What Brexit means for financial services


Authored by RSM US LLP

The much-debated Brexit deal was finally signed on Dec. 31, bringing some degree of resolution to the issue but leaving many questions for the financial services industry. The Trade and Cooperation Agreement (TCA) between the U.K. and the European Union does not include any material specifically on financial services other than the limited material on services in general. Instead, there is a broad commitment to cooperate and the promise of a further statement in March.

Although the failure to agree on the continuation of passporting rights in the EU was expected, the failure to agree on equivalence determinations was not expected—although that is unlikely to have major short-term implications. Until a memorandum of understanding is reached, financial services firms face uncertainty on this issue.

Passporting and equivalence: the background

For several decades, U.K. financial services firms operated in the EU under passporting arrangements in which contracts issued in the U.K. were 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 its price for continuing these arrangements would be dynamic regulatory alignment. In other words, rights for the EU will drag along U.K. regulation as it so decided. The previous British government, under Theresa May, had already decided that in light of London’s scale as a financial services market, this approach would not be sensible.

British financial services firms were required to create structures to replicate the distribution advantages of passporting—and our experience is that, following the outcome of the Brexit referendum, these firms have been undertaking such restructuring to achieve this.

Such restructuring usually involved establishing or repurposing a business onshore in the EU, which itself then often formed a branch back in U.K. to enable two-way traffic. Local EU regulators required that the onshore businesses have substance (i.e., 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 single EU center has emerged.

Equivalence is a system used to grant domestic market access to foreign firms. It occurs when either the EU or the U.K. 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 II, reinsurance may be counted for solvency purposes if issued in an equivalent jurisdiction, such as Japan or Bermuda. CRD IV 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; assessments are launched at the EU’s discretion. Equivalence 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 U.K. not agree on equivalence?

At the time of the withdrawal treaty, which came into effect on Jan. 31, 2020, the connected memorandum of understanding foresaw that the EU would reach equivalence determinations on the U.K. by June 30, 2020. Unfortunately, this did not occur; EU negotiators cited the need to understand more about U.K. regulation before concluding equivalence.

The implications for clients

Now that the TCA has been reached, EU passporting for U.K. financial services is dead, and its revival is highly unlikely. 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 limited in time or scope.

Therefore, clients should assume that the contingency measures they and the U.K. and EU financial services firms deal with will have 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, or not fit for purpose, or in a suboptimal EU jurisdiction for the purpose, or vulnerable to regulatory change of stance, or simply too expensive.

Derivatives trading

The U.K.’s Financial Conduct Authority (FCA) was forced to use a temporary transitional power (TTP) to make necessary changes while not disrupting the $200 billion daily 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 for proprietary trades and will be subject to review 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 U.K. 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. Thus, in order to prevent costly errors, it is imperative for providers to ensure they are applying the correct VAT treatment to supplies. Moreover, 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, financial services providers with 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, starting Jan. 1, 2021, VAT incurred on the costs of supplying most financial services to recipients outside the U.K. will be recoverable, regardless of where the recipient is located.

Tax matters

Leaving the EU means that certain EU law is no longer applicable to British companies. Specifically, withholding taxes on dividend and interest payments from the EU to the U.K. 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 U.K. (and vice versa).

Small firms often want as little overseas presence as they can agree on with the regulator. This can raise questions on substance and where central management and control is exercised, and whether there is a risk that HMRC might argue that the overseas entity is a U.K. tax resident.

In regard to employees, again while not specific to financial services, when advising clients we have discussed how to staff the new entity (e.g., seconding existing staff members, using dual contracts and discussing the implications of U.K. staff creating a taxable presence in an overseas jurisdiction).

With a network of financial services experts across Europe, RSM is an ideal choice for assisting with these changes.