With the start of 2021 ushering in a new era for Britain, having left the EU’s single market, the agreed trade deal continues to be debated and questioned. But with a deal on financial services to be negotiated separately in the coming months, there is uncertainty surrounding the sector which contributes around £130bn to the UK economy and provides 1.1 million jobs. With financial services such a huge export success for the UK, and London in particular, this article questions how Brexit will impact the financial services industry and London’s position as one of the world’s leading financial centres.
Immediate losses from Brexit
With the UK’s exit from the EU single market, UK financial services firms have lost their passporting rights allowing firms to sell their services in the EU from their UK base without additional regulatory clearances. In the first week of 2021, trading in EU shares fled London, with approximately €6.5bn in trades a day shifting to Paris, Amsterdam, and other continental locations, in a move to comply with Brussels’ share trading obligation forcing EU investors to trade EU stocks internally. The loss of passporting rights has resulted in traders being unable to speak to EU-based clients without an EU-based trader on the communication line. With 40% of the UK financial services’ exports going to the EU single market, the significant export markets developed on the foundations of passporting arrangements seem to be breaking down. More substantial than the shift in capacity or employment, has been the transfer of banking assets — mostly to Frankfurt — with £1.2tn having left London since the Brexit vote in 2016. Yet Brussels has agreed to roll over current arrangements for clearing euro-denominated derivatives, a business wholly dominated by London-based clearing houses. With London responsible for 84% of EU derivatives trading between 2016 and 2019, and an equivalence ruling being granted for 18 months in this business area, the losses in the context of the City of London at large may not be so consequential in the short-term.
Is the City of London under threat?
With a dedicated infrastructure built up around its financial services industry, London has established itself and fortified its competitive advantage in Europe as its premier financial hub. You cannot refute that London offers a plethora of non-mutually exclusive factors that entice both new investment and some of the world’s best talent into finance. The city’s globally distinguished education, entertainment, and arts is an attractive offer for new hires, providing a lifestyle unmatched elsewhere in Europe. The British rule of law and ecosystem around finance, with law firms and consultants in close proximity, provides greater efficiency for firms based in the metropole. Accordingly, David Schwimmer, chief executive of London Stock Exchange Group states he has “a lot of confidence in London and its positioning” due to its “winning combination”. This amalgamation of factors ensures London supersedes its European competitors, with fragmentation across Europe reducing competitor advantage.
However, US banks that have invested heavily in London are now starting to gradually shift capacity to Europe, in an attempt to spread their bets in an environment of uncertainty. Yet the shift is not as momentous as initially predicted — the estimated displacement of 10,000 jobs since 2016 is far less than the 232,000 predicted in a London Stock Exchange survey after the Brexit result was announced. Despite the relatively minimal scale of this shift, the next wave of multinational corporations may find London’s offer less appealing than they would have done pre-Brexit. We could potentially be seeing this trend take place at present, with multiple fintech firms already relocating or establishing new headquarters in Europe — Revolut, Curve, and Yapily have all set up their base in Lithuania in the last few years. This stems from ease of access to deep European markets and strong government development of sector infrastructure and ecosystem. With home working threatening the demand for cities — and in particular London, with its expensive housing and long, tiring commutes on public transport — the long-term attraction of a post-Brexit City of London could be very different to that of the present.
An equivalence deal recognises the quality of UK regulations and aids cross-border sales between the UK and the EU. It recognises the alignment between the rules and supervisory standards of the UK and the EU, enabling greater access to the European market. Despite the UK granting EU access to its domestic market in 28 areas of financial services — including exchanges, investment firms, and credit rating agencies — the EU has failed to reciprocate this, denying equivalence rulings to many sectors of our financial services industry. The UK’s outcomes-based proposal, in which markets are deemed to be equivalent if the same standards are achieved regardless of different supervisory arrangements, was bluntly rejected by the EU. The rejection was founded on the European concern of UK regulatory divergence from the EU, with recent remarks from the Chancellor of the Exchequer signalling the UK could embark on an era of deregulation. This uncertainty surrounding the UK’s regulatory framework is a sticking point for any equivalence ruling on financial services. Despite an agreement in the Brexit trade deal to draw up a memorandum of understanding on UK-EU regulatory cooperation by March, this falls short of a replacement for the certainty of single market access and passporting rights.
Opportunities for UK financial services post-Brexit
Divergence from EU policy
Rishi Sunak, UK Chancellor of the Exchequer, has claimed that the new regulatory autonomy that the UK has achieved through Brexit could in fact boost financial services and enable Britain to further establish its dominance as a global financial centre. With an independent regulatory framework, financiers could potentially seek fast-growing business lines to add to the well-established global FX and derivatives trading that London is globally renowned for. For example, a 2019 EU ban on the trading of Swiss shares excluded the UK from trading in hundreds of Swiss stocks and a market size of €1.2bn a day in trade. Trading in Swiss shares is expected to be brought back to London by mid-February, marking the first significant split from EU policy on financial services and is a hallmark gesture of UK financial regulatory independence. The UK are also looking at a review of the listing regime for technology companies, as well as expanding Islamic finance and improving the flow of capital to life sciences.
A key staple of the UK’s future plans for financial services is to become a world-leading green finance hub, on the back of a global shift towards green energy and sustainable projects which accelerated in 2020. With the COP26 international climate talks set to be held in Glasgow this year, the UK is positioning itself to pioneer the way and channel more private capital into sustainable projects, financing the transition to a greener economy in the long-term. Financial services are set to be a “critical enabler” in the UK’s efforts to hit its net zero-carbon target by 2050, with the Chancellor pledging to launch the UK’s first “green gilt” in 2021 to help fund low-carbon infrastructure projects. The UK Sustainable Investment and Finance Association has called on the UK government to adopt an “EU plan plus” in order to mirror and improve upon the EU’s landmark sustainable finance regulation.
Deregulation: Big Bang 2.0?
The Big Bang
The “Big Bang” is the moniker associated with the era of financial deregulation that occurred under Margaret Thatcher in the 1980s. This entailed abolishing minimum fixed commissions on trades, the separation between those who traded stocks and shares and those who advised investors was ended, and foreign firms were allowed to own UK brokers, opening up London to huge investment by international banks. Sir George Bolton believed that if capital could flow more freely, then London, with its expertise and traditions, would benefit hugely — and it did. The financial deregulation and electronic trading transformation of the 1980s helped London outpace its European competitors, and clearly establish itself as the frontrunner to challenge Wall Street’s dominance.
A regulatory “race to the bottom”?
However, lessons need to be drawn from the 2008 financial crisis as to the dangers of deregulation. A new era of deregulation post-Brexit, (as implied by the Chancellor’s comments of a “Big Bang 2.0” and the Prime Minister appealing executives for ideas to cut regulatory and legislative burdens) could attract new enterprise and pave the way for innovation in high-growth sectors. Conversely, it could also lead the UK down a perilous and unsustainable path if not handled correctly and with due diligence. This is considered to be the most significant barrier to any EU equivalence ruling on UK financial services, with concerns as to the delicate balancing act the UK will strike with its independent regulatory framework. Financial regulation provides the rule of the game, it is only right that innovation should be promoted in a fashion that can be sustained indefinitely. Good quality regulations will allow UK financial services to inspire confidence from its customers over the long-run, and good governance should underpin London’s evolution in a sustainable way. A course of reregulation rather than deregulation may be the most effective path for UK financial services post-Brexit.