James Sherwin-Smith
11 min readMar 14, 2016


Payments in the UK: a simple thought experiment to show why leaving the EU is extremely complicated and deserves greater engagement

How engaged are you on the topic of #Brexit? Have you switched off already, given all the big egos posturing, the scaremongering and the references to “Project Fear”?

I hope not. As Nick Clegg pointed out at an event I was fortunate to attend in January, the UK had 18 months to consider whether to replace first past the post with the alternative transferable vote (ATV) electoral system. Scotland had 10 months to decide whether to split from the UK. But we have been given less than 4 months to decide our future in Europe: a politically accelerated timetable for, arguably, a far more significant change. Our former Deputy Prime Minister thinks this is deeply concerning, and, in this regard, I agree with Nick.

Don’t just think EU, think EEA too

Now I will be the first to admit that I have reassessed my views on this topic recently. As the CEO of a fintech startup in London, I was asked last week by the Silicon Roundabout blog for a 50 word answer to the question: What would leaving the EU mean for London and the UK’s tech community? My answer at the time:

“Nothing. While the UK might leave the EU, we will still be part of the European Economic Area (EEA) which will require the UK to respect the fundamental freedoms of the free movement of people, capital and trade.”

Source: Wikipedia users DieBuche, The Emirr (CC 3.0)

I was guided by the above diagram which attempts to explain the complex relationships that different countries have with various European organisations. This diagram shows that the UK is a member of:

  • the Council of Europe, through which the UK helped create the European Convention on Human Rights
  • the European Union (EU), which is why the UK has to abide by laws and rules adopted by the European Parliament and the Council of the EU
  • the European Economic Area (EEA), which provides for the free movement of persons, goods, services and capital within the internal market of the European Union (EU) among its 28 Member States, as well as three of the four Member States of the European Free Trade Association (EFTA): Iceland, Liechtenstein and Norway.
  • the common travel area with Ireland, which means I can visit the Republic of Ireland with photo ID instead of a passport

I had assumed that if the UK left the EU, we would, significantly, still be part of the EEA, so people, capital and trade could still move freely in and out of the UK. Effectively, the UK would follow the yellow path and end up at 1 on the diagram above. However I’ve now been told by some very astute lawyers (a large group of whom I consulted with before writing this article*) that I am wrong. The other 27 members of the EU, and the three non-EU EEA members, would have to unanimously agree to the UK joining the EEA.

We simply cannot presume that the UK will get the same status as Norway, Iceland and Lichtenstein — we would have to apply and be accepted into the EEA, and potentially by EFTA too. So there’s a real danger that the UK would take the orange path and end up at 2 on the diagram, potentially for some time, isolated on its own.

Is this a probable, political outcome if the UK chooses to leave? It’s hard to say. This recent war game, run by Open Europe working with former European heads of state and senior politicians, suggests it’s definitely a possibility.

Trade wars are bad, and the economic stakes are very high

Is forcing the UK out of the single market a rational economic outcome? On a holistic basis, absolutely not. Trade wars are bad for everyone, regardless of which side you’re on. To be clear, collectively the EEA has more to lose than the UK does, as two of my colleagues articulate well in this Twitter debate with Robin Klein, one of the UK’s better known technology venture capitalists. As Greg, our CRO and a founder at Growth Street, puts it — we’ll just end up buying more Land Rovers and Nissans instead of BMWs and Renaults. So in other words: Jai, Sugoi, Pfft, and Boff!

But a little bit of pain shared unequally across 27 nations could make it attractive for just one Member State to punish the UK for abandoning the EU and to discourage other Member States from leaving. Plus there could be considerable spoils to divide up if our current access to the European ‘single market’ is denied. So from a single Member State’s perspective, there could be a solid economic argument to expel the UK for that state’s particular national economic gain.

As my colleague Greg pointed out in the Twitter exchange, the UK runs an export surplus in services, but a slightly larger deficit in goods. Much of that services surplus is attributable to the City of London. According to this 2015 note from the Library of the House of Commons:

“In 2014, financial and insurance services contributed £126.9 billion in gross value added (GVA) to the UK economy, 8.0% of the UK’s total GVA. London accounted for 50.5% of the total financial and insurance sector GVA in the UK in 2012. The sector’s contribution to UK jobs is around 3.4%. Trade in financial services makes up a substantial proportion of the UK’s trade surplus in services. In 2013/14, the banking sector alone contributed £21.4 billion to UK tax receipts in corporation tax, income tax, national insurance and through the bank levy.”

This research note refers purely to the direct contribution made by the financial and insurance sector. A significant indirect contribution should also be taken into consideration given the multitude of professional services firms that are employed as a result — IT, PR, consulting, law etc.

Any Member State who might want to challenge London’s position as the financial capital of Europe (e.g. France or Germany, who may want to enhance Paris and Frankfurt instead) might decide that the UK outside the EEA is a good idea. Imagine if euro clearing was forbidden in London (something the ECB has desired for a number of years). You might also be forced to cease operations in all branches, and be restricted from contacting customers and investors remotely across EU Member States because your EEA rights to ‘passport’ onto the continent have been withdrawn with the UK’s departure from the EU. The impact on London, and the UK, could be massive.

Getting to grips with EU legislation

It’s only when you begin to examine the implications of Brexit on European FS legislation and regulation that the full potential impact of the UK leaving the EU really hits home. It’s worth noting at this point that there are two types of instrument used by the EU to regulate the market, EU Directives and EU Regulations.

EU Directives are addressed to Member States rather than their citizens and are, therefore, only legally binding upon the states themselves. EU Directives provide a framework for implementation but they must be “transposed”, typically within two years, into domestic law, with the practical details of implementation left for Member States to decide. Failure to transpose an EU Directive, or transposing an EU Directive incorrectly is an infringement of EU law which can result in enforcement action being taken by the EU Commission against the Member State concerned. The UK is often accused of “gold-plating”, going further than others to follow the letter of the directive, and doing so on an accelerated timetable.

EU Regulations, however, apply directly in all Member States, under the power of the various treaties signed by Member States, the last being the Treaty of Lisbon (which include Article 50, permitting a Member State to withdraw from the EU). Failure of an organisation to adhere to an EU Regulation could result in enforcement in the national courts. Failure by a Member State government to enforce an EU Regulation could result in infringement proceedings by the EU Commission as described above in relation to EU Directives.

Payments — a practical example

To make this less abstract, it’s perhaps best to take a practical example that affects us all: payments — given individuals, businesses and governments all send and receive money.

The EU Payment Services Directive (2007) was transposed into UK law, and can be found on the UK statue books as the Payment Services Regulations (2009). A key piece of payments legislation, the transposition of the EU PSD into the UK PSRs has supported significant innovation and competition in the UK. This includes the creation and regulation of non-bank payment institutions, and helps to increase consumer protection and transparency. For example, prepaid cards can be issued to consumers by non-bank organisations, which have given rise to new brands competing in the payments space, e.g. travel cards which reduce the cost of exchange and handling foreign currencies when abroad. Further, if you are defrauded of money from your bank account, it is the PSRs that limit your liability in the absence of any personal negligence.

The PSD will be repealed and replaced with a new Directive (known as PSD2), which has been in force since 12 January 2016, and should be transposed into national law by EU Member States by January 2018. PSD2 contains some highly contentious requirements, including forcing banks to open up account access and payment initiation services to third parties, so that bank customers can query their balances and initiate payment instructions via a third party, instead of directly with their bank.

The EU Regulation on Interchange Fees for Card-based Payment Transactions (known as IFR) was adopted by the European Parliament and the Council of the EU in April 2015. As of 9 December 2015, caps have been placed on the fees that card issuers can charge merchants when cardholders purchase goods or services. (Whenever you spend with a card, the merchant has to pay a proportion of the transaction to the various parties used to facilitate the transaction.) The most significant cap was placed on credit cards: issuers cannot charge more than 0.3% of the transaction value, whereas in the past it may have been 1% or more.

What does this mean to you and me? According to this consultation process, run by HM Treasury, the British Retail Consortium estimated the impact of these caps on fees could save merchants in the UK £480 million each year. Whether these savings are passed on to consumers, however, remains to be seen. Evidence from other markets where caps on interchange were introduced, e.g. Australia, suggests that merchants mostly pocket the change, and where possible add surcharges, while issuers charge or increase the fees that cardholders pay issuers for the privilege of holding a payment card.

But more importantly, if you previously received a reward for spending on your payment card from the issuer, you may have found recently that the reward value has been either significantly reduced or removed altogether. This is because the income that issuers receive from interchange has been curtailed.

Brexit decision, ambiguity and aftermath

So, given the above examples of European regulation and legislation, what would happen if on 24th June 2016 we wake up to find that the majority of the UK has voted to leave the EU?

First, the UK would need to state our intention to withdraw from the EU, under the process set out in Article 50 of the Treaty of Lisbon.

Second, the UK would then need to negotiate the terms of our withdrawal. Article 50 provides an initial two year period to do this, and any agreement would need the support of 20 out of the remaining 27 Member States, representing at least 65% of the population, and the approval of the European Parliament (a simple majority of its 751 MEPs — MEPs from the UK would probably be permitted to vote, because at this stage it would still formally be part of the EU).

Two years feels like a long time, but some commentators, including my colleague Jerry Taylor (who contributed to the Twitter debate referenced above), have suggested that it could take 10 years of work to achieve the bilateral and multilateral agreements that the UK would seek to achieve. And here lies the rub: the UK can ask for an extension on the two year negotiation period, but under Article 50, this must be a unanimous decision of the European Council. Therefore only one Member State needs to say no, and two years after serving notice of our intent to leave the EU, we would be isolated from the single market (i.e. the orange path that gets the UK to point 2 on the diagram above).

If the UK does choose to Brexit, during the intervening period from 24th June 2016 until the day we actually leave, there is going to be considerable ambiguity.

Taking the payment example above, the PSD will live on, as it was transposed into the UK PSRs, until such time that we decide to amend or repeal this now UK legislation.

PSD2 would in theory need to be transposed by January 2018 (as the UK will remain subject to the EU treaties until the date of departure), but if we’re negotiating our departure, would we see it though? Some argue yes, in order to smooth out exit negotiations and to achieve some level of parity with major trading partners especially if we wanted to retain access to the single market through the EEA. Others might say no, on the basis that the UK has been pushing ahead for an open banking standard anyway via the Open Banking Working Group, so PSD2 isn’t needed, especially as the UK can operate outside the Single European Payments Area (SEPA).

On exit from the EU, the IFR regarding interchange fees would technically be enforceable no longer. Arguably from the date we decide to leave, the government and the regulators may be reluctant to enforce the rules in the IFR, given that any infringement proceedings by the EU Commission before the Court of Justice of the European Union (CJEU) would be unlikely.

The real question then becomes whether the new UK Payment Systems Regulator would again bare its teeth. Its strongly presented current proposals for example will require the banks to sell off their stakes in VocaLink (which operates most of the UK’s interbank payment infrastructure), for which MasterCard is rumoured to have made a bid. The interesting part here is that IFR was always dis-proportionally punitive on the UK cards industry, as the UK has always been a more credit card, and rewards, focused market than those of other European Member States. In an effort to not entirely ostracise the banks (nearly all have substantial credit card portfolios), might the Government, the FCA and the Payment Systems Regulator let IFR go and let interchange fees rise?

If voters were rational

So given the above, how would you vote on 23rd June 2016 — stay, or leave?

If you’re pro London as the financial capital of Europe, given its contribution to the UK economy and employment, you should probably vote stay.

Are you happy to see the UK re-balance its economy away from financial services, and keen to get more rewards for your payment card spending? Vote leave.

Regardless of your current views and interests, please do engage others on this topic, don’t shy away from the debate, and make sure you can and do vote on 23rd June 2016.

James Sherwin-Smith is CEO of Growth Street, an alternative finance platform for SMEs, and was formerly a Senior Principal at MasterCard Advisors and a Principal at Oliver Wyman. James is greatly indebted to several private individuals who helped him understand some of the issues covered in this article. However, any errors or omissions are James’ mistakes, not theirs.



James Sherwin-Smith

Engineer by education, Consultant by experience, Entrepreneur at heart. My professional focus is #fintech & #payments, I’m an #avgeek + #cricket fan