Blog Post

Losing “EU passport” would damage City of London

If the UK cannot secure a “Norway” deal and stay within the internal market, the UK will lose the passporting rights which make London attractive as a financial centre. The macroeconomic fall-out from Brexit has also damaged the performance of banks and insurers.

By: Date: June 28, 2016 Topic: Finance & Financial Regulation

1. Passporting

Part of London’s attractiveness as international financial centre is the access to the internal market of the wider European Economic Area (EEA). By using a UK licence as European passport, foreign financial firms can offer their financial services throughout the EEA. If the UK cannot secure a “Norway” deal and stay within the internal market, the UK will lose these passporting rights.

The internal market is underpinned by a network of Directives and Regulations, which permit access to other EEA member states if a firm has a licence in one member state (the ‘home’ member state). The most important directives for financial services are:

  • the Capital Requirements Directive (CRD IV, 2013/36/EU) for banking
  • the Markets in Financial Instruments Directive (MiFID, 2004/39/EC) for investment services
  • the Alternative Investment Fund Managers Directive (AIFMD, 2011/61/EU) for hedge funds and private equity
  • the Insurance and Reinsurance Directive (Solvency II, 2009/138/EC) for insurance

We illustrate the how the passport works legally with the Capital Requirements Directive (CRD IV), the legal framework for credit institutions (banks). The passport consist of several elements of the CRD IV:

  • Licence: Title III of CRD IV (Articles 8 to 21) specifies the requirements for access to activity of credit institutions. The main element is authorisation by the home supervisor, which provides the single licence.
  • Freedom of establishment: Title V (Articles 33-39) contains the provisions concerning the freedom of establishment and the freedom to provide services. It means that if a credit institution is authorised in one member state, it has the freedom to establish a branch in (or to provide services to) any other EEA member state without prior approval. The credit institution only needs to notify the host country supervisor.
  • Home supervision: Title VII sets out the principles of prudential supervision, which predominantly gives powers to the home supervisor with some very limited powers for the host supervisor in the area of liquidity supervision. As these powers of liquidity supervision are related to the operations in different currencies, the new European Banking Supervision framework has decided to give up these host country powers within the euro area, which uses the single currency (Schoenmaker and Veron, 2016).

This system of full access based on a single passport (provided by the home country supervisor) is constrained to the EEA. So, if the UK were to leave the EEA, UK licensed banks (either UK head-quartered or foreign-headquartered) would need to obtain an extra licence from the host supervisor in an EEA member state in order to offer financial services in that member state.

An extra licence would be necessary for all forms of cross-border services, ie through the establishment of a branch or subsidiary or through the direct offering of cross-border services. The UK would then become a third country, which needs to find a point of access for business in the EEA. Similarly, EEA financial institutions would need to apply for a licence to enter the UK. The other Directives apply a similar passporting system to the CRD IV.

2. Banking vs insurance

An interesting question is whether different financial sectors are equally affected by possible changes in passporting arrangements for the financial sector. We examine the two largest financial sectors, banking and insurance. It appears that banking relies far more on the passport than insurance. We measure this by differentiating cross-border business through branches (based on the passport) and subsidiaries (new licence).

Table 1 reports the relative share of branches and subsidiaries in cross-border business. The passport (branch) is not important for insurance. The aggregate number for all EU member states is 13 percent, and even less for the UK at 9 percent. These are minor amounts. The main vehicle is through subsidiaries, because insurers want to contain ‘insurance’ risk in separate legal entities. At the aggregate EU level, the relative share of branches is 36% for banking.

Finally, European banks typically use their passport to enter the London wholesale market; that is for 69 percent of the cases. Many international banks, including the major European ones, have branches operating in London, which is an international financial centre, but actually do little business with UK clients (Burrows and Low, 2015).

Summing up, insurance will be far less affected than banking if and when the UK leaves the EU. Next, the major European banks would need to apply for a UK licence, if they want to keep on doing business in London. Examples are Deutsche, BNP Paribas, Societe Generale, ING and UniCredit. The largest European bank in London is Deutsche Bank, which gets 19 percent of its total net revenues from its UK branch (Deutsche Bank, Annual Report 2015). In turn, the UK banks would need to apply for a licence in the EEA. Some major banks have already a subsidiary on the continent: HSBC in France and RBS in the Netherlands. Barclays is operating through branches, for example, in Italy and France (Schoenmaker and Véron, 2016). Lloyds Bank has almost no foreign business.

3. What do the stock markets tell us?

Next to changes in passporting arrangements, the macroeconomic fallout from Brexit also damages the performance of banks and insurers. Reduced economic growth will directly affect banks in the UK as well as the rest of Europe. Lower interest rates would affect the business model of banks. Insurance companies would also suffer from lower interest rates, as the discounted value of their liabilities increases. On the asset side, insurers have made losses due to the financial market turmoil.

Figures 1 to 5 illustrate stock market performance in the UK as well as 4 other major EU countries from 22 June (the day before the referendum) till 28 June (3 working days after the referendum). Banks and insurers have experienced a far larger price decline than non-financial companies. While UK insurers are more affected that UK banks, it is the opposite for their European counterparts. In line with the larger changes in passporting arrangements, the banks are more affected than insurers in the 4 EU countries.

The authors would like to thank Bennet Berger and Alvaro Leandro for excellent research assistance.

 


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read about event More on this topic

Upcoming Event

Oct
29
08:30

Bank resolution: its impact in the EU

Closed-door workshop on various aspects of bank resolution.

Speakers: Jon Cunliffe, Martin J. Gruenberg and Elke König Topic: Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article Download PDF More on this topic More by this author

External Publication

An Effective Regime for Non-viable Banks: US Experience and Considerations for EU Reform

The US regime for non-viable banks has maintained a high degree of stability and public confidence by protecting deposits, while working to minimise the public cost of that protection. EU reformers can draw valuable insights from the US experience. A review of the US regime supports arguments in favour of harmonisation and centralisation of bank insolvency proceedings and deposit insurance in Europe’s banking union.

By: Nicolas Véron Topic: Finance & Financial Regulation Date: July 22, 2019
Read article More on this topic More by this author

Blog Post

Croatia’s path into the banking union

Croatia seems a suitable candidate for euro area accession: there is a tight peg to the euro, high public debt is coming down, and the banking sector is already dominated by euro area banks. But the Eurogroup has rightly targeted reforms of the state’s role in the economy as a precondition for participation in ERM II and the banking union. None of the announced reform plans are new or easily concluded within the timeframe that has now been agreed.

By: Alexander Lehmann Topic: European Macroeconomics & Governance Date: July 18, 2019
Read article More on this topic More by this author

Opinion

Brexit banking exodus creates a dilemma for Dublin

Irish consumers’ interests may not coincide with the needs of banks relocating here.

By: Rebecca Christie Topic: Finance & Financial Regulation Date: July 10, 2019
Read article More on this topic

Blog Post

‘Lo spread’: The collateral damage of Italy’s confrontation with the EU

The authors assess whether the European Commission's actions towards Italy since September 2018 have had a visible impact on the spread between Italian sovereign-bond yields and those of Germany, and particularly whether the Commission’s warnings have acted as a ‘signalling device’ for bond-market participants that it might be difficult for Italy to obtain the support of the ESM or the ECB’s OMT programme if needed.

By: Grégory Claeys and Jan Mazza Topic: European Macroeconomics & Governance Date: July 8, 2019
Read article More on this topic More by this author

Podcast

Podcast

Director's Cut: Priorities for the new ECB president

In this Director's Cut of 'The Sound of Economics', Guntram Wolff talks to two of the authors of Bruegel's memo to the new ECB president, Maria Demertzis and Grégory Claeys, to specify the most important issues at the beginning of this eight-year cycle and to clarify the parameters within which the new incumbent will have to work.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: July 4, 2019
Read article Download PDF More on this topic

Policy Brief

Preparing for uncertainty

Memo to the president of the European Central Bank. Grégory Claeys, Maria Demertzis and Francesco Papadia present the challenges that the next ECB president will face during the upcoming mandate, reinventing monetary policy in a system riddled with uncertainties.

By: Grégory Claeys, Maria Demertzis and Francesco Papadia Topic: European Macroeconomics & Governance Date: July 3, 2019
Read article More on this topic More by this author

Blog Post

The breakdown of the covered interest rate parity condition

A textbook condition of international finance breaks down. Economic research identifies the interplay between divergent monetary policies and new financial regulation as the source of the puzzle, and generates concerns about unintended consequences for financing conditions and financial stability.

By: Konstantinos Efstathiou Topic: Finance & Financial Regulation Date: July 1, 2019
Read article More on this topic More by this author

Blog Post

Where Brexit goes, the law shall follow

How the financial industry and the law firms that support it are preparing for what comes next

By: Rebecca Christie Topic: European Macroeconomics & Governance Date: June 25, 2019
Read about event More on this topic

Past Event

Past Event

Sound at last? Assessing a decade of financial regulation

What has changed since the financial crisis of 2008 that makes the financial system sound at last? Is regulatory reform going in the right direction? Has it run its course? 

Speakers: Patrick Bolton, Rebecca Christie, Maria Demertzis, Mathias Dewatripont and Xavier Vives Topic: Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: June 20, 2019
Read article More on this topic More by this author

Blog Post

The next ECB president

On May 28th, EU heads of state and government will start the nomination process for the next ECB president. Leaving names of possible candidates aside, this review tries to isolate the arguments about what qualifications the new president should have and what challenges he or she is likely to face.

By: Konstantinos Efstathiou Topic: European Macroeconomics & Governance Date: May 27, 2019
Read article More on this topic More by this author

Podcast

Podcast

Backstage: The EU financial services landscape after Brexit

Bruegel fellows Rebecca Christie and Nicolas Véron discuss how the map of the EU's financial services industry has begun to change, and how it might eventually settle.

By: The Sound of Economics Topic: Finance & Financial Regulation Date: April 30, 2019
Load more posts