Written by David Blake
This article was first published in Briefings for Britain and we republish with kind permission.
The City of London is the predominant financial centre in Europe. It does six times more financial services business with the EU than the EU does with the UK. More financial services business is done in Canary Wharf than in the whole of the EU combined. London accounts for 40% of Europe’s assets under management (and 85% of hedge fund assets), 60% of its capital markets business, 78% of its foreign exchange trading, and 74% of its derivatives trading. The UK securities market is the biggest in Europe, the UK banking sector is the biggest source of cross-border lending to EU banks and corporates with more than £1tn of loans outstanding, and the UK is by far the largest market in Europe for ‘alternative finance’. Exports of UK financial and insurance services are around £82bn, of which £33bn or 40% go to the EU.
Fishing, by contrast, contributes 0.02% (£437m) to UK GDP. So financial services is around 300 times more important to the UK economy than fishing. Yet the new UK-EU Trade and Cooperation Agreement (TCA) gives the EU a 5.5-year transition agreement on EU fishing boats in UK waters, but has no transition for financial services sold into the EU.
Instead, all that has been agreed is a non-binding commitment for the UK and the EU to cooperate in order to reach a ‘memorandum of understanding’ (MOU) on financial services regulation, with negotiations beginning before March 2021. Each side is able to suspend any agreement for a number of reasons, ‘including in order to preserve financial stability and the integrity of financial markets’.
Under current EU rules, the UK financial sector can only access the single market if the EU determines that the UK financial regulatory system is deemed to be ‘equivalent’ to that of the EU, meaning that it achieves the same outcomes as its own rules, as well as preserving financial stability, investor protection, market integrity and a level playing field in the EU single market.
However, equivalence only allows for market access in specific areas and excludes most types of banking (such as deposit-taking, lending and payment services), as well as the provision of fund management services to retail customers. Equivalence can also be withdrawn at short notice (typically 30 days). Furthermore, despite being a technical matter of determining whether a third-country’s regulations are equivalent, there is a ‘clear political dimension’ to the decision. In the case of the UK, the EU is concerned about ‘possible divergence from EU rules’ as a reason for withholding equivalence.
It is clearly not a sustainable long-term position for the UK to operate a £30bn+ business in the EU which can be stopped on a whim with 30 days’ notice. There is also the question of costs as Omar Ali, the head of financial services at EY, points out: ‘Equivalency isn’t just about access; it’s about the cost of doing business. A lack of equivalence decisions would increase the cost of doing business for financial services firms and the clients they serve’.
Furthermore, the nature of the political dimension is clear. The EU sees Brexit as an opportunity to force significant chunks of UK financial services to move to the EU. More than £1trn of investment funds have been moved from London to the EU since 2016. The EU is particularly keen to see euro-denominated business – most of which has been carried out in London ‒ moved into the Eurozone. For example, it has refused to allow trading in euro-denominated shares on platforms outside the EU after Brexit. As a result, Monday 4 January 2021, the first day of trading following the introduction of the TCA, witnessed the first-ever trading of shares ‒ some £6bn-worth in total ‒ on the Cboe NL and the London Stock Exchange’s Turquoise platforms both in Amsterdam and Aquis Exchange’s platform in Paris. This means that trading was split across three separate trading platforms, thereby reducing liquidity.
While the UK has granted a temporary permissions regime to a large number of EU companies, allowing them to continue to do business in London and to allow UK firms to use venues in the EU, the EU has refused to reciprocate and has banned EU companies from trading swaps and other derivatives on platforms in London. The euro-denominated derivatives market in London is worth €78trn.
There are two additional important issues of concern and these are movement of people and data. While the TCA permits visa-free travelling for 90 days in any 6-month period to attend meetings, conferences and conducting research, any sale of goods or services to the public will require a visa. In terms of data, financial services firms need to ensure they comply with EU data sharing rules, which covers client paperwork and personal data under GDPR.
Stay tuned tomorrow for Part Two.
Photo by Got Credit