead to an exodus of these firms from London. While each arrangement will likely carry its own unique costs and disruptions to the financial services sector, the long-term success of any post-Brexit arrangements will likely turn on the magnitude of its respective burden, and whether it is significant enough to drive financial service firms out of the U.K. Furthermore, continued uncertainty about what the potential post-Brexit arrangement will be carries its own costs, too, as firms need to develop and prepare worst-case scenario plans in the event of an unfavorable outcome. As a result, policymakers are faced with a paradox of sorts: where designing an effective post-Brexit arrangement will require thorough consideration of the costs that will be imposed on the financial services sector, but continued delays due to extensive considerations will increase uncertainty costs to the sector. Therefore, in the interest of reaching the most efficient post-Brexit outcome, the sooner policymakers take initiative and clearly map out their goals for an arrangement, the better.
 See, e.g., William Shaw, Equivalence, Not Passporting, Is Brexit Cure, Says Study, Law360 (Nov. 3, 2016, 5:36 PM GMT), http://www.law360.com/articles/859082/equivalence-not-passporting-is-brexit-cure-says-study; Stephen Fidler, London’s City Faces a Post-Brexit Dilemma, Wall St. J. (Oct. 27, 2016, 5:20 PM), http://www.wsj.com/articles/londons-city-faces-a-post-brexit-dilemma-1477603209; Gavin Finch, Banks’ Brexit Future Hinges on Passporting Rights, Bloomberg (Oct. 19, 2016, 7:01 PM), http://www.bloomberg.com/news/articles/2016-10-19/u-k-banks-brexit-hopes-boil-down-to-one-word-quicktake-q-a.
 Barnabas Reynolds, A Blueprint for Brexit: The Future of Global Financial Services and Markets in the UK 11 (Politeia 2016), http://www.shearman.com/~/media/Files/NewsInsights/Publications/2016/11/Barnabas-Reynolds–A-Blueprint-for-Brexit.pdf.
Isaac Wohl, Exec. Briefings on Trade: The Impact of Brexit on Financial Services 1 (USITC 2016), https://www.usitc.gov/publications/332/executive_briefings/wohl_brexit_and_financial_services_final.pdf.
By some estimates, the U.K.’s financial sector and related services currently generates around $300 billion in output yearly, and accounts for seventy-eight percent of European foreign-exchange trading, seventy-four percent of interest-rate derivatives trading, and eighty-five percent of hedge fund assets under management, among other impressive figures. See id.; Simon Nixon, The U.K.’s Big Brexit Test: Holding on to London’s Financial Crown, Wall St. J. (July 17, 2016, 1:36 PM), http://www.wsj.com/articles/the-u-k-s-big-brexit-test-holding-on-to-londons-financial-crown-1468776973.
 Wohl, supra note 3 (citing Global Financial Centers Index ranking London as world’s top financial center).
 See Reynolds, supra note 2, at 4–8.
 Gavin Finch, U.K. Needs to Give Banks Clarity on Brexit Future or Face Exodus, Bloomberg (Oct. 16, 2016, 7:01 PM), http://www.bloomberg.com/news/articles/2016-10-16/u-k-needs-to-give-banks-clarity-on-brexit-future-or-face-exodus.
 See, e.g., Nixon, supra note 4.
 Reynolds, supra note 2, at 11.
 Id. at 11–12.
 Of particular concern is that the U.K. would be subject to legal interpretations by the European Court of Justice, which has a reputation for being unpredictable in while aggressively favoring a single market agenda. Id. at 12.
1–4: The Four Freedoms, Eur. Pol’y Ctr: Pol’y Areas, http://www.europeanpolicy.org/en/european-policies/single-market.html.
 Reynolds, supra note 2, at 12.
 Id. at 4.
 Id. at 13.
 Timothy Ross, Banks Likely to Lose Passporting with Brexit, Official Says, Bloomberg (Oct. 26, 2016, 3:51 PM), http://www.bloomberg.com/news/articles/2016-10-26/banks-likely-to-lose-passporting-with-brexit-u-k-official-says.
 Reynolds, supra note 2, at 13.
 Fidler, supra note 1.
 Reynolds, supra note 2, at 5.
 Id. at 6.
 Finch, supra note 1.
 Id. For a basis of comparison, the recent equivalence-based deal between the E.U. Commission and the U.S. CFTC regarding central clearing rules for derivatives transactions took nearly four years to negotiate.
 See Fidler, supra note 1.
 Id. This assumes that the E.U. Commission, or other regulatory authority, will not revoke or deny an equivalency determination for political reasons, which would present its own problems. See Reynolds, supra note 2, at 21–23, for a general discussion about potential politicization in the Brexit negotiations.
 Reynolds, supra note 2, at 7.
 Id. at 8.
 Id. at 6–8.
 See id. at 27–29.
 See Nixon, supra note 4.
 See, e.g., Greg Ip, Future of Banking Looks Dark – Why That’s a Problem, Wall St. J. (Oct. 12, 2016, 6:21 PM), http://www.wsj.com/articles/future-of-banking-looks-darkwhy-thats-a-problem-1476292425.
 But see Reynolds, supra note 2, at 29.
 For discussions on potential cities where these firms may relocate and potential drawbacks, see, e.g., William Wilkes, Moving to Frankfurt After Brexit Could be a Squeeze for Banks, Wall St. J. (Oct. 26, 2016, 5:30 AM), http://www.wsj.com/articles/moving-to-frankfurt-after-brexit-could-be-a-squeeze-for-banks-1477474204; and Daniel Boffey, Brexit: Leading Banks Set to Pull Out of UK Early Next Year, The Guardian (Oct. 22, 2016, 4:00 PM), https://www.theguardian.com/politics/2016/oct/22/leading-banks-set-to-pull-out-of-brexit-uk.
 Wohl, supra note 3, at 1.
 See Nixon, supra note 4.
 See Finch, supra note 1.