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There’s a little-known EU rule that may stop the Brexit banking exodus

Simon Dawson | Bloomberg | Getty Images

The U.K.'s decision to leave the EU last month has ignited fears of an exodus of banking talent from the City of London, but a little-known set of rules is being drafted that could well bypass post-Brexit barriers and allow access to the privileges the country had before.

Implementation of the so-called Markets in Financial Instruments Directive II (MIFID II) in January 2018 could give banks from non-EU member states a legal advantage, essentially doing away with cross-border restrictions and allowing for standardized licensing for most financial services.

CNBC looks at what MIFID II could mean for the British finance industry after the U.K. cuts the cord.


The breakdown: What is MIFID II?

MIFID II builds on its predecessor MIFID I, which is considered the regulatory "cornerstone" for the EU's financial sector, standardizing business conduct, transparency and protections across the single market. The single market is an association of countries trading with each other without restrictions or tariffs and financial firms are worried that the U.K. could lose access to this and not be able to sell their services across the region with the same ease as before.

The 2007 financial crisis highlighted the need for additional rules and requirements, to make financial markets, "more efficient, resilient and transparent," European Securities and Markets Authority documents explain.

It's meant to tackle speculative investments by non-financial firms, regulate commodity derivative trading, high-frequency-trading, introduce liquidity assessments for non-equity assets, and improve disclosures.

Currently, a bank based in an EU country has a financial "passport" that allows it to do business in another member state. However, the brand new MIFID II will notably include changes to the "passporting" regime which allows firms in to carry out business or perform investment services across borders without needing to obtain an independent license in each country.

Why does this matter for the UK?

"Potentially relevant to Brexit, is this concept of third country status," Nikki Johnstone, an associate in the global banking and payment systems practice at law firm Paul Hastings, told CNBC by phone.

MIFID II effectively allows firms from non-EU member states to access the EU market. "Now in theory this would include the U.K. in a scenario where it has left the EU," Johnstone said.

Firms looking for access would have to apply through the European Supervisory Authority and would need to have an equivalent regulatory framework in place, Johnstone explained.


However, it seems that financial services already operating in the U.K. would surely qualify.

In the wake of the Brexit referendum results, the U.K.'s Financial Conduct Authority issued a statement explaining that EU laws will still apply to all firms under their jurisdiction, including those which are "still to come into effect" like MIFID II, up until parliament and the ruling government officially trigger a Brexit.

This means U.K.-based financial services will have prepared to abide by all rules under MIFID II, and therefore qualify to access the single market, whether or not Brexit is triggered.

The burning question: Could this keep UK-based banks from leaving Britain?

"From what I can tell, there's great will within the financial services community to have access to the single market, and there's a reason for renewed interest in the third country regime and how the U.K. will interact (with the EU)," Johnstone said.

But an air of uncertainty may be enough to drive key financial services away.

Research published by J.P.Morgan on July 1 suggests a Brexit scenario where there will be "clear evidence of multinational operations shifting the locations of their activity out of the U.K. given the regulatory uncertainties."

"Financial services are among the sectors that will be most exposed to this process," the note explained.

"Even if the U.K. begins to signal that it will compromise on other priorities in order to secure 'full' access to the single market in financial services, there is a clear risk that euro-denominated activities relocate to within the EU simply to ensure continuity of relationships," the note also stated.


The lure of Paris?

In the meantime, EU countries like France will take the opportunity to lure banks eastward.

In a speech delivered to finance industry representatives on July 6, French Prime Minister Manuel Valls said he wanted Paris to be Europe's top financial center, adding that the government will set up a one-stop administrative agency for foreign firms looking to set up in France, Reuters reported. That's on top of an extended tax relief regime for expats.

"U.K banks may want to set up separate entities in other EU countries, others will be aware they have a choice to which member state they go to," Johnstone said.

The main point, Johstone added, is that firms which are set to abide by MIFID II will be ready for whatever Brexit model politicians settle on.


MIFID II is set to be implemented January 3, 2018. The EU's treasured single market allows easy access to the trading bloc but also requires the free movement of people within the region. The latter could be politically sensitive after the U.K.'s referendum, which suggested that many voters were centered on the issue of migration. Thus, a model like Norway's – which is in the European Economic Area and still accepts the free movement of people – could prove too much of a hurdle for the future government.

Many industry sectors have called on U.K. lawmakers to maintain access to the single market and fear darker days ahead if it fails to do so. But, for the financial industry at least, this new directive may well prove to be a small ray of light on the horizon.