Over the past decades the UK has solidified and maintained its position as the highest net exporter of financial services, and London, with its convenient time zone, English speaking population and light regulation has been acknowledged as the world’s financial capital. This comes as no surprise, taking into consideration the historical legacy of the country. Since the Roman conquest, London has flourished financially, and by the 1600s it had already established itself as a center for business and in 1694 the second-oldest bank in the world, the Bank of England, was formed.

The geographical position has also played to their advantage. London’s transport capabilities have enabled the ease of trade since its formation. The River Thames provided easy access for trade, and when the rail network became popular, major national and international networks became available. Furthermore, with the advancements in air travel, the 20th century saw the rise of three major airports, Heathrow, Gatwick and London Stansted which opened up new opportunities at a global level.

This brief retrospective illustrates the fact Britain has been set on an ascending trend for centuries, due to its maritime hegemony, booming financial sector and as the birthplace of the industrial revolution. But new sociopolitical and economic dynamics seem to challenge that position. Brexit and the possible loss of passporting rights for firms in Britain raises important questions related to the ability of the country to remain at the heart of the international monetary system.

Brexit, a brief overview

Brexit entails the separation of the United Kingdom and Northern Ireland from the European Union. The decision was taken following the referendum from June 23, 2016, and the withdrawal notification from March 29, 2017. Since then, the deadlines for a definitive exit from the EU have been extended, the last date being October 31, 2019. The date by which the UK Parliament’s EU Withdrawal Agreement should be enacted. Following this agreement, the UK would leave the EU Single Market and the EU Customs Union, the end of the transitional period, being December 31, 2020. Otherwise, the trade relationship between the EU and the UK will be governed by the rules of the World Trade Organization, starting from October 31, 2019.

Following the latest developments in UK domestic politics, Boris Johnson’s election as the leader of the Conservative Party and consequently the country, the goal of the new government is to withdraw from the EU on October 31, 2019, with or without a trade deal. Taking into consideration these circumstances, and the EU’s refusal to reopen negotiations on the Withdrawal Agreement, the UK’s separation from the EU without an agreement seems imminent, an outcome which will have a major impact on UK-EU trade.

The withdrawal of the United Kingdom of Great Britain and Northern Ireland from the European Union without an agreement will mean a return to the provisions of multilateral trade agreements, under the aegis of the World Trade Organization (WTO). Therefore, customs duties will be applied at the level of the most favored nation clause. The average customs duty applicable to exports to the UK would be 5.7%, and the average customs duty applicable to UK exports to the EU market would be 4.3%, with some agricultural products exceeding 20%.

Soft Brexit

The UK financial market has always favoured a soft exit from Europe because if Britain remains closely aligned with the EU will significantly reduce trade disruptions, an obvious priority for any UK business. According to an OFX survey, 45% of Small to Medium Enterprises (SME) claim Western Europe as their favourite export market. The value of seamless access to Europe’s trade and talent potential is indisputable. Soft Brexit is the preferred outcome of UK businesses because it means that the country will still be part of the European Single Market. Companies will continue to trade tariff-free so the impact on international payments would be minimal as trading operations will follow the same pattern.

Hard Brexit

A hard Brexit presents itself as a more drastic outcome because the UK will immediately leave the EU, with no agreement about the separation process. The UK will suddenly leave the Single Market and Customs Union, which facilitate more advantageous trades between EU members by eliminating checks and tariffs. By leaving the EU Single Market, the UK will need to forge a new relationship with Europe based on World Trade Organisation rules. Hard Brexit, also known as no-deal Brexit, will mean that the UK will immediately leave EU institutions such as the European Court of Justice and Europol, while also renouncing its membership in EU bodies which govern rules on everything from medicine to trademarks. A complete rupture from the EU also means that the UK will no longer contribute to the EU budget, a sum roughly estimated at GBP 9bn per year.

Commenting on the implications of a no-deal Brexit scenario, Mark Bolsom, Head of M3 Payments stated that “A no-deal Brexit is likely to hit the pound hard against the other currencies. This is important in the UK which imports more than it exports, so as the pound falls, the price of imported goods and services increases. This can impact the price of food, cars, everything and increase the cost of living substantially. This also could increase the cost of doing international business for UK based companies. They could find themselves paying more for supplies and imports. There is also the issue of passporting financial services across the EU. Many businesses, including banks and money transfer businesses, have opted to set up offices in mainland Europe in order to continue to provide the same services that they do now. Obviously, this has significantly increased their cost base.”

As there is no precedent, the outcome of a hard Brexit is unclear, and experts are still debating the possible beneficial and negative outcomes. Since the referendum passed in 2016, the GBP has fluctuated sharply in the last three years, embarking on a predominantly negative trend. As a result, investors who purchase large amounts of currency will start avoiding the GBP, as political and economic uncertainty may drastically devalue the currency. But experts claim that this can go both ways. A weak GBP can stimulate overseas trade, making them more attractive for British exporters. This is because a weakened GBP can make British products more appealing to foreign buyers, as GBP denominated goods become more affordable. Overall, the uncertainty hovering around the British pound and how much it could potentially devalue, puts entrepreneurs in a precarious position, as they need to carefully plan the timing of international payments, to make sure they get the best rates.

UK under World Trade Organization rules

If there is no trade deal between the EU and UK before Brexit, then WTO rules will apply after October 31st, 2019. Most countries, including the UK, are already members of WTO, and they agree on certain rules on how nations conduct trading operations with each other. As a member of the EU, the UK trades with the rest of the world on the basis of around 750 agreements negotiated by the EU on behalf of its members. But after a hard Brexit, this could change.

In a no-deal Brexit scenario, tariffs would be reintroduced for trade in goods between the UK and the EU. The average EU tariffs on goods are around 1.5%, but some industry sectors such as agriculture and automotive, are subjected to larger tariffs. Entrepreneurs need to check the potential impact the reintroduction of tariffs could have on their businesses. The services sector could also be affected by new restrictions on market access. Depending on the sector in question, the impact can be significant. Border checks and customs controls will likely add time to shipment delivery. Under WTO rules, UK-EU trade will most likely be subjected to border checks which will act as a bottleneck for deliveries and supply chain. The impact will be felt more strongly by industries where time is of the essence, and where perishable goods are involved, such as the food, pharmaceutical, and chemical industry. Documentation and paperwork will take center stage. It will be mandatory to have all the correct certifications and licenses prepared and at hand across every stage of the trading operations so that you can always prove the origin and nature of the traded goods. It is very likely that companies will increase their dependency on third parties for outsourcing much of this work. A negative consequence of this dynamic will be increased costs. The situation will become especially convoluted when a business is shipping products made of parts from different countries. Under a no-deal Brexit scenario, where WTO rules are applied to trade between the UK and EU and the rest of the world, entrepreneurs who plan ahead and take the time to analyze how these changes impact their business, will have a competitive advantage.

UK and the Single European Payments Area (SEPA) under Brexit

The European Payments Council (EPC) has outlined in a position paper published in May 2018 its stance on three possible post-Brexit scenarios and how they will affect the SEPA schemes. As a member of the EU, the UK is part of SEPA and many UK payment service providers participate in the four SEPA payment mechanisms: 82 in SEPA Credit Transfer (SCT), 38 in SEPA Direct Debit (SDD) Core, 26 in SDD B2B and one in SCT Instant. Due to the uncertainty surrounding the Brexit phenomenon, the dynamic between the UK and SEPA may change. In their report, EPC states that “Brexit will most probably bring significant changes and will reshape the relationships between the EU and the UK in the financial services domain”. It is interesting to note that in the scenarios outlined by EPC, the UK has the potential to continue to provide SEPA services.

SEPA is a payment integration initiative of the EU whose goal is to simplify bank transfers denominated in EUR. SEPA was designed as a set of tools and standards to improve the efficiency of cross-border payments and transform fragmented national markets for EUR payments into a single domestic one. Overall, it is a mechanism which harmonises the way cashless euro payments are made across Europe, allowing European consumers, enterprises and public-sector organisations to make and receive credit.

“On a more technical level, there are unanswered questions about the UK’s ability to continue with SEPA payments and gain access to euro clearing and settlement mechanisms… this is quite technical, but again it has forced payment companies to consider opening euro offices.
from an SME perspective, the exchange rate volatility driven by Brexit uncertainty is primarily the main cause of concern and only adds to the many issues brought about by Brexit.” added Mark Bolsom.

First scenario: the UK remains in the European Economic Area (EEA)

“If the UK leaves the EU but remains in the European Economic Area (EEA), the UK laws and regulations should remain aligned with the EU legal framework which would allow the UK scheme participants to continue their participation in the SEPA schemes.”

Second scenario: the UK leaves EEA, but signs a free trade agreement with “functional equivalence”

“If the UK leaves the EU and the EEA but puts in place a free trade agreement between the EU and UK which results in ‘functional equivalence’ of the EU legal framework, in other words, if the UK implements requirements equivalent to the criteria for participation in the SEPA schemes, this would allow the UK scheme participants to continue their participation in the SEPA schemes. It is not excluded in this scenario that the EPC may have to assess and confirm any functional equivalence of the UK’s legal framework with European Union law.”

Third scenario: there is no legal alignment

“If the UK leaves the EU and does not remain in the EEA or does not agree on an alignment of its relevant legal framework with that of the EU, the eligibility of the UK to be part of the geographical scope of the SEPA schemes will need to be assessed by the EPC on the basis of an application from the UK PSPs’ community. As the geographical scope of SEPA already extends beyond the EU and EEA, including several third countries and territories, the option remains that the UK continues in the scope of the SEPA schemes, provided it fulfils the eligibility criteria.”

Brexit is a complex process which does not have a precedent. As such, there is a myriad of things that could change for digital payments when the UK leaves the European Union. Ultimately, the magnitude of the changes which will unfold depends entirely on the type of Brexit we are going to witness. In order to maintain a competitive edge, financial services firms and any business which make use of digital payments needs to ensure their readiness to respond and adapt to regulatory requirements that will appear after Brexit.