Brexit – what next for the UK financial services & insurance sectors?
In June, the UK voted to leave the European Union. Businesses must now prepare to mitigate any risks and take advantage of opportunities this huge step change will undoubtedly bring. Below, we seek to highlight key areas and challenges firms should consider.
Somewhat predictably, the initial effects of the result have already been felt by the FTSE, the currency markets and the wider UK economy, however little else can be said with any confidence of how the longer lasting impacts will affect the industry. However, it must not be overlooked that the UK financial services & insurance sector is no stranger to change, disruption and seemingly insurmountable obstacles. Not only has the sector survived a global financial meltdown and a commodity prices nosedive in recent years, the industry has also always demonstrated a unique ability to overcome challenges and thrive despite them.
Key areas insurance businesses must monitor the development of include:
Until the full two year exit term is compete, EU directives will remain applicable to UK regulated businesses. Furthermore, the regulator released a statement to explicitly say that firms must continue to abide by their obligations under UK law, including those derived from EU law, and continue with implementation plans for legislation that is still to come into effect (including MiFID II). The reality is that a wholesale rollback of regulatory pressures originating from the EU is still unlikely. Major European-level initiatives such as Solvency II have already been incorporated into UK law; they are an integral part of the system in this country. However, the longer term impacts of the decision to leave the EU on the overall regulatory framework for the UK will depend, in part, on the relationship that the UK seeks with the EU in the future.
Inextricably linked to the issue of continued compliance with EU regulation is that of passporting. Were the UK to leave the EU, we would lose the automatic right to passport business from the UK into the EU and vice versa unless a special arrangement can be negotiated. The insurance industry is likely to want to retain access to EU market with a new trade deal in order to preserve lucrative ties and be able to sell cross-border, UK-based insurers are likely to find they still have to comply with EU regulation. However, this could mean that all British based businesses would need to do to circumvent the loss of UK passporting rights is set up a brass plate subsidiary in a member state to process business essentially still done in the UK. However, the added complication, costs and complexity of this method could cause businesses to leave the UK all together in favour of Frankfurt or Paris.
Firms must conduct an impact analysis of how Brexit will affect them and whether their structures are fit for purpose. It is imperative firms to ensure their business models and legal entity structures not only adapt to take advantage of the changing regulatory and tax developments but also considering whether to remain in in the UK.
As long as the UK remains a member state of the EU, current tax rules will apply. However, firms need to be aware of certain tax rules that may well change in the longer term, for example, two key areas include:
1) EU tax rules relating to state aid – subsidies given to parts of the industry by the UK government are currently prohibited without the permission of the Commission. The Commission takes the view that making a tax relief available to a particular industry is the equivalent of subsidising it from public funds. Yet post-exit, the UK will be able to give whatever tax reliefs it wishes. Thus, an exit from the union gives the UK carte blanche to issue tax relief to the financial services sector to encourage investment. Some of the reliefs currently under these rules are those for the Enterprise Investment Scheme, Venture Capital Trusts and research and development expenditure.
2) Free movement of capital and establishment – these freedoms are enshrined in the EU treaty and the European Court of Justice has been active in enforcing changes to members states’ tax rules based upon them. In broad terms the requirement is that the law of a member state should not treat its own nationals or enterprises more favourably than those of other member states. Upon exit however, the UK will no longer have any obligation or inclination to favour enterprises of EU states over those established elsewhere in the world, or to grant UK tax reliefs that were never intended to apply in a cross-border context.
Initially there is likely to be very little if any change to current VAT rules for businesses. Currently, if the UK wishes to introduce a new VAT exemption, or change the rules as to the place where cross-border supplies of services are treated as made for VAT purposes, it cannot do so. Once the UK has left the EU it will be free to do as it pleases.
While the UK may be able to repeal current VAT rules, in practice there appears to be little realistic prospect of it happening as it is a major source of revenue for the Treasury, particularly from the financial sector. In addition, VAT is by no means solely an EU tax; an increasing number of countries in all parts of the world have introduced VAT (or a broadly equivalent goods and services tax) in recent years. More significant is the freedom that leaving the EU will give the Government to introduce different VAT rates for different purposes (including rates above or below the current EU maximum and minimum) and to exempt or zero-rate further items.
We are entering a new era for the UK financial services & insurance sector; whether that era will be a period of growth and prosperity or not remains to be seen. What is clear is that the next few years will be an unprecedented period of uncertainty within the industry.
On the whole, it is unlikely for regulatory or tax requirements to be lessened, increased or otherwise significantly modified in the short term. However, business must make sure they maintain a firm grip on how these requirements develop over the two years of exit negotiations and beyond, if Article 50 is to be triggered. Similarly, firms should consider conducting an impact analysis to ensure the operating model and legal entity structure is fit for purpose in this new era.