The EU’s chief Brexit negotiator Michel Barnier made it clear on Monday that, when the UK leaves the single market, financial services firms based in Britain will lose their “passporting” rights.
“On financial services, UK voices suggest that Brexit does not mean Brexit. Brexit means Brexit, everywhere,” Mr Barnier told the Centre for European Reform.
“The legal consequence of Brexit is that the UK financial service providers lose their EU passport.”
But what is the passport? How important is it? Does this come as a surprise? And what will it mean for the wider economy?
What is this passport?
It enables financial firms in the UK to sell their services right across the EU.
So, for instance, a UK-bank based in London can sell financial services to a company based in Prague as easily as if that company was based in Preston. There are no regulatory barriers.
This freedom is the essence of the single market in financial services.
But it’s not just UK banks that have this freedom but also foreign financial firms with bases in the UK.
So, for instance, an American bank with a London subsidiary can currently sell services right across the EU as if it were a European financial services company itself.
So losing the passport means they can no longer do this?
Well, they could no longer be able to operate these services out of the UK or the City of London.
To continue selling to clients within the EU as they do now they would have to establish subsidiaries within the EU and apply for a local licence.
So is this news a shock?
The reality is that banks gave up on hopes of the UK retaining the passport some time ago.
When it became clear that Theresa May was not going to try to keep the UK as an effective member of the single market after Brexit it was obvious that the passport would ultimately go.
What Mr Barnier’s words do is puncture the belief that something called “equivalence” will come to the rescue.
What is equivalence?
It is short for “regulatory equivalence”.
This is the idea that if the UK financial regulator adopts the same regulatory standards as the pan-European financial regulator the European regulator will continue to allow UK-based financial firms to operate as they do now in Europe.
Mr Barnier’s words suggest this isn’t going to be acceptable to Europe.
How much will this cost the financial sector?
The EU is a huge market of 500 million people and some 22 million firms, so it’s clearly problematic if UK-based financial firms find it more difficult to offer them services.
The Financial Conduct Authority regulator says that around 5,500 financial firms in the UK currently have EU passporting rights and the British Bankers Association says UK financial firms exported over £20bn of services in 2014.
The Financial Times has reported that some in the City estimate that as much as 20 per cent of UK-based firms’ investment and capital markets revenue (around £9bn) could be disrupted if the UK loses the EU passport.
How much will this cost the UK?
A recent survey for Reuters suggested around 10,000 finance jobs could be shifted out of Britain over the next few years if the UK loses the passport. Given jobs in financial services tend to be higher paid than the average, this would have a cost in foregone income tax revenue.
A separate report for TheCityUK lobby group, compiled by the consultancy Oliver Wyman last year, was more alarming.
Assuming the loss of the passport and zero regulatory equivalence after Brexit, it estimated that UK finance firms could shed 35,000 finance jobs.
It also warned the UK exchequer could lose £5bn of tax revenues a year. Such a hole would need to be plugged either by higher taxes or lower spending or more borrowing.
The truth is that it is very hard to estimate the cost with any precision because it depends on the behavioural response of a diverse range of financial firms and also how the long-term growth rate of the overall sector is impacted.
Yet there is no doubting the importance of the overall financial services sector for the UK economy.
It accounts for around 7 per cent of total UK economic output and supports around 1 million jobs. Finance is also a critical UK exporter and a major recipient of foreign direct investment.
Anything that damages this sector (and losing the EU financial services passport will unquestionably damage it) can be reasonably expected to have serious negative effects on the overall UK economy.