The Brexit referendum vote is over and counter to almost all forecasts the UK has indeed voted to leave the EU. The simple Leave or Remain question took place on the 23rd June with the result announced on the 24th. UK citizens were asked this question: “Should the United Kingdom remain a member of the European Union or leave the European Union”. Stakeholders the world over are now starting to digest the implications of Brexit. This article briefly describes the impact and consequences of a Brexit vote on the European payments landscape. In particular, we consider the implications for payment companies – EU and non EU –  that currently passport a UK license across EU.

Brexit and the payments industry

Just to set the scene – as part of the EU, the UK is often viewed as an entry point to the EU’s single market in financial services. London in particular has become an attractive location for EU and non-EU companies alike to headquarter and access the EU market from. Financial services companies, including payment companies, like the combination of the UKs business friendly environment and the ability to take advantage of the EUs passporting system.

This system, enshrined in EU directives, allows payment companies authorised in one member state to carry on business in other member states without the need for multiple separate authorizations. Moreover, they can do this without the need for any local subsidiary or physical presence. So they typically obtain a UK licence and then passport this licence across the EU and beyond to all 35 SEPA markets (28 EU member states plus 7 non EU states: Iceland, Liechtenstein, Norway, Monaco, San Marino, Switzerland and Andorra). The passporting system supports other financial services regulation and guidance and is central to EU efforts to create a common European rule book that provides for a single European market in financial services. In the case of payments, passporting is a critical building block of EU legislation such as PSD1/2 and IFR.

Non-EU countries can participate in the passporting system so long as their regulatory regime is assessed as equivalent to that of the EU. Regulatory equivalence (RE) is an important concept to note for Brexit. It is under RE that the 7 non EU states have joined SEPA (Iceland, Liechtenstein, Norway which have signed the EEA agreement and Monaco, San Marino, Switzerland and Andorra which have special agreements in place with the EU).

The first point to remember then, is that an exit from the EU does not necessarily mean that companies will no longer be able to passport their UK licences across the EU. The UK could still be party to the passporting system via a specific agreement part of which will be maintaining regulatory equivalence.

Crystal ball time

So what are the Brexit scenarios and what type of agreement is likely and will the passporting status quo be maintained? Here is a breakdown of the most plausible exit agreements.

Scenario 1: EEA-EFTA Model

The first viable option would be for the UK to pursue what is known as the Norway model.  UK would essentially rejoin the EEA (European Economic Area) as a fresh new member of EFTA (European Free Trade Area). As it stands under this scenario the passporting status quo is maintained. However, there is a gulf between the EFTA and the EU in terms of financial services regulation and this likely to widen over time. This could impact passporting out of the UK in long run. As it stands the EEA-EFTA model also requires full adoption of EU regulations and standards including free movement of labour. Given immigration is the key Brexit driver, this scenario is unlikely.

Scenario 2: Customs Union

An alternative to EFTA would be a customs union which for example Turkey has signed with the EU. Customs union are step beyond Free Trade agreements, in that countries also have a common foreign trade policy ie: one set of policies for trading with countries outside the union. This is an unlikely scenario given freedom to trade internationally is a key Brexit driver. Moreover, from a financial services point of view this scenario is not desirable as customs union typically do not extend to trade in services – financial or otherwise. Under this scenario then, passporting status quo is not maintained and payment companies will need to restructure their operations.

Scenario 3: Bilateral Agreements

The bilateral accords scenario has for while been a strong contender. In this scenario the UK would negotiate multiple individual agreements by sector and country. Switzerland has followed this route and has signed over 120 bilateral agreements with the EU. None of these agreements however cover passporting out of Switzerland (as a result Swiss financial institutions often tend to choose the UK to passport out of – an option that would for example be closed off to them in the event of Brexit without a supportive exit agreement). Under this scenario then, passporting status quo maybe maintained depending on whether it is successfully included in any agreement. The bilateral accord scenario is anyway becoming less likely. The Swiss agreement is incredibly complex to manage and requires constant renegotiation. Both sides are actively seeking to find an alternative model.

Scenario 4: Bespoke FTA (Free Trade Agreement)

So we come to the two most likely scenarios. The first is a bespoke Free Trade Agreement option between the UK and the EU. All thing considered, this type of agreement probably offers both sides the best chance for a mutually desirable outcome. The benefits of this approach is that it could lead to a single comprehensive deal rather than piecemeal agreements. This is however a big undertaking with negotiations starting on a blank page. Precedents do exist. Mexico has a free trade agreement in place with the EU for both goods and services. The UK version would most likely aim to include passporting. Under this scenario then, passporting status quo is maintained. However, the likely duration of a bespoke FTA negotiation is extremely difficult to forecast. It’s certainly years rather than months. There is also no guarantee that both sides will reach a mutually agreeable outcome and negotiations could easily end up in a stale mate or break down completely.

The timing of a notification to withdraw from the EU by the UK will be crucial. Article 50 of the Treaty on European Union signed in 2007 – which was an updated version of the original Maastricht Treaty signed in 1992 – provides for the withdrawal process. There is some wriggle room but in essence once notification is made, there will be a 2-year timeframe to agree on an exit plan ie: an agreement that takes into account the UKs future relationship with the EU. As notification will probably be a precursor to starting exit negotiations, the clock could start ticking fairly soon – so we might expect a deadline in the second half of 2018. Both sides can agree to extend the negotiating window, but the EU will require unanimity of all members to so. In the event of no FTA agreement after two years, an automatic exit (supported by basic and limited agreement) is likely.

Scenario 5: Fall Back On Existing WTO Agreement  

This brings us on to the final scenario. This is the fall back to existing WTO (World Trade Organisation) rules governing trade. Under this scenario, the UK will not be party to any agreement with the EU. This scenario is most likely to occur if other negotiations fail. Under this scenario then, passporting status quo is definitely not maintained and payment companies will need to restructure their operations.

What to do?

In summary then, in terms of likely exit negotiations there is what the Governor of the bank of England describes as the ‘the mutual recognition/third country continuum’. That is to say possibilities ranging from full mutual recognition at one end, to the possibility of the UK having third country status, at the other end of the spectrum. The former maintains the current passporting status quo whereas the latter will not. As this article has attempted to point out, now that the UK has voted to leave, the likely target will probably be to negotiate a full bespoke FTA. If this is achieved, then the current status quo regarding passporting is maintained. There will likely be a lot of ups and downs in any negotiations. Protracted negotiations will lead to a period of significant confusion in the payments and wider financial services industry and disruption to business as usual. Its possible that the EU might find itself stuck between striving for a quick resolution on one hand, whilst seeking to punish – or least not offer favourable terms to the UK, on the other. The situation could end up in limbo for a while. Along the way the passporting status quo will be maintained. At some point however, both sides may give up and choose to fall back on the WTO option. This is the worst case scenario for payment companies, requiring them to restructure their operations to accommodate for the fact that they will no longer be able to passport their UK licence across the EU. Instead payments companies will probably need to obtain a new authorisation from a regulator in another EU state and passport from there around the EU. Most will then have a UK licence and report to the UK regulator and in addition have a new licence and report to a new regulator elsewhere in the EU. The regulatory burden on payment companies will undoubtedly rise as will the underlying cost of doing business.

The situation is unprecedented. No member state has withdrawn from the EU so this is new territory for everyone. There will no doubt be a very uncertain period extending out until the Autumn at the earliest until the fog starts to lift slightly. Prudent companies are best off preparing contingency plans for the worst case scenario. Companies will need to consider the need to restructure their operations and decide if a transfer elsewhere in the EU is required. Now that the UK has voted to leave, given licence applications can take the best part of a year (and more) to complete, companies probably need to start developing such contingency plans pretty soon.

Martin Koderisch is Manager in the London office of Edgar, Dunn & Company