We now have just two months left until the October European summit that was meant to agree a Brexit deal. We have seen a flurry of diplomacy by the prime minister and Jeremy Hunt as they seek to avert too firm an EU rejection of the Chequers plan.
Whilst much has been written about the impact of Brexit on volatility and markets we wanted to provide our clients, and in particular our EU resident clients, with an update on Brexit related matters and our views on issues raised by Brexit. We have also provided a Frequently Asked Question section for our EU resident clients as an Appendix to this note.
Will a deal be reached with the EU?
Dominic Raab, the UK’s Secretary of State for exiting the EU, said that while agreeing a “good deal” with the EU27 is “the most likely outcome” of Brexit talks, it is important that the UK is ready should no withdrawal agreement be reached. At the talks on 31 August, Mr Barnier said he was confident an agreement could be reached by the October deadline and promised a “partnership without precedent” with the UK after Brexit.
The sticking point continues to relate to what should happen to the Northern Ireland border if the UK and EU are unable to reach a trade deal that would see an open border maintained.
Contingency plans from the EU and from the UK government in the event of a no deal Brexit have now begun to be published, whilst the government’s presentation explaining its vision for a future UK-EU partnership on financial services post-Brexit continues to be explored.
HFMC Wealth view: We do still feel that, on balance, a deal is more likely than no-deal and our working assumption for our clients is that a deal will be reached. As The Economist noted this week, Mr Barnier has his own reasons for wanting success on this front. A failed negotiation that led to a no-deal Brexit would “badly damage Mr Barnier, who harbours hopes of being the next president of the European Commission. That should make him the ally of the British, not their enemy, in finding a mutually acceptable deal.
What if no deal is reached and we exit on WTO terms?
Despite our expectation of a deal being done, we remain keen to understand the position in the event of both “deal” and “no deal” scenarios. On 23rd August the government issued 25 technical notices spanning a broad range of issues and sectors, including financial services, the regulation of medicines and medical devices, importing and exporting, farming and VAT, that highlight the practical effects that could result from the UK exiting the EU on 29 March 2019 without having reached an agreement on the terms of its withdrawal with the remaining 27 EU member states. Further “no deal” technical notices are expected to be issued over the coming weeks.
The government used its paper to highlight actions it has already taken to limit the immediate impact of a no-deal Brexit on financial services firms. Those actions include its move to establish a new temporary permissions regime that would allow EU-based financial services firms to continue operating in the UK for a limited period in that eventuality.
A draft withdrawal agreement, endorsed by EU leaders in March, contained a transitional period running from the date of the UK’s formal exit from the EU on 29 March 2019 until 31 December 2020. During this period, the UK would maintain “all the advantage and benefits” of the EU single market and customs union, but will no longer participate in EU decision-making.
In light of this agreement, UK regulators believe that it is “reasonable for firms currently carrying on regulated activities in the UK by means of passporting rights, or the EU framework for central counterparties, to plan that they will be able to continue undertaking these activities during the implementation period in much the same way as now”, according to the Bank of England.
HFMC Wealth view: Both the EU plans and the UK plans confirm how disruptive a no-deal Brexit will be, but they do also show the UK suffering the most. As such neither side wants such a result. We believe that the economic downsides will be greater under this scenario and will review this in our Investment Strategy document.
What is passporting and why does it matter?
The EU passporting system for banks and financial services firms, including HFMC Wealth, enable any firm authorised in any EU or EEA state to trade freely in any other with minimal additional authorisation. Non-EU firms face significant regulatory barriers to providing cross border investment services to customers in many EU member states. Advice may continue to be given in the UK to non UK residents when they are in the UK.
A temporary recognition regime for central counterparties has also been proposed by the government in draft legislation, and similar temporary regimes are also anticipated for EEA-based electronic money and payment institutions, registered account information service providers, and EEA funds that are marketed into the UK, the government has said. EU lenders and clearing houses which currently ‘passport’ their services into the UK should be able to rely on their existing regulatory permissions until the end of the post-Brexit transitional period, UK regulators have said.
HFMC Wealth view: At the moment, if a UK fund manager passports into another EU country, a resident of that EU country can invest in that UK domiciled fund. In the event of a “no deal” Brexit, whilst the UK government is committing to unilaterally putting in place a temporary permissions regime to enable EU firms to continue to effectively passport into the UK for up to 3 years whilst such firms go through the process of applying to be directly authorised in the UK, the UK government cannot force EU countries to reciprocate that arrangement. Therefore, it is possible that UK fund managers currently operating in the EU under the passporting regime will not be able to do so post-Brexit. This may restrict the investment options of people living in the EU who may therefore not be able to access UK domiciled funds post-Brexit. We do note that many Investment Banks and other financial services organisations have offices in both the UK and the EU and are expected to be able to continue to offer their services to EU and UK residents alike.
We will keep this position under review at our Investment Committee meetings in order to be able to provide suitable asset allocations and funds for our EU based clients. Whilst not wishing to focus in this note on investment matters we will of course continue to consider the potential impact of Brexit when making asset allocation decisions. Clients’ portfolios already have a wider geographical exposure than the EU and so are more a proxy for the global economy than a local barometer. Even in a “no deal” scenario, the UK is the fifth largest economy in the world and some reduction in GDP in the short term should not be cause for panic.
The coordinated statements, issued by the Bank of England and the Financial Conduct Authority (FCA), are dependent on the incorporation of the ‘implementation period’ agreed by negotiators for the EU and UK into the final withdrawal agreement. They are also based on “the presumption that there will continue to be a high degree of supervisory cooperation between the UK and EU”, according to the Bank of England.
Despite focusing on the no-deal implications for financial services, the government’s paper has advised financial services firms to continue their Brexit planning on the basis that an implementation period will be agreed between UK and EU Brexit negotiators.
HFMC view: At this stage, we do continue to plan on the basis that an implementation period will be in place from March 2019 to December 2020, and continue to follow guidance from the regulators.
The UK government has also committed to legislating, if necessary, for a ‘backstop’ temporary permission regime, to ensure that passporting firms can continue to operate in the UK in the event of a “sudden loss of permission” while they apply for full authorisation. The regulators intend to set out how this will operate later this year, they said.
The Bank of England has also issued supervisory statements setting out its position on the authorisation and supervision of international branches of banks and insurers, in response to its consultations of 20 December 2017.
The UK regulators have recognised and are addressing to the extent that they are able, the issues faced by incoming firms if no deal is reached. The temporary permissions proposal for example is very welcome. However, it remains unclear what, if any, reciprocal arrangements will be proposed by EU regulators.
HFMC Wealth view: For this reason we are considering our options in relation to the provision of advice to non UK resident individuals and whether establishing an EU subsidiary which is authorised in a member state is the prudent approach and we are watching this closely.
We have not established an EU subsidiary that is authorised, though this is an option that remains under consideration by our Board, pending the continuing political negotiations. As recommended by the government paper, we are continuing our Brexit planning on the basis that an implementation period will be agreed between UK and EU Brexit negotiators.
There will be continuing volatility and uncertainty in markets and in the political sphere. The UK certainly doesn’t “hold all of the cards” as once claimed by Michael Gove, and Britain does seem to be steadily ceding ground to the EU. Financial services is understood to be critical to the future success of the UK, and is an area that has direct impact on EU and UK residents alike so politicians are very aware that this needs agreement sooner rather than later.
We expect that London will remain the region’s dominant financial centre, due to both the huge volumes of non-EU business done here (which is likely to remain, not least because of a preference for commercial transactions to be subject to English law) but also due to the lack of any clear alternative centre in the EU. We expect that the EU would struggle to determine where that would be without a protracted, internal squabble.
Whilst we recognise the valued concerns of our EU clients in particular in relation to how Brexit will impact upon them, we believe that there is one clear takeaway – there is no need to rush into making any decisions, instead there are many reasons to study, watch and wait.
The main risks in relation to UK and EU residents alike relate to passporting and this is receiving high levels of focus both at home and abroad. It is in the interests of both the EU and the UK to resolve this and as such we do expect a resolution to be reached, even if it is at the last minute.
We will continue to take all factors into account when considering market, distribution, and product risks alike to support you in achieving your strategic goals. As a company servicing the needs of global high net worth individuals, we are working in close cooperation with our partners and remain ready to apply our insight, expertise and entrepreneurial spirit to all your challenges, responding effectively to the new political and economic landscape in Europe.
For further advice, please do get in touch with your wealth adviser at HFMC Wealth.
Appendix – FAQs for EU resident clients
What impact does Brexit have on taxes if I live in the EU?
Tax laws are generally determined by the individual member states, and as long as they do not contravene the overriding EU principles such as freedom of movement of people and goods, they are not usually affected by the EU, with the notable exception of VAT. The UK has double taxation treaties with all EU member states on an individual basis.
HFMC view: These double taxation treaties do not depend on EU membership. Therefore we should not expect any real impact on income and capital gains taxes as a direct result of Brexit. Other taxes which should not be affected as a direct result of Brexit include: inheritance tax, local property taxes (such as taxe d’habitation and taxe foncière for residents in France) and stamp duty on property purchases.
However, taxes may change as an indirect result of Brexit; for example the UK government may decide to increase income tax because of the economic impact of Brexit or it may decide to introduce tax breaks that would previously have been contrary to EU law.
What about social security payments for healthcare if I live in the EU?
Social security covers areas such as access to healthcare and pensions that are of importance to many people who will be affected when Britain leaves the EU.
Social security is the area where individuals are most likely to feel the effects of Brexit. If the UK remains in the European Economic Area (EEA), like Norway, Iceland and Liechtenstein, then it is unlikely we will see major changes because the EU social security legislation extends to EEA countries.
However, if the UK doesn’t remain in the EEA then we need to seriously consider that the UK’s social security relationship with the remaining EU members could resemble what is in place with other nations.
What impact will Brexit have on my State Pension if I live in the EU?
In August 2017, the Government indicated that British pensioners who live in the EU will continue to see their state pension payments increased each year after Brexit. The British government intends to continue increasing state pensions to expatriates in the EU after the UK leaves the EU in 2019. The update showed that Britain and the EU had the same position on annual increases: that they would continue to be made as now after Brexit.
In addition, National Insurance contributions made while abroad will also continue to count towards the state pension. You should get the full state pension, worth £159.55 a week, if you have 35 or more “qualifying” NI years on your record.
The agreement also covers people in countries that are part of the European Economic Area – Norway, Iceland and Lichtenstein – as well as Switzerland.
The options for British expatriates and their pensions continue to include remaining in your current scheme; income drawdown; Self-Invested Personal Pensions (SIPPs); Qualifying Recognised Overseas Pension Schemes (QROPS); and buying an annuity.
Those that have not yet purchased an annuity should review how each will work for you, the pros and cons, tax implications in your country of residence, whether you can pass the balance on to your chosen beneficiaries, etc. The selection of the correct option is a minefield for the unwary, so this is an area where specialist advice is more than invaluable and HFMC Wealth would be glad to assist further in this regard.
What about the position for pensions and insurances in payment if I live in the EU?
As previously mentioned, UK insurance companies and pension providers currently use “passporting rights” to sell pensions, insurance and savings products across borders to customers in the EU. The Association of British Insurers (ABI) has confirmed that insurers and pension providers need to be authorised in an EU country to make payments directly to customers living in the EU.
As per the above statement, the reporting on this issue has definitely caused confusion. The Technical Notice issued last week is not however talking about all pensions paid to expatriates in the EEA. It addresses the position of EEA customers of UK firms operating in the EEA under a passporting arrangement, which is where the firm actually sells cross border under the freedom of services rules.
This is considered in the paragraph headed Individual and business customers – EEA customers (including UK citizens living abroad) of UK firms operating in the EEA.
It’s our view that the vast majority of pensioners with UK pensions will not be affected by this. This is because it is very unusual for pensions to be sold cross-border because of different tax treatments in other jurisdictions. We have consulted on this with the pension providers that we use, and the most comprehensive summary we have received (from Aegon) is as follows:
“The Aegon position for pensions that were not sold under passporting arrangements, but instead were sold to people living in the UK who subsequently moved, is that we expect to carry on making payments to these customers. Under FCA guidance at SUP Appendix 3 the UK remains the regulatory jurisdiction for these policyholders https://www.handbook.fca.org.uk/handbook/SUP/App/3.pdf
We believe that some reporters read the technical note in advance of Domenic Raab’s recent speech and perhaps didn’t appreciate the significance of the fact that the paper is talking about passporting. It would be easy for someone not familiar with the position to assume that this meant all pensions with non-UK members but this isn’t the case. Mr Raab then compounded the problem because he was asked a question about this after his speech and also talked as if this refers to all pensioners. His level of (understandable) lack of knowledge on this was further exposed when he went on to say that Spain won’t want UK pensioners living in Southern Spain to be disadvantaged. In fact, our understanding is that the Spanish regulator has already said that servicing existing contracts doesn’t amount to regulated activity in Spain (a view also taken by the regulators in France and Luxembourg so far). That means that even passported customers in Spain can receive payments from UK firms.”
For expatriates with UK personal pensions and insurance contracts that were sold to them in the EEA using passporting – which can run into decades beyond Brexit – this means they may no longer be able to receive payments directly in the EU post-Brexit (the UK State Pension is not affected).
Providers would face the dilemma of choosing between breaching contract law (by failing to honour their contracts with members) or breaking European law. However, this is only the case if nothing were to change between now and the date the UK actually leaves the EU.
The reality is that this is one of the crucial issues being addressed in Brexit negotiations. With citizens and businesses potentially affected on both sides, it is of mutual benefit to agree a solution in time.
HFMC Wealth view: We anticipate that an agreement will be made in time given the direct impact on both EU and UK citizens.
If the transition period does not materialise, the UK’s temporary permission regime is only effective for EEA firms operating in the UK and offers nothing for UK firms wishing to conduct activities in other jurisdictions without the benefit of passporting rights.
Comments made by the European Insurance and Occupational Pensions Authority (EIOPA) in December 2017 about cross-border legacy insurance business also suggest that EU countries may be less accommodating of UK firms post-Brexit than would reciprocate the UK’s relatively benign approach to EEA firms. How firms respond to this dilemma is likely to depend on the significance of their cross-border activities and the extent of any disruption that would be caused by an early loss of passporting rights.
We have extended our due diligence of our pension and insurance providers and are presently collating responses to determine which companies that we presently use have subsidiaries in the EU that are authorised.
In the event of a worst case scenario we anticipate that payments could be made to a UK bank account by the UK provider, and you may then instruct your bank to set up a standing order to make a payment to your EU bank account. Alternatively, advice could be provided to transfer existing pensions to a structure that is already compliant in your country of residency, an EU/EEA-based Qualifying Recognised Overseas Pension Scheme (QROPS), though this can be expensive.