Falling on World Trade Organisation rules in case of no deal Brexit may not be a viable option; Maximilian Turunen clarifies the WTO’s Most Favoured Nation obligation and its impacts on financial services.

The looming Brexit deadline is causing uncertainty for all industries, particularly the financial services sector. Following the International Trade Secretary’s 60-40 odds for leaving the EU without a deal, banks’ Brexit preparations have just got even harder.

Time is running out for financial services

Banks and other financial services firms have been planning for multiple scenarios since the referendum result. A no-deal scenario has formed part of this planning activity although alternative possible outcomes have been considered. The alternatives include appropriate transition periods, free trade agreements along with more nuanced, piecemeal scenarios that anticipate industry-specific arrangements.

The negotiating stance of the UK government remains focused on the movement of goods as opposed to services. Partly this is driven by fear of having to establish a hard border between the Republic of Ireland and Northern Ireland or alternatively between Northern Ireland and the rest of the UK. The decision not to bring in services too early was a considered, delicate choreography to avoid involving the City of London. Both parties acknowledge the importance of the financial services sector to the UK. But do European negotiators also appreciate the benefits of having continued access to the services the City provides the continent?

Soon time will run out. The war of words between the European Banking Authority and the Chancellor of the Exchequer about Brexit preparations is not getting us any closer to an agreement. The UK exiting the European Union without a negotiated settlement would leave the two parties operating under the World Trade Organisation (WTO) rules governing members’ trade arrangements with each other, an option favoured by some hard Brexiteers.

Crashing out and the most favoured nation obligation

For financial services firms, one of the more important WTO agreements is the General Agreement on Trade in Services (GATS) which governs the service sectors. GATS assumes no right of market access and that individual countries set their own plans on market liberalisation.

An important commitment that underpins the free trade in services is the Most Favoured Nation (MFN) treatment obligation. MFN insists that, in the absence of an exemption (such as a free trade agreement), no nation can discriminate between like services supplied by different WTO member countries. Where a country has liberalised their economy in a given sector, this principle exists to enable a level playing field for service providers globally.

By leaving the EU, the UK becomes a third country and loses its passporting rights. Without a negotiated settlement, the UK will be able to provide a very limited number of cross-border services. The EU is a restricted trade area which would admit the UK’s financial service offering along with the rest of the WTO members without any preferential treatment as per the MFN provisions.

Banks and other financial institutions would be unable to fully service their European clients without having fully capitalised subsidiaries in an EU country, a very costly exercise. In the same vein, Financial Market Infrastructure (FMI) providers would be limited in the services they offer clients within the single market.

Any suggestion of opening up the trade in services with the UK would force the EU to open up trade to other WTO members. Similarly, the UK will be unable to grant special access to the EU without giving similar access to all other WTO members. This complexity alone should deter the most trenchant Brexiteers from an over-reliance on the WTO rules.

The equivalence option – walking a political tightrope

Financial services firms have been robustly implementing MiFID II, PSD2 and other various directives and regulations to align business models and compliance with European standards. Although the UK will be de facto equivalent on the point of exit, the granting of formal equivalence is a political process involving the European Commission. This means that the mere fact that the UK supervisory and regulatory approach is aligned to the EU may not be sufficient for a successful equivalence application. The equivalence decision can also be repealed with relatively short lead-in times.

Going down the equivalence route could also mean that the UK becomes a rule taker, accepting directives and regulations passed by the European Commission without having a say in their application. This may open the door to expensive European requirements which UK firms would have to implement contradicting the aims of the local regulatory and supervisory agenda.

Thorough operational analysis is required

Firms are still discovering operational areas where a no-deal Brexit would cause untold disruption. One area where the limited market access will manifest is with firms’ clearing arrangements. For example, Brent oil futures within the European markets are currently typically cleared through London. LCH, ICE Clear Europe and LME Clear process more than $450tn in interest rate, credit, forex and metals-related swaps from all corners of the world. More to the point, many of these instruments are not admitted to continental clearing houses and therefore pose a real threat to the markets and financial institutions in the case of a no-deal Brexit.

Some European firms are quickly coming to a realisation that closing out these positions would be very costly. Furthermore, the inability to continue clearing through London might hinder their ability to hedge efficiently, exposing the trading businesses to unacceptable risk. Steven Maijjoor, ESMA Chairman, has advocated for EU access to UK clearing houses.

As with all other Brexit planning, a thorough ongoing analysis of the existing positions is required. A fundamental review of positions which would fall foul of the third country regime must be completed by all firms who trade in centrally cleared derivatives. Optionality between closing out positions and finding other alternatives to the UK clearing houses must be investigated and costing must inform the strategic solutions.

Way forward

In summary, having to operate under the WTO rules after a no deal Brexit would pose challenges which currently appear insurmountable. The technical obstacles for using existing market infrastructure alone would, in the absence of further guidance and continuity planning from the negotiating parties, bring the operations of the markets to a halt, or at the very least cause severe disruption and have serious cost implications to institutions and their clients.

A proactive review of the worst hit areas of the trading books and a clear organisational plan for the no deal scenario are essential for firms’ ability to continue conducting business in an adverse negotiating outcome.  For EU firms, this means seeking out alternatives and engaging with continental market infrastructure providers.

It’s also vitally important the negotiating teams on both sides receive coordinated messages from the industry. Be this via the supervisors, industry associations or through bilateral representations to the government, the message must be clear: no-deal Brexit poses a real threat to the overall continuity of the markets.


Maximilian is a Principal with over ten years’ experience working in regulatory change concentrating on the financial services sector.



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