BREXIT: prepare for market volatility regardless of vote result, experts say

Out-Law Analysis | 12 May 2016 | 11:47 am | 5 min. read

FOCUS: Financial markets are volatile by nature, and this is likely to be the case regardless of whether the UK votes to leave the EU on 23 June. But with the future of financial regulation at the top of the agenda, firms would be wise to develop contingency plans now, according to experts at Pinsent Masons, the law firm behind Out-Law.com.

This is part of Out-Law’s series of news and insights from Pinsent Masons lawyers and other experts on the impact of the UK’s EU referendum. Sign up to receive our Brexit updates by email.

EU passporting rules, which enable UK-authorised financial firms to operate within Europe without having to obtain separate authorisation in every country, are extremely valuable – as we have already seen in the context of insurance business. Banks and investment firms are similarly able to take advantage of these rules, which also increase the attractiveness of the financial centre of the City of London as a European base for so-called ‘third country’ firms from the likes of the US or Japan.

"Currently, over 250 foreign banks have offices in the UK, including a large number whose European headquarters are in London," said Tony Anderson, a banking law expert at Pinsent Masons. "If a Brexit occurs, these firms will need to make other arrangements to gain access to the EU single market, with Frankfurt or Paris appearing to be attractive destinations for a new EU headquarters."

"That isn’t to say that we will see a rush of firms moving out of London – shifting headquarters carries huge time and cost implications, and will very much depend on the amount of business each firm has in the UK," said insurance law expert Tobin Ashby. "Dual headquarters could be a better solution for some firms, depending on their circumstances."

Increased regulatory burdens?

Given the amount of financial regulation that comes from Europe, regulatory reform would pose significant challenges to firms in the event of a Brexit vote.

"Although historically the UK had a reputation for ‘gold-plating’ regulatory requirements set at EU level, more recently it has been a steadying influence on some of the more excessive regulatory proposals. Certainly the UK has been very influential in the development of financial services regulation so it would be extremely unlikely for any mass deregulation to take place should the UK vote to leave the EU," said financial regulation expert Elizabeth Budd of Pinsent Masons. "Over time, this could have an impact as regulations and laws evolve: the UK could be operating subtly different regulatory requirements from those followed by its European neighbours."

"A potential difficulty here could be the UK’s ability to demonstrate equivalent regulatory protections in order to do business with the EU as a ‘third country’," said banking law expert Tony Anderson. "Much of this would depend on the nature of the UK’s post-Brexit relationship with the EU, whether as a member of the European Economic Area (EEA) or European Free Trade Area (EFTA), or in a bespoke form. The UK may have to adopt certain EU standards and regulations as part of a continuing relationship, but without having had a say in them."

"As a member of the EU, the UK has had significant influence on financial services regulation, especially that of wholesale financial markets. Indeed, the European Banking Authority (EBA) is based in London. Were the UK to leave the EU, the EBA would naturally depart these shores – while the UK would have to consider whether to engage in a relationship with Europe similar to that employed by Norway via EEA and EFTA membership, or EFTA-only member Switzerland. Neither of these countries has direct influence on financial services policy-setting or regulation; and both have significantly different economies to that of the UK," he said.

New opportunities

Elizabeth Budd said that firms themselves were at present fairly split on the benefits of continuing EU membership.

"Those who thrive in volatile markets appear happy to exit the EU and ride out the effects for 10 years to see what sort of market the UK ends up with," she said. "Firms with a large proportion of EU-centric business are much more in favour of retaining the status quo."

"Firms with purely domestic business or whose business primarily excludes Europe may benefit from no longer being subject to EU-level regulation, depending on what the UK decides to replace it with," said banking law expert Tony Anderson. "A Brexit vote may mean that firms place more of a focus on other markets such as China, which may open up new opportunities."

The question of whether firms and highly-qualified individuals would immediately relocate to Frankfurt or Paris in the event of a vote to leave the EU was "not going to be a sudden issue", said Elizabeth Budd. "Business that goes through London will not suddenly stop going through London, both because of the infrastructure that is already in existence to cope with that business, and because of the people who are already here," she said.

"It could be a good 10 years before the markets settle and new rules emerge – and many firms, particularly in the investment/asset management and insurance sub-sectors, are already looking that far ahead," she said.

In any event, London would continue to attract talent if the business was still here, and if the UK continued to provide "enough of a window to foreign investment", Tony Anderson said.

"Individuals that are really wanted are also likely to receive preferential treatment, in the same way as is currently done with recruitment of the highest calibre of employees from the likes of the US," Elizabeth Budd added.

Impact on the Financial Services Compensation Scheme

The UK’s deposit protection scheme, the Financial Services Compensation Scheme (FSCS), currently provides much-needed protection and security to the vast majority of individuals who have bank accounts or investments in the UK, up to a €100,000 limit which is set by the EU.

"Should the UK vote to leave the EU, it is not clear what would happen to this limit, although in all likelihood a protection of this type would continue to exist and would continue to be funded by the UK financial services industry," said Michael Ruck, a financial regulation and enforcement expert. "However, the level of the limit would be set by the UK government in place at the time rather than by the EU. As an example, in places like Guernsey and Jersey that operate significant financial centres while not being part of the EU, deposit protection is limited to the first £50,000."

"It is impossible to predict whether any market volatility as a result of a vote to leave the EU would result in greater defaults in the short term, with greater recourse to the compensation offered through the FSCS," said financial regulation expert David Heffron. "If it does, this could put unexpected pressure on FSCS funding – which may, in turn, mean increasing the levies passed onto firms, or the need for the FSCS to raise an interim levy."

What should financial firms do now?

UK regulators have already asked all financial firms to look at their risk positions in the event of a ‘leave’ vote. Firms will be required to have plans in place to deal with market volatility post-vote or even a potential recession, in line with their regular risk planning requirements.

"The most immediate concern is likely to be firms’ capital reserves, which was what most affected financial firms during the crisis of 2008," said Elizabeth Budd.

"Most firms appear to be carrying on with business as usual given the considerable uncertainty and the fact that the UK will have two years after giving notice of its intention to leave the EU in which to negotiate further and work out a plan," she said.