UK 3-year ‘passporting’ plan for EU firms may break WTO rules, say analysts

Plans by the UK government to unilaterally allow non­UK financial firms in the rest of the European Economic Area (EEA) to “passport” into the UK for three years after Brexit to give them time to set up regulated entities in the UK has been viewed by analysts as preferential treatment and could be challenged by other World Trade Organisation (WTO) members.

The analysts cite Article II of the WTO’s General Agreement on Trade in Services (GATS), which states that any member of the WTO “shall accord immediately and unconditionally to services and service suppliers of any other member treatment no less favourable than that it accords to like services and service suppliers of any other country”.

The clause, oftentimes dubbed the “most favoured nation clause”, in fact forbids any country from giving special favour to any other, and that countries can only give preferential status to other states as part of a formal trade arrangement that is reciprocal, like the EU and EEA.

In this case, the UK in its no-Brexit deal stance would be granting special favours to EEA banks that it was not offering to banks in other countries. To this end, analysts say the plan to favour firms from the EEA could be illegal under the WTO rules

According to reports by Global Capital, the government’s Brexit papers seem to have glossed over this problem, but lawyers have commented on it and learned that the government is well aware of the issue.

The Treasury has argued that the plan can be allowed under an exemption in WTO rules for financial services, which allows countries to protect their markets. But specialists say this will be open to challenge.

The risk of the UK leaving the European Union without an agreement on terms is becoming nightmarish for financial markets, which are intensely regulated, since, the UK’s main role is as a service provider to EU­based clients, when it comes to wholesale capital markets.

Financial specialists have therefore been scrutinising the relevant parts of the batch of papers produced by the government on Thursday last week to give the private sector advice on how to act if the UK has to leave the union without a deal.

While this “temporary permissions regime” would not ensure that UK firms would enjoy passporting rights in the EEA, it would at least save UK customers from losing the services of other European firms. It might also induce the EU to reciprocate.

According to UK Treasury department, WTO rules permit use of a prudential exception in the area of financial services, which is contained in the GATS Annex on financial services.

The GATS Annex provides that WTO members may take measures for prudential reasons, including for the protection of investors, depositors, policyholders or persons to whom a fiduciary duty is owed by a financial service supplier, or to ensure the integrity and stability of the financial system.

The Treasury department added that the UK’s proposed temporary permissions regime (TPR) was one such measure. The Treasury argued it would minimise the disruption faced by EEA firms and UK businesses and consumers due to the loss of passporting rights arising from EU withdrawal.

“In practice it means that eligible EEA firms can continue their activities in the UK for a time­limited period after exit day, in order to allow them to obtain UK authorisation or transfer business to a UK entity as necessary,” the Treasury is quoted as saying, adding that “Given the use of this prudential exception, the most favoured nation rule does not oblige the UK to provide the same measure to financial institutions of other WTO members.”

Experts familiar with WTO rules believe there could be strong arguments to support this measure as a short-term bridge to avoid a Brexit day cliff­edge. But if the right lasted for three years, they say, other WTO member states could challenge this as preferential.

In article 2(a) of the financial services annex of GATS — where the prudential exemption relied on by the Treasury is set out — the rules say that although there is scope for a member state to use prudential measures to preserve financial stability, those measures “shall not be used as a means of avoiding a member state’s commitments or obligations under the agreement”.

Impartiality towards all third countries is a central tenet of the WTO and of GATS.

This is just one of many difficulties the UK’s capital markets are facing in contemplating a no­deal Brexit. The immediate hurdle for the UK to overcome is getting its WTO schedule approved. This means applying to become a full member of the WTO, independent of the EU.