OREANDA-NEWS. A worst-case withdrawal of passporting rights in isolation is unlikely to be a ratings changer for major UK banks and international banks with large operations in the UK, says Fitch Ratings. However, it is difficult to predict how negotiations will play out for financial services passporting once the UK leaves the EU because there are many permutations.

Major international banks are used to business restructuring. They have been focusing on resolution planning, and optimising operational and capital efficiency in the face of regulatory and business headwinds. But relocating businesses to other EU countries to preserve passporting rights would be costly and disruptive at a time when many banks, particularly in Europe, are struggling to make adequate returns.

The Joint Committee of the European Supervisory Authorities' report this month published an aggregate return on equity (ROE) of 5.8% for EU banks as of 1Q16 and only three European global systemically important banks achieved an ROE in excess of 10% in 2015. Nonetheless, we believe the costs and disruption are likely to be manageable in the context of banks' overall credit profiles.

The worst outcome is that UK-established financial services companies lose their ability to passport products and services into the EU. In this case, UK-domiciled banks with an international profile, such as HSBC, and subsidiaries of non-EU banks using the UK as a bridgehead into the EU, such as JPMorgan Chase, would assess the best strategy for their EU businesses. Banks headquartered in the eurozone with substantial operations in the UK may also need to make costly adaptations to their business models.

Most banks that would need to transfer businesses out of the UK already have existing EU subsidiaries, which could be bolstered to handle increased volumes and operations. Deciding where to locate EU operations will depend on a broad range of factors, such as the location of existing legal entities, language requirements, staff expertise and cost, labour law flexibility, tax considerations, logistics and incentives offered by the different countries.

Management would also consider the functions and headcount numbers required by national authorities to be granted appropriate licences when relocating. We expect relocations to be considered in the global context of moving back - and middle-office functions to cheaper locations.

We believe the UK will fight hard to preserve the dominance of London as a financial centre and it may well be easier on EU and international banks using "inbound" passports to provide services in the UK than the EU authorities might be on UK firms using "outbound" passports. Recent data from the Financial Conduct Authority said 5,500 firms use outbound passports in respect of various EU financial services directives and about 8,000 firms use inbound passports. These numbers include firms other than banks, such as insurance companies and asset managers.

UK firms may be able to benefit from third-party equivalence rules in respect of some services, but this would require European Commission sign-off. The UK's financial services legislation is consistent with the EU's and the UK should meet equivalence thresholds with respect to this legislation. Equivalence recognition would allow UK-based financial institutions to continue to operate in the EU.

The privileges of equivalence are broadly similar to passporting rights, but they are unlikely to be as robust and not all banking services are eligible for equivalence rules. Relying on equivalence agreements is less desirable for firms because the EU could withdraw any equivalence decision it makes. As relevant EU legislation changes, there is a risk that the corresponding UK legislation could lose its "equivalent" designation unless the UK mimicked these changes.