Written evidence – Personal Investment Management & Financial Advice Association (PIMFA) (DND0045)

About PIMFA

1. The Personal Investment Management & Financial Advice Association (“PIMFA”) was created on 1 June 2017 by the merger between the Wealth Management Association (“WMA”) and the Association of Personal Financial Advisers (“APFA”). PIMFA’s members (numbering over 2,200 firms) cover a broad spectrum of business offering wealth management, investment and personal financial advice, and execution services, and PIMFA is the main UK organisation representing this sector. The membership serves the savings and investments and financial advice needs of approximately 6 million retail clients who are almost all private investors and voters.  While mostly focussed on clientele in the United Kingdom, a number of our members also have businesses in the European Union or provide cross-border services into the European Union, and are therefore directly impacted by Brexit.  A significant proportion of PIMFA member clients living in non-UK EU countries are British expatriates.

Introduction

2. The European Council recently agreed to start internal preparatory discussions about the framework for the future UK/EU relationship and on a transitional arrangement to help get there. In remarks at the October European Council meeting, Donald Tusk said that “And as we are all working actively on a deal, I hope we will be able to move to the second phase of our talks in December[1]”. The goal of achieving a Brexit deal is still on the table and the government needs to decide what it wants this to look like, so we know what we are aiming for, and how to manage the stumbling blocks that will arise en route to this objective.  At the time of writing we do not know what that objective is and therefore what the best UK negotiating stance should be.

3. For PIMFA the key elements on which to base any deal should be:

1. a one-step Brexit, meaning only one change for firms to accommodate a new business environment caused by Brexit; financial services businesses have gone through major expensive, complex and difficult changes in recent months occasioned by the new requirements of the Markets in Financial Instruments Directive and Regulation (MiFID II/MiFIR), the Packaged Retail Insurance-based and Investment Products Regulation (PRIIPs), and the Benchmarks Regulation, all of which come into effect on 3 January 2018; imposing further substantial changes a year after that, and then more some two or three years later, both because of Brexit, will result in significant business disruption and costs that will adversely affect retail financial consumers and potentially the value of their assets; there must be only one further adaptation beyond that demanded by new legislation in January 2018;
2. a minimum 2 years transition or ‘implementation’ period, but preferably 3-5 years, to allow enough time for firms to prepare and for the government to achieve a comprehensive future partnership with the EU; there should be minimal disruption inter alia to supply chains, regulatory frameworks, market access, and client relationships during this period, while with the UK outside the EU it should permit the undertaking of needed independent actions, such as negotiating free trade agreements with other countries and indeed the EU itself; but arrangements must be kept as close as possible to the status quo, including with regard to the single market and customs union, in order to  avoid business dislocation with its adverse consequences for employment, growth, and tax revenue;
3. a robust and ambitious future UK/EU agreement at the end of the transition phase which allows the maintenance of continued ease of access by business to the EU market and to the widest possible pool of skilled labour; there are different ways in which such an agreement can be conceived: it may be in the form of a mutual recognition arrangement which allows for cross-border services and goods supply on the basis of different regulatory and quality control approaches but to the same standard; or it may be more along the free trade agreement lines for specific categories of supply; but it will be granular in content and need to permit access to the single market and skills, and be capable of accommodating at least some divergence of rules.
4. clarity of intention: business will require clarity of intention on the part of the government very soon if it is not to migrate away from UK in numbers sufficient to make a major impact on employment, tax receipts, and the UK’s place in the world; the main component of this clarity is with regard to the transitional period: it is vital that certainty that this will happen with as much of the status quo intact as possible, as outlined above, is provided by the end 2017 in order to allow firms not to operate against the worst case scenario of no deal; they will do this if they do not see that their EU business will be protected under a transitional arrangement while the future EU/UK agreement is being negotiated; and doing so will entail migrating the operation of their EU business out of the UK to minimise disruption to it.   

What would be the implications, good and bad, of ‘no deal’?

4. The effect of the transition period/future arrangement approach outlined above will be to allow industry to continue its EU business uninterrupted while a final agreement is being negotiated, to know what that agreement will look like, and to have time to prepare for when it comes into force. The certainty that approach will provide will be good for business and individuals alike since it will preserve employment, income, and growth while a final post-Brexit EU/UK agreement is awaited.  It will also provide certainty of tax revenues to the government when the burden of payments previously made by EU institutions will increasingly fall to HMG.  It would reduce costs and help maintain the value of sterling and of the assets of private investors such as those with a personal pension plan pending a final agreement, and ensure that firms had only one change to make following the 2018 changes they have already had to undergo.  Finally, if they know what kind of EU/UK agreement they are planning for, the change can be made smoothly and with minimal if any business and jobs disruption. 

5. None of this will however be possible in a no deal situation.  Instead there would be dislocation of supply flows and restrictions on access to clients in EU member states and to EU exchanges for transacting deals in, for example, EU-listed equity.  The impact would be felt immediately in the management of discretionary accounts for private individuals, where some normal EU-oriented market operations could not be undertaken, and for private investors managing their own accounts if, for example, UK equity markets and sterling both fell as expected.  WTO rules would not mitigate the situation because they do not in general apply to financial services and in particular not to the retail investment and savings aspects of those.

6. We provide below further details related to some of the potential implications of no deal for retail financial services.

Passporting and equivalence: where the financial services sector serves retail investment clients, as is the case with PIMFA member firms, the ‘passport’ system, whereby a firm authorised in one EU member state can deal direct with retail clients in other member states without establishing an entity there, cannot apply to firms in third countries.

• No Deal Issues: No ‘equivalence’ test is permitted for retail, so when the UK leaves the EU the UK-based retail investment firms currently serving clients elsewhere in the EU will have to set up entities in other countries and be authorised there if they wish to carry on with the business.
• They cannot passport unless a specific arrangement permits it.
• This would add to existing costs and impediments regarding serving clients and could occur under both ‘deal’ and ‘no deal’ situations. 
• However, a deal could include arrangements which circumvent this situation, such as staying in the single market, or a negotiated mutual recognition settlement that allowed for direct retail client access UK/EU and vice versa. 
• A transitional arrangement that maintains the status quo, as outlined above, for a temporary period would also avoid the problem and have the added advantage of providing time for firms to work out the best solutions to suit a finally agreed deal, which they might then know more about.
• The worst case scenario is no transition, no deal and a departure from the EU at the end of March 2019. This would maximise all the business dislocations, cost and access problems, and other disadvantages outlined above.
• Above all, private clients in other EU member states will risk being left stranded as the firms dealing with their portfolios would find difficulties in connecting with them.

Access to funds: a significant percentage of retail investments is made into many tens of thousands of funds of different structures, composition, and types. A large proportion of these are listed funds in the form of investment companies (ICs) or exchange traded funds (ETFs), although unit trusts are also still extant.  Investment in the listed funds takes the form of buying the shares of the listed entity.  An important subsection of these funds, notably of the ETFs, is categorised as UCITS, which is the main EU-authorised fund grouping for retail investments.  Investment in a UCITS can also be made in the more traditional way off-exchange by buying units. Under current EU arrangements investment in UCITs and other EU-domiciled and managed funds is simple. Funds are domiciled in different jurisdictions depending on tax and other considerations.  The main domiciles for retail-accessible funds such as UCITS are Dublin and Luxembourg, although the listed funds centre in the EU is the UK, specifically the London Stock Exchange. Fund managers on the other hand may often not be in the same jurisdiction as the funds they manage, an arrangement called ‘delegation back’.  So many Luxembourg and Dublin funds are managed out of London, the biggest centre in the EU (and the second biggest in the world) for the fund management industry. 

• No Deal Issues: UK departure from the EU would make these arrangements more complicated and very probably more expensive to use.
• Under no deal the UK would be a third country.  Funds domiciled in such countries cannot be called UCITS, even if they have UCITS characteristics.
• This would adversely affect UCITS domiciled in the UK and possibly the listed UCITS market in London. 
• UCITS domiciled here would either have to be re-domiciled into another EU member state to retain the UCITS cachet and remain marketable to retail clients across the EU, or be called something else and not be marketable to retail investors in the EU outside the UK.
• This could reduce the market for such funds and increase the cost of accessing them by or for retail investors; it could also reduce the numbers of such funds, thus reducing consumer choice.
• UK firms managing mandates for clients outside the UK and wishing to invest in funds could find difficulty in doing do owing to the passporting problems outlined above and the absence of UCITS in the UK.
• ETFs listed in London as UCITs could not continue as such.  A no deal Brexit could adversely affect trade volumes in these products with knock-on effects on the profiles of retail clients, and also lead to a shift of such ETF listings out of London.
• If delegation back is not permitted to third countries outside the EU the London fund management community would be affected. 
• Firms managing EU funds such as UCITS or dealing with EU clients might have to move out of London to other centres across the EU to continue their European business.
• If so, PIMFA firms investing retail portfolios through these managers might need to look again at how they distribute this business. There could be additional costs or even some reduction in the availability of managers with whom to place instructions.
• Extra costs and reduced choice could ultimately adversely affect the investment situation and perhaps asset valuations of retail client portfolios.
• With transition and the right kind of UK/EU deal many if not all of these problems of disruption, readjustment, and costs could be avoided.
• The worst case scenario is once again a no transition, no deal Brexit in late March 2019; this would magnify the kinds of difficulties outlined above with potentially poor consequences for retail investors while firms struggled to adapt to sudden movements in funds and managers and consequent supply chain disruptions.

Cross-border brokerage: There is little direct cross-border share dealing in the retail sector.  However the portfolios managed by PIMFA member firms for private clients frequently comprise at least one European equity fund as well as bond funds that may contain corporate bonds listed on EU exchanges.  In a post-Brexit situation it will be important for access to trading on a simple and cost-effective basis from the UK into the EU stock markets for retail purposes to enable continued management of these retail assets. At present this can be undertaken under the passporting system cheaply, easily and directly, without the intermediation of a local member of the EU exchange. After Brexit the passport will not be available and access would have to be via a local exchange member, so the portfolios risk having extra costs imposed unless a deal is made.  This would need either to ensure ongoing direct access via the passport, as a transitional arrangement described above would allow, or easy access to brokers at reasonable cost on relevant EU exchanges, who could then undertake the necessary transactions for the client portfolio. Sound portfolio management for retail clients would be more difficult if access were restricted or costs substantially increased.

• No Deal Issues: without a deal on departure, and a reasonable transitional arrangement to allow for a deal to be negotiated, the sudden switch from easy access to EU exchanges under passporting arrangements to more complex access via local brokers, who would have to be found at prices to be agreed, would risk causing dislocation in transactions and related business flows.
• This could increase costs and jeopardise sound portfolio management, risking increasing costs to private investors and not optimising the value of their assets.

Channel Islands and the Isle of Man: the Channel Islands and Isle of Man are not members of the EU; as a result there is a tendency to assume little effect on the UK’s relations with them in the event of Brexit.  However, the Channel Islands and the Isle of Man play an important role in the management of private client portfolios in the wealth management sector, and to the extent that this role is predicated on the UK’s EU membership it will be important to ensure that Brexit does not damage it.  The islands provide a base for fund domicile and retail investment outside the UK, for example through the funds listed on the Channel Islands Stock Exchange, and firms also use their operations there to provide services back into the UK, sometimes direct to clients but also to businesses.

• No Deal Issues: We have no specific points to make about how a no-deal Brexit might adversely or otherwise affect the overall ‘islands situation’, but raise the concern because of the significance of the islands to the retail financial sector.  Their profile in the wholesale markets, where the main cross-border issues in relation to Brexit arise, is lower and the importance of preserving efficient and cost-effective links with the islands would not normally figure in that context.
• What must be avoided in any case is sudden change and business dislocation in UK/Islands retail investment business. That could adversely affect retail portfolios and would be undesirable. Policies that avoid this should be pursued.

Free Movement of People: PIMFA member firms are overwhelmingly in favour of maintaining access to the widest possible pool of skilled labour in order to ensure they can provide the best service to their retail client base. This includes recruiting staff from the UK, the rest of the EU and the rest of the world.  Restrictions on access, certainly sweeping and unconsidered restrictions on access, would risk in the longer term reducing the skill and knowledge base that firms depend on for the quality of their retail service offering. That could have an adverse knock-on effect on the global competitiveness of the UK wealth management sector at a time when the UK is seeking to reposition itself internationally.  As the world’s current second largest wealth management centre outside the USA, we believe that the UK should leverage its position in the industry to form more of a global hub. Brexit will make this an even more vital task. Restricting the skilled labour recruitment pool would be counter to this objective. 

• No Deal Issue: we are concerned that a no deal Brexit would bring with it a higher level of risk of a restrictive set of arrangements governing access to the widest possible pool of skilled labour. As explained above, this would be disadvantageous to the UK retail investment and advice industry and their clients.

Divergence, Equivalence, and Market Access: At present, the UK has not said it would like to differentiate itself from EU financial services law after Brexit. This makes sense as this reflects the practices adopted by international fora and implemented at EU regional level, which the UK has helped to shape[2]. The Prime Minister recently insisted on the importance of a trade deal with the EU based on ‘high regulatory standards’ and this is in line with our recommendation to continue applying EU law for a transitional period until a future deal is agreed. 

• No Deal Issues: Despite these assurances, a no-deal Brexit would almost certainly entail more, and more rapid, divergence of financial services legislation and regulation between the EU and the UK than in the case of a deal. 
• It is not known what sort of long-term arrangement the Government wants with the EU, but we assume that it would ideally not preclude market access arrangements from either side.
• In financial services and the services sector generally such access is dependent not on freedom from tariffs but equivalence of regulation. 
• Without a deal the higher probability of divergence between UK and EU financial services regulation and the absence of the possibility of equivalence would create highly restricted and limited mutual market access.
• This would have powerfully negative consequences for the UK’s largest industry and an impact on UK employment, growth, investment and tax revenues.
• As noted above, WTO terms do not in general target the services sector but are much more focused on trade in goods.  Falling back on them in the event of no deal would be of little assistance.
• Even though the majority of PIMFA members do not have clients in other EU member states, they would still require market access for the reasons cited above connected with funds, brokerage, and the quality of portfolio management.  
• More generally, the setting of the sector in the UK’s large financial services ecosystem, and the ease of access that has provided in support of the work of the PIMFA community, has given it a regional and global competitive advantage.
• PIMFA members do not want this ecosystem fragmented as a result of Brexit and, as noted above, we believe the UK should pursue the issue of global competitive advantage with added vigour outside the EU; damaging the base on which this effort should be built will damage the effort itself. 
• But with a reasonable long term deal, carefully negotiated in the last part of the Article 50 notification period and during the transitional status quo period afterwards, mutual market access could be retained to the benefit of the EU and the UK and the negative consequences of no deal described above could be avoided.
• Hence potential divergence caused by no deal would adversely affect the PIMFA sector through more disruption and higher costs.
• A deal would go some way, perhaps a long way depending on the nature of the deal, to mitigating this situation and retaining the best aspects that the two markets have to offer each other.

Is a transition arrangement a necessary component of any lasting agreement, and if so, why?

7. As PIMFA has stated in previous papers[3], negotiations under Article 50 are time limited and limited also by the UK’s continuing EU membership, so a transition agreement is necessary to maintain the status quo as far as possible (as argued above in this response) in order to secure business continuity while allowing detailed preparation for a future UK/EU partnership.

8. Most of the arguments in favour of a transitional arrangement have been set out above, but to summarise:

• agreeing one would be in the interest of continuing mutual market access and business stability and continuity, as well as client retail access in other EU member states;
• this would have beneficial effects on employment, growth, investment, and tax revenues for government;
• negotiation of the new relationship and business adjustment to it prior to it starting will take some 3-5 years, so the Prime Minister’s recent statements regarding two years should be taken as an absolute minimum with likely revision upwards;
• the nature of the future UK/EU relationship should be well defined and set out prior to the end of the transition period and a date set for its commencement, at which point the transition period will cease and the new relationship will start to operate;
• firms should have been given ample time to know what the new arrangements will be and to adjust to them;
• the value of a transition period is less as Brexit approaches: one of its purposes will be to give certainty to firms planning for the post-Brexit situation and if that is not early enough they will already have made their decisions regarding locating business operations;
• if a clear transition commitment is not made by early 2018, many firms will have removed EU business headquarters from the UK  by the time that it is, and that will defeat one of the purposes of transition.

9. Our main concern remains as described above: the disruption that a no deal scenario would cause and the dangers of major business dislocation, with consequent employment, growth, investment, and tax revenue losses, that the resultant cliff edge effect would entail for the financial services sector. In our industry, nearly a quarter of annual revenue comes from business related to the EU[4]. In fact, the Government, in its recent response to the House of Lords report on Brexit: Financial Services, mentioned that “The UK’s financial services industry plays a vital role in the UK, European and global economies (…) The government is clear that an agreement that preserves the greatest possible market access is in the best economic interests of both the UK and the EU[5]”.

10. A transition period would help to achieve this objective and avoid serious market loss and economic damage. As a result, PIMFA’s main priority is for a one-step Brexit in which firms have to apply future changes arising from withdrawal only once. This means retaining EU legislation and institutional linkages and responsibilities for the UK during transition but enforcing the new dispositions when the future deal commences. This scenario saves not only markets but also costs and business quality; this can only benefit retail financial services investors and savers whose asset values are far more likely to be protected this way than in a cliff edge situation with almost certain losses in sterling value and greater market volatility.

What will be the keys of a transition arrangement? How will the UK-EU relationship be conducted during the transition period?

11. The key elements in a transition arrangement will be to maintain the status quo as far as possible for all the reasons given above.  We would also want to see clear road maps for UK financial services and other EU market dependent industries. Such road maps might include a commitment to negotiate a longer-term generic agreement to cover those industries and make sure that the “greatest possible market access” is achieved. In PIMFA’s view this would have to cover the handling and possible control of potential regulatory divergence after a transitional period, as noted above, and also how to deal with disputes following the loss of jurisdiction in the UK of the European Court of Justice (CJEU). The IRSG’s proposal for a Forum for Regulatory Alignment may have some merit here.

12. The status quo would require not only the same EU regulation in both the EU 27 and the UK, but also, in order to avoid chaos and disruption, agreement on the handling of major issues such as freedom of movement for people as well as services, goods, and capital; and dispute resolution, which might well mean continuing the role of the CJEU during the transition period.  As Michel Barnier has said: “Should a time-limited prolongation of Union acquis be considered, this would require existing Union regulatory, budgetary, supervisory, judiciary and enforcement instruments and structures to apply.[6]” 

13. Below is a summary of key elements PIMFA would like to see as part of a bespoke future UK/EU agreement:

• Access to the widest possible pool of skilled labour: see above.
• Reciprocal access to markets: see above.
• Regulatory certainty for business: to enable market access including access to clients, funds and brokerage, and control or prevent divergence.
• Certainty for retail clients: a bad deal could endanger the values of portfolios, savings and investments of private investors and their families; the future trade deal and the rules applicable during the transition period must provide security against chaos and give confidence to the retail investing public that their interests and asset values, including the value of their pensions, are being catered for.
• Prevent fragmentation: to maintain market access the rules must remain aligned; the UK has played an active part in shaping much of EU financial services legislation and divergence will cause not only market disruption but additional costs for the consumer to pay. A focus on outcomes rather than inputs in equivalence judgments would help.

How long should the transition period last?

14. A minimum of 2 years following the end of the Article 50 notification period, but preferably 3-5 years to allow business adjustment and a single change, depending on how long it takes to negotiate the final bespoke deal; for arguments see above and PIMFA’s response to the recent House of Lords Inquiry into Financial Regulation and Supervision following Brexit. This will benefit all key parties by getting a one-step Brexit.

Further recommendations

15. The UK government’s reports reflecting the impact of Brexit for a deal and no deal scenario on 50 sectors of the economy should be made public. The government’s position could be better understood in such circumstances by the public at large, which is important on an issue of such major national interest and significance.