Written by David Blake
This article was first published in Briefings for Britain and we republish with kind permission.
So what is the alternative to the UK refusing to be a Brussels rule taker and the EU refusing to agree a financial services deal based on enhanced equivalence or mutual recognition? The straightforward answer is that the City of London is strong enough to go it alone and adopt what is known as the World Financial Centre model.
This would allow the UK to continue doing business in the EU – even without single market access via passporting, an enhanced equivalence regime or mutual recognition – by making maximum use of international law protections: exploiting ‘reverse solicitation exemptions’ or ‘overseas persons exemptions’ which allow financial institutions to provide certain cross-border services to a wholesale client without being registered or authorised in that client’s member state, so long as the services are provided on the initiative of the client; making use of existing EU and member state laws that allow private placements and cross-border dealings – including multiple on-the-ground visits – without a local branch or licence; and making use of human rights legislation – the European Convention on Human Rights and the EU’s own Charter of Fundamental Rights – that protects property rights under contracts between UK and EU27 businesses that existed prior to Brexit.
In addition, it is common for financial regulators to permit the ‘delegation’ of certain financial services to entities regulated in other jurisdictions. This is typical of portfolio management, where fund managers frequently operate a portfolio management hub, enabling economies of scale and other efficiencies. In Europe, this hub is London. Two key questions are whether the EU will: a) allow EU fund managers to continue to use London as their European portfolio management hub and b) allow UK portfolio managers to enter into arrangements with a third-party ‘host’ EU fund manager, subject to complying with EU delegation rules.
An Institute of Economic Affairs report discussed the financial services regulations that would be needed to support the World Financial Centre model. The regulations must: not restrict growth in financial services, not encourage regulatory arbitrage, not prevent sections of the economy from accessing capital or other financial products, help to develop safe but competitive markets, and facilitate the growth of new and small businesses.
With these aims in mind, the report recommends that London should form an alliance with other major financial centres, such as Switzerland and Singapore, to enable further and deeper integration opportunities. A UK regime of multilateral mutual recognition would allow the UK to strengthen its involvement in global regulation formation and dispute resolution.
Freed from burdensome and costly EU regulations – equivalent to 2-3% of the financial sector’s annual costs – Economists for Free Trade have estimated that the City would grow by £20bn over the next ten years under this model. Chancellor Rishi Sunak argues that Brexit will be equivalent to ‘Big Bang 2.0’ and that the City’s ‘culture and creativity’ will see it rise to greater global heights. He said he was keen to re-examine the listing regime, so that London became a more compelling listing destination for the biggest new firms. He was also keen for London to become a global centre for financial innovation, such as in green bonds and digital currencies.
There are grounds for optimism coming from the industry itself. Immediately following the Brexit Referendum in 2016, there were scare stories about massive job losses in the City of London as firms moved workers to Paris and Frankfurt. Consultant Oliver Wyman predicted 75,000 job losses, while Xavier Rolet, then chief executive of the London Stock Exchange, predicted 200,000 job losses. In the event, just 7,000 jobs were relocated. This indicates strong confidence that the UK can thrive after Brexit even in the absence of a deal.
This is confirmed by a New Year survey conducted by the strongly anti-Brexit Financial News on 4 January 2021:
* The City of London is going to be fine. London has adapted to changing circumstances time and time again and will continue to be a global financial hub (Bob Diamond, former Barclays chief executive)
* London will remain one of the world’s leading financial centres and an attractive place to do business. It has a diverse pool of talent, a reputation for innovation and a business friendly regulatory and legal environment. Many financial institutions have long factored Brexit into their plans (Farmida Bi, chair EMEA, Norton Rose Fulbright)
* London will remain one of the world’s leading financial hubs – I don’t think there is any city in Europe that can compete with its combination of infrastructure and quality of life and it will continue to shine (Manolo Falco, co-head of banking, capital markets and advisory, Citigroup)
* Financial services was one of the first industries to prepare for Brexit, because of the importance of having the right licence to operate, and it moved quickly to set up new operations to continue operating in the EU. I expect many financial institutions to step back now and consider how they conduct business across Europe, and where efficiencies can still be made. An evolving regulatory environment in the UK could spark innovation, attract new talent and push UK financial institutions to consider new areas of growth, like investing in clean technologies (Richard Hammell, UK head of financial services, Deloitte)
These quotes from senior industry practitioners make clear two things. First, they believe that the UK financial services industry was so well prepared for Brexit by setting up operations in the EU that they are now in a position to rationalise their pan-European operations to reduce costs. Second, they believe that London’s future as one of the world’s leading financial centres is secure so long as London adopts an evolving regulatory environment that sparks innovation and attracts new talent. This is very good news.
But we should not underestimate the battle ahead. The even more anti-Brexit Financial Times reports a ‘senior EU official’ as saying ‘you can’t expect the UK to remain a [financial services] hub for the EU. It’s not sustainable, and makes no sense in the mid-to-longer run, even if that drives up costs for some businesses’. Peter Foster, the author of the article, states that ‘The prevailing view in Brussels seems to be that given that dual regimes [for financial services and food etc] will emerge over time…it makes no sense to have the UK as an EU hub for very much. This penny is now starting to drop’.
We should also expect to see more scare stories like these over the next few months:
* City faces years of Brexit limbo in equivalence snag: ‘The liquidity has already shifted‘
The key issue is equivalence: ‘The UK is now in a very difficult position where Europe has the upper hand in any negotiation as the liquidity has already shifted.’
City firms may have to wait for ‘years’ for a meaningful UK-EU agreement on financial services, according to experts in the field.
The prospects are so bleak for anything more than the current bare-bones arrangements, according to some, that as far as the City is concerned it will be operating under no-deal Brexit conditions for the foreseeable future (Financial News, 6 January 2021).
* Morgan Stanley bolsters Frankfurt syndicate desk in wake of Brexit
Morgan Stanley is set to bolster its syndicate team in Frankfurt, as part of the US bank’s efforts to comply with new post-Brexit rules for UK-based finance firms (Financial News, 7 January 2021).
The idea that liquidity has already shifted to the EU is ridiculous. The idea that Frankfurt will replace London as Europe’s financial hub is equally ridiculous.
The EU’s hostility to our ‘Anglo-Saxon’ financial system runs very deep and goes back to the very origins of the European Economic Community.* We should therefore expect it to be very insistent that we follow their rules in order to access their single market. We should be equally insistent that we will do no such thing. This time we must not compromise. It’s time to stop another disaster.