What Brexit means for financial services

The much-awaited and debated Brexit deal was finally signed on December 31, 2020, and has left many questions unanswered for financial services. The Trade and Co-operation Agreement (TCA) between the UK and the EU does not include any material specifically on financial services, other than the limited general material on services. Appended to the TCA, there is a Joint Declaration that merely commits the EU and UK to agree to co-operate on financial services regulation and make a further statement in March 2021.

Although the failure to agree on the continuation of passporting rights in the EU was fully expected, the failure to agree on equivalence determinations was unexpected, however it is not likely to have any major short-term implications. Until a memorandum of understanding is reached, financial service firms will have to deal with further uncertainty. 

Passporting and equivalence: the background

For decades, UK financial services firms operated in the EU under passporting arrangements whereby contracts issued in the UK are good for acceptance throughout the EU. Following the decision to leave the EU, and much earlier in the negotiating process in 2018 and 2019, the EU made clear that their price for continuing these arrangements would be dynamic regulatory alignment: rights for the EU to drag along UK regulation, as it so decided. The previous British government under Theresa May had already decided stating that it would not be sensible in light of London’s scale as a financial services market. 

Therefore, UK financial services firms were required to create structures to replicate the distribution advantages of passporting. Our experience is that following the outcome of the Brexit referendum, these firms have been undertaking restructuring to achieve these structures. Such restructuring usually involved establishing or re-purposing a business onshore in the EU, which often itself then formed a branch back in the UK operation to enable two-way traffic. Local EU regulators required that the onshore businesses have substance - they can’t just be brass plates - but even so, they have rarely been substantial. Even the largest firms have rarely relocated more than a few hundred jobs, and no one EU centre has emerged. 

Equivalence is a system used to grant domestic market access to foreign firms. It occurs when either the EU or the UK decides that the other jurisdiction is adequate for some limited purpose on a case-by-case basis. 

An example from the insurance market is that under Solvency IIa, reinsurance may be counted for solvency purposes if issued in an equivalent jurisdiction, such as Japan or Bermuda. CRD IVb has a similar facility in that EU banks can treat counterparties in an equivalent jurisdiction the same as EU counterparties for the purposes of capital management. 

Still, it’s important to note that the current EU equivalence regime is no direct substitute for passporting. Equivalence is not negotiated but requested and assessments are launched at the EU’s discretion. It can also be withdrawn, along with any rights that depend on it, at the EU’s discretion if a country is judged to have diverged from EU standards for any reason.

Why did the EU and UK not agree on equivalence?

At the time of the Withdrawal Treaty, which came into effect on January 31, 2020, the connected Memorandum of Understanding foresaw that the EU would reach equivalence determinations on the UK by June 30, 2020. Unfortunately, this did not occur, and EU negotiators cited the need to understand more about UK regulation before deciding on equivalence. 

The implications for clients

Now that the TCA has been reached, EU passporting for UK financial services is dead and is highly unlikely to be revived in the planning horizon. The EU has not granted equivalence as part of the TCA, and if our reading is correct, it may well not be, or it will be very limited in time or scope.  

Therefore, clients should assume that the contingency measures that they and the UK and EU financial services firms that they deal with have implemented will probably become semi-permanent.

In the medium term though, we can expect to see quite a bit of changes to these contingency plans as it becomes clear that some are:

  • unnecessarily elaborate;
  • not fit for purpose;
  • in a suboptimal EU jurisdiction for the purpose;
  • vulnerable to regulatory change of stance; or
  • too expensive.

Derivatives trading

The UK’s Financial Conduct Authority (FCA), was forced to use a temporary transitional power (TTP) to make necessary changes and not disrupt the $200 billion-a-day market in London for interest-rate swap trades, as reported by Bloomberg. The temporary rules allow for London based branches of European investment firms to trade in EU venues so long as they do so for EU clients. This relief is not extended to firms trading for non-EU clients or their own proprietary trades and are subject to be reviewed on March 31, 2021. While this calmed fears right before the TCA was signed, the longer-term implications are still unknown.


From a VAT perspective, there is a possibility that the creation of new overseas branches and subsidiaries will give rise to irrecoverable VAT charges – either in the UK branch/subsidiary, or in the overseas branch/subsidiary. This includes, but is not limited to, irrecoverable VAT which could arise on intra-entity management services. As a result, in order to prevent costly errors, it is important that providers ensure that they are applying the correct VAT treatment to supplies. In addition to this, if a significant irrecoverable VAT cost arises as a result of the creation of new branches/subsidiaries, it is worth considering whether certain transactions should be restructured.

On the upside, FS providers which provide services to EU clients should now be able to enjoy an improved VAT recovery position. Previously, some providers were unable to recover VAT on the costs associated with the provision of these services. However, from January 1, VAT incurred on the costs of supplying most financial services to recipients outside the UK will be recoverable, wherever in the world the recipient is located.

Tax matters

Leaving the EU means that certain EU law is no longer applicable to UK companies. Specifically withholding taxes on dividend and interest payments from the EU to the UK can now arise (depending on relevant double tax treaty) as the EU Parent Subsidiary and EU Interest and Royalty directives will no longer apply to payments made to the UK (and vice-versa).

Small firms often want as little overseas presence as they can agree with the regulator. This can raise questions over substance, where Central Management and Control is exercised and whether there is a risk that HMRC might argue that the overseas entity is UK tax resident.

When advising clients in relation to employees we have discussed how to staff the new entity, eg how to second existing staff members, the use of dual contracts and the implications of UK staff creating a taxable presence in an overseas jurisdiction, again this is not FS specific.

With a network of FS experts across Europe, RSM remains well placed to help with these changes.

a Solvency II is a Directive in European Union law that codifies and harmonizes the EU insurance regulation.

b The Capital Requirements Directive IV (CRD IV) is an EU legislative package that contains prudential rules for banks, building societies, and investment firms


Brexit - into 2021

There is no doubt that Brexit will have far-reaching impacts, with reverberations felt across every sector. Many in the business world will understandably be concerned.

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