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Managing Brexit in Financial Services

Nicholas Sowels
p. 141-159

Résumés

Cet article a pour objectif de passer en revue les principaux défis posés par le Brexit aux services financiers basés au Royaume-Uni et à l’Union européenne. Il avance l’idée que les institutions financières ayant anticipé la possibilité d’un Brexit sans accord, les risques les plus graves d’instabilité financière sont moindres. Cependant, à long terme, le Brexit soulève des problèmes réglementaires importants, car l’accès au marché européen fondé sur « l’équivalence » sera beaucoup plus difficile que l’accès automatique actuel fondé sur la reconnaissance mutuelle et les « droits de passeport ». Ce processus engendrera des côuts pour le Royaume-Uni comme pour l’UE.

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Introduction

1Financial services had the potential for being one of the most contentious sectors in the Brexit negotiations, and perhaps the most risky. To be sure, at the time of writing (mid-February 2019), the unfolding of Brexit remains fundamentally uncertain, and there is a real possibility of a no-deal crash out Brexit at the end of March 2019. However, the likely impact of Brexit for financial services seems fairly clear. There are hurdles that will need to be crossed, and some may still turn out to be tricky, if not outright confrontational. But the worries about calamitous breakdowns, as sketched out in the event of a no-deal Brexit in other sectors like food, pharmaceuticals, do not seem to be threatening financial services – at least not yet.

  • 1 See the definition of ‘passporting’ Note 24 in Martine Azuelos’ contribution.

2There are several explanations for this. To begin with, following Theresa May’s Lancaster House speech in January 2017, it became cler that UK-based financial service companies will lose their passporting rights1 to operate in the EU market, and so financial businesses have had some indication of where the future economic relationship between the UK and the EU will take them. Significantly, the replacement of passporting rights by so-called equivalence recognition allowing mutual market access will not affect financial activities uniformly. Banking services will be excluded from any future equivalence regime, for example. But then, the big international banks are either already fully-present in other European countries, or in the process of moving operations. Such adjustments are not easy and may be costly, but for major players they are manageable. Similarly, regulators are aware of the importance of preventing major instability in financial markets. Given the resources available to financial services companies and regulators on the whole, the sector has had capacity to plan for events as they unfold, although big questions still need to be tackled, such as the future of euro-denominated derivative trading in London. Lastly, financial services by their nature are today largely traded and delivered via Internet and telecommunications : they do not face the same physical obstacles to movement that trade in goods. So the challenges lie elsewhere.

3This article begins by looking at some of the problems raised by a no-deal crash out. It then reviews key issues concerning service sector trade under WTO rules, before looking at the issue of equivalence, which is most likely to be central to future trade in financial services between the UK and the EU, whatever the long-term trade arrangements the two parties eventually agree to. The following section returns to the question of euro-denominated derivative trading, which today takes places largely in London. Finally, the article examines some of the broader economic questions raised by Brexit, including challenges for the EU.

Dealing with a crash-out no-deal Brexit 

  • 2 Britain is set to leave the EU at 11 pm London time on 29 March, a Friday.

4In the event of the UK crashing out of the EU with no deal at the end of March 2019, the impact on financial services is likely to be less visible immediately than in goods industries. This stems from the simple fact that financial services do not go through customs and border controls, so there will be no infrastructural bottlenecks similar to those that are likely to slow down trade flows in physical goods going through Dover. There should be no physical impediments to normal transactions taking place electronically the day after Brexit, although much will depend on what regulatory regime will be operating on 1st April, the first working day after Brexit.2

  • 3 HM Treasury, Banking, insurance and other financial services if there’s no Brexit deal: technical n (...)

5In particular, there are significant concerns about the legal void caused by leaving without a deal, and the implications this has especially for contract continuity in a whole range of services, notably for insurance contracts and derivative contracts. To date, the responses by authorities on both sides of the Channel appear to be asymmetric on these issues. In the UK, guidelines updated by HM Treasury in early 2019 stress that in the event of a no-deal Brexit, a Temporary Permissions Regime (TPR) will allow non-UK Central Counter Parties (CCPs ; i.e. exchanges on which standardised derivatives are traded – see below) to continue to provide clearing services to UK firms, for a period of up to three years, while they apply for recognition in the UK. This is in line with a more general policy of allowing a whole range of financial businesses from the European Economic Area which presently have passporting rights to continue operations in the UK for three years after exit, while they apply for full authorisation from UK regulators.3 It is a position coherent both with ensuring short-term financial stability – by avoiding immediate market disruptions after 29 March 2019 – and with supporting the future development of the UK and notably London as a global financial centre.

  • 4 Central securities depositories hold assets (shares and bonds) so that their change of ownership do (...)
  • 5 European Commission, Press release, ‘Brexit: European Commission implements “no-deal” Contingency A (...)

6On the EU side, contingency measures in the event of a no-deal Brexit are so far more limited. In line with the EU’s general approach of ensuring that leaving the EU is less advantageous than remaining in the Union, and that exiting with no deal is less favourable than exiting with a deal, the Commission has so far stated that only a limited number of contingency measures are necessary ‘to safeguard financial stability in the EU 27’, including : temporary and conditional equivalence for 12 months to prevent immediate disruption in the central clearing of derivatives ; temporary and conditional equivalence for 24 months for central securities depositories (of financial assets)4 in the UK, used by EU operators, etc.5

  • 6 ECB, press release, Statement: ECB and BoE convene joint technical working group on Brexit-related (...)
  • 7 The Financial Conduct Authority (FCA) came into force on 1 April 2013, following the Financial Serv (...)
  • 8 Brunsden J., Binham C., ‘UK and EU financial regulators to examine hard Brexit impact’, The Financi (...)
  • 9 As Janan Ganesh of the Financial Times noted later, when the Governor was being widely attacked by (...)

7More generally, aware of the risks of a no-deal crash out, the Bank of England and the European Central bank announced in April 2018 that they would ‘convene a technical working group on risk management in the period around 30 March 2019 in the area of financial services’.6 Speaking shortly before this official announcement, Andrew Bailey, chief executive of the UK Financial Conduct Authority,7 said that the EU and UK had a ‘common obligation to do everything we can’ to preserve financial stability.8 Whatever one’s views about central bankers, this suggests that there are still at least some ‘adults in the room’ with serious concerns about the risks to financial stability caused by Brexit, in an era of globally interconnected financial markets. Indeed, to some extent, we have been here before. On Friday 24 June 2016, when Britain’s political establishment woke up completely gobsmacked at the unexpected referendum result, it took Mark Carney, Governor of the Bank of England, to step up to the plate to calm markets.9 Unlike the politicians in Westminster, the Bank seems to have planned for the possibility of a Leave vote, surely haunted by the collapse of Lehman Brothers in September 2008 which sparked the full blown international financial crisis.

8As the clock winds down to Brexit, it seems likely that preparations are being made on both sides of the Channel, and within the global central banking community more broadly, to ensure financial stability in case of a crash out. This cannot of course provide guarantees against unforeseen events, but at least major identifiable threats should be dealt with.

  • 10 HM Treasury, ibid.

9That said, even if the financial authorities on both sides of the Channel are likely to do all they can to prevent severe instability resulting from a crash-out Brexit, it will still lead to numerous practical disruptions in daily business. In its guidelines updated in January 2019, HM Treasury points to numerous difficulties which individuals and companies could face in the absence temporary measures by the EU, including : loss of direct access to central payments infrastructure in the EU (such as TARGET 2 and the Single Euro Payments Area (SEPA)), meaning they could face higher transactions costs and longer delays ; higher card payment costs and possible surcharging ; difficulties for UK citizens living in Europe in accessing existing lending and deposits services provided by UK firms ; and an end to the ability of clients in the European Economic Area to use services provided by UK-based investment banks, etc.10

Leaving on WTO conditions

  • 11 Prime Minister, The Future Relationship between the United Kingdom and the European Union, Cm 9593, (...)

10Reverting to WTO rules is frequently put forward by muscular Brexiteers as a perfectly feasible strategy for the UK. They invariably mention that the many countries trade substantially with the EU on the basis of WTO rules. This is true, but it ignores the far greater economic integration achieved by the EU, notably through the Single Market. In particular, it ignores the fact that WTO trade liberalisation is generally far less advanced in services than in physical goods trade. Thus, the government’s White Paper of July 2018, the so-called ‘Chequers plan’, begins by noting the importance of services to the UK economy (79 % of gross value added) and the fact that in 2017, 21 % of EU27 service imports came from the UK, whereas 20 % of EU27 service exports went to UK.11

11The White Paper recalls that under the WTO’s General Agreement on Trade in Services (GATS) four modes for supplying services internationally are defined :

  • 12 Ibid.

i) a service crossing a border (provided by telephone for example); ii) a consumer of a service crossing a border (as in the case of tourism); iii) a service provider establishing a legal presence across a border (such as a retail chain setting up outlets in another country); and iv) a service provider crossing a border to a consumer (for example, a lawyer going to another country to provide legal advice to a client).12

12Significantly, the White Paper calls for measures which ‘build on’ these principles of international trade and the precedents of existing EU trade agreements. These include :

  • 13 Ibid.

i) ‘general provisions’ that minimise the introduction of discriminatory and non-discriminatory barriers to establishment, investment and the cross-border provision of services, with barriers only permitted where that is agreed upfront; ii) a system of mutual recognition of professional qualifications to enable professionals to provide services across the UK and the EU; iii) additional mutually beneficial arrangements for professional and business services; and iv) a new economic and regulatory arrangement for financial services.13

13While these proposals remain very general, they hint at numerous problems which moving to WTO trade arrangements raise for services. In particular, they are in effect calling for an extension of the principles of the Single Market in regulating service sector trade between the UK and the EU, in terms of non-discrimination and mutual recognition. In doing so, they repeat the usual contradictions of Britain’s Brexiteer approach of wanting to have one’s cake and eat it : in this case, continuing to have access to EU markets while also diverging in terms of regulations and escaping from EU law, as safeguarded by the European Court of Justice. Yet, in a report published in November 2018, the National Institute for Economic and Social Research (NIESR) unambiguously noted that :

The extent of service sector liberalisation under GATS is low. The number of sectors that the EU is prepared to open to non-EU countries is small and as a result of that the arrangements that are likely to be negotiated for services trade are likely to be less ambitious than the trade in goods.[…]

  • 14 Hantzsche A., Kara A., Young G., The Economic Effects of the Government’s Proposed Brexit Deal, Nat (...)

To date, the global experience with free trade agreements in services is scarce because comprehensive liberalisation requires regulatory alignment similar to that provided by the EU’s Single Market… […]. We therefore assume a reduction in services trade with the EU of 60 per cent, at the lower bound of empirical estimates ranging from 61 to 65 per cent.14

An Enhanced Equivalence Regime for Financial Services in a Future Free Trade Agreement between the EU and the UK

  • 15 Department for Exiting the European Union, Political Declaration Setting Out the Framework for the (...)

14Given this thwarted nature of service sector trade under WTO rules, it is not surprising that the Political Declaration Setting Out the Framework for the Future Relationship between the European Union and the United Kingdom published in November 2018 to accompany the Withdrawal Agreement calls for ‘ambitious, comprehensive and balanced arrangements on trade in services and investment’ and that the ‘Parties should aim to deliver a level of liberalisation in trade in services well beyond Parties’ World Trade Organization (WTO) commitments and building on recent [European] Union Free Trade Agreements (FTAs)’.15

15In order to achieve these goals, the Political Declaration calls on both parties to include ‘market access provisions and national treatment under host state rules for [each others’] service providers and investors’ in the future trade and economic cooperation regime to be negotiated after Brexit. The aim here is to ensure non-discrimination against each others’ firms, as is currently the case under the Single Market. More particularly, licensing procedures and specific regulatory provisions in sectors of ‘mutual interest’ such as telecommunications, financial services, delivery services and international maritime transport services are to be agreed in the future.

16For financial services, the key mechanism for ensuring bilateral market access lies in developing enhanced equivalence regimes. This means that regulators in the EU and the UK will provide market access on the basis that they will acknowledge each others’ regulatory and supervisory regimes as ‘equivalent for relevant purposes’. Such equivalence already exists for other third parties, and on Day 1 after the UK leaves the Single Market (be it 30 March 2019, 1 January 2021 or possibly a later date) the two regulatory regimes will obviously be the same. In the short term, there should be no problems providing market access on a reciprocal basis, as long as this is legally agreed and ratified quickly.

  • 16 The Directorate-General for Internal Policies summarises the equivalence regime in a Briefing entit (...)

17But there are caveats. To begin with, not all financial activities are accepted on the basis of equivalence. This is particularly the case of banking services, for which the EU does not accept equivalence. Under the EU’s Capital Requirements Directive (CRD IV) and Regulation (CRR), retail and wholesale banking services provided by UK-based financial institutions will not have access to the Single Market : equivalence is no substitute for passporting, and this is important to a significant amount of UK-EU business (see below). Similarly, investment services for retail customers (regulated by the EU’s Markets in Financial Instruments Directive and Regulation (MiFID II and MiFIR) will also no longer have access to the EU market. The same is true for investment funds regulated by the EU’s Undertakings for Collective Investment in Transferable Securities Directive 2009 (or UCITSD). Insurance will be the other major activity to be affected by the loss of passporting, under the EU’s Solvency II Directive, although re-insurance services (a wholesale activity between businesses) will continue to have access to the EU market.16

18At the end of 2018 and in early 2019, the UK approach, as formulated in the White Paper, has been to seek deeper market access than the EU equivalence regime would normally allow. On the UK side, the broad position is to support access to British markets for EU-based institutions, as part of its overall strategy of maintaining the position of London and the UK as a leading – if not the leading – global financial centre. In exchange, there is some hope that the EU will make special arrangements for UK-based companies. There are arguably some grounds for hope here, as loss of access to UK-based services is likely to raise borrowing costs generally for EU households, firms and possibly even governments : a reduction in competition, any closing off of Europe’s deepest capital markets will likely lead to higher prices of capital (i.e. higher interest rates and transactions costs) as well as perhaps a narrowing of financial products available throughout the EU. The EU and Member States have a clear incentive to avoid such costs.

  • 17 An excellent summary of the difference between mutual recognition/passporting and equivalence is gi (...)

19However, continued market access without automatic passports, based on enhanced equivalence may not come about quite so easily. Under mutual recognition and passporting, the default position is one of near-automatic market access across all EU Member States. By contrast, under equivalence procedures, the default position requires authorities to examine the legislation and regulatory framework of the other negotiating party and validate that there are sufficient guarantees to allow market access. For the EU, this is a relatively complex and cumbersome process. Initial assessment is done by arm’s-length EU agencies, with the final decision being taken by the EU Commission, policed by a regulatory committee of Member States’ representatives who must positively approve the decision. The European Parliament does not have a formal role in this process, but its observers are invited to meetings where decisions by the regulatory committee are made. The Commission, for its part, must stick to its remit under powers granted to it by EU Directives, and the European Court of Justice may review conformity with EU law. Even if the UK leaves the EU with the same regime on Day 1, guaranteeing future market access which does not exist under present EU equivalence procedures will require negotiation and assessment and will surely take time. It will require agreements to be reached and signed. This will likely involve the continued sharing of some sort of a common rulebook as well as arbitration mechanisms for settling disputes. All of this can be done, but it is not automatic, and likely not to be easy, given the complexity of services involved, the need for consumer protection, as well as the care that all parties have to take concerning financial stability and clear lines of responsibility for dealing with difficulties, especially possible financial shocks in the future. If there is a deal and hence a transition period under which the status quo prevails, this will of course help, but the equivalence assessment process is likely to be long, and in some ways never-ending as new financial products and services in the future will require new assessments.17

  • 18 Ibid.

20Compounding the difficulties of moving from passporting to equivalence are the ambiguities of the British position on future regulation of financial services.18 On the one hand, certain aspects of re-regulation since the financial crisis have been more demanding in the UK than in the rest of Europe, and arguably Britain may pursue a competitive strategy based on better regulation than in the EU. It is noteworthy for example that British regulators have pushed for higher capital ratios to protect bank solvency than their EU counterparts. Similarly, structural change has been greater in the UK than in the other major EU countries because British banks have been obliged to ‘ring fence’ their commercial/retail activities from their investment bank activities. This process has taken years to implement, but as of 2019, commercial banking activities as well as their assets and accounts have been separated out within banking groups so that they should be protected in banking crises arising in groups’ investment banking activities. Also, since 2016, a Senior Managers Regime has been established by the Financial Conduct Authority to improve bank governance by increasing individual accountability and responsibility in deposit taking institutions and investment firms operating in the UK. As of December 2018, this has also been extended to insurers.

21On the other hand, the essential strategy of hard Brexiteers in the Conservative party and free-market think tanks like the Institute for Economic Affairs is that Britain should develop its competitive position through deregulation. As part of the London market already acts as an off-shore banking centre and de facto tax haven – connected with other international tax havens that are still British dependencies (the Channel Islands, the Cayman Islands, etc.) – there will be legitimate concerns in the EU that the UK may push for both market access and deregulation at the same time. The only way of dealing with this is likely to involve the continual assessment of equivalence.

Euro-denominated derivative trading

  • 19 J.,Brunsden J., Stafford P., ‘What is London’s clearing market and why is Brussels worried?’, The F (...)
  • 20 Mayor of London, ‘Future of London’s Euro clearing business on agenda’, 12 November 2018, Press rel (...)

22Aside from the impact on banking, Brexit is likely to have long term consequences on London as a centre for euro-denominated derivatives trading. This is currently an important activity for London, where it is estimated that about 80 to 90 % of euro-denominated derivatives are currently traded : daily trading volumes can exceed a notional $ 900 billion.19 In the event of hard Brexit, an agreement has been reached which will allow London to continue doing such business temporarily.20 But over the longer term, Brexit is likely to lead to a push by various European authorities to bring much derivative trading within the jurisdiction of the European Union, and ultimately the Eurozone. This could lead to significant frictions between the UK and the EU down the line, as they negotiate a future trade arrangement. The shift of derivatives trading to the Eurozone will however not be easy. It entails possible risks of financial instability and will very likely lead to higher financial transactions costs for European borrowers (governments, companies and households).

23As with historical trading in futures contracts on commodities, actors in the real economy use derivatives as a form of protection or hedge against unexpected price movements : for example, farmers may use derivatives to ensure that they get a fixed price for their output at harvest. According to the European Securities and Markets Authority (ESMA), 69 % percent global derivatives trading occurred in interest rate derivatives. Put very simply, these allow companies to swap variable interest rate payments (linked to central bank lending rates plus a mark-up), for fixed interest rate payments and so have greater certainty over the payments they have to make during the repayment period on loans. The counterparties to such swaps essentially speculate on the fact that the floating interest rate payments (plus the mark-up) will be less than the fixed rate payments over the maturity of the loan. Similar derivatives exist for foreign exchange rates, etc.

  • 21 Mersch Y., ‘Euro Clearing – the open race’, Keynote speech by Mr Mersch, Member of the Executive Bo (...)
  • 22 Stafford P., ‘Why clearing matters to the City of London’, The Financial Times, December 15, 2016.

24Since the re-regulation of finance following the 2007-08 financial crisis, trading in standardised derivatives in particular has to take place through so-called central counterparties (CCPs) : in 2009, 40 % of all interest rate derivatives contracts were cleared through CCPs, but by 2017 this had increased to 83 %.21 These are exchanges which provide transparency to trades but also, significantly, guarantee the two sides of a trade in case one party fails to honour its side of the contract. Such CCPs gain in cost efficiency by being big and booking a large number of trades. The larger the trading volumes, the lower the fixed (infrastructural) costs of the exchange and lower the relative impact of defaults on individual contracts. Relocating such business will not be easy : it could be technically difficult and perhaps risky in terms of financial stability, and it will likely entail higher costs for European business wishing to use derivatives. It has been estimated, for example, that forcing business currently conducted in London into the fragmented CCPs across the EU could raise margin costs (i.e. the capital that businesses have to place as collateral with the CCPs to limit the latters’ exposure in case of default) by as much as $ 77 billion.22

  • 23 Barker A., Stafford P., ‘Victory for UK over eurozone clearing houses’, The Financial Times, March (...)

25And yet it seems quite likely that over time the various European authorities (the European Central Bank (ECB), European Securities and Markets Authority, the European Commission etc.) will push for such derivative trading to be brought under their jurisdiction, in order to maintain conformity with European Market Infrastructure Regulation (or EMIR, which regulates CCPs), given concerns for financial stability. It should be recalled in particular that the ECB pushed for euro-denominated derivative trading to be brought into the Eurozone in 2011, following concerns that the London Clearing House (the main CCP owned by the London Stock Exchange) had increased margin payments on derivatives of Irish and Portuguese government bonds and thereby had contributed to a small extent to the sovereign debt crisis in the EU at the time. The British Chancellor of the Exchequer then (George Osborne) took the ECB to court, and in 2015 the EU general court found the ECB ‘[did] not have the competence necessary to regulate the activity of securities clearing systems’. As a result, the ECB could not force operations to occur in the Eurozone.23 As the UK leaves the European Union, pressure from EU regulators are reasserting themselves, and Britain would obviously no longer receive protection by the European courts as a Member State. For the UK, however, such moves may be considered as particularly hostile and protectionist. As a result, they could weigh on the negotiations around the future trading relationship between the EU and Britain.

Economic considerations and company strategies

  • 24 I heard this point being made by Olivier Guersant, the Director-general of Financial Stability, Fin (...)

26The possible tug-of-war over the location of CCPs and the upcoming negotiations over equivalence and market access mask the fundamental economic challenge which Brexit poses to the EU and the UK. The EU is going to lose its largest financial centre with Brexit, while UK-based financial services are going to lose automatic access to their European customer base. Both parties will have to adjust, and it will carry costs all round.24

  • 25 Wyman O., ‘The Impact of the UK’s exit from the EU on the UK-based financial services sector’, Octo (...)
  • 26 Noonan L., Jenkins P., Morris S., ‘Bank of America says no going back on its $400m plans for Brexit (...)

27At the end of 2016, the consulting company Oliver Wyman produced a much cited-study about the losses to UK-based finance which could follow from Brexit. According to this study, banking services benefit most from passporting, and access to the EU market contributes to a fifth of revenues generated (£ 23 billion to £ 27 billion). In the event of the UK’s relationship with the EU being based on World Trade Organisation rules, then 40-50 % of EU-related activity (£ 18-20 billion in earnings) would be at risk. This in turn would be accompanied by job losses in the order of 31-35,000 with alls in tax revenues of about £ 5 billion.25 Today, these figures look exaggerated, and announcement made by major banks in terms of relocating business have so far tended to be piecemeal. However, there is a steady trickle of banks and financial companies announcing the relocation of staff and business activities to various European financial centres. In mid-February 2019, for example, the Bank of America announced that it was moving $ 50bn of banking assets to an 800-person operation in Dublin while also creating a 500-strong trading business in Paris. The total costs of such relocations are estimated to run to a colossal $ 400 million. Not surprisingly, Bank of America has made clear not just that its European headquarters will henceforth be in Dublin, but also that ‘[t]here isn’t a return. That bridge has been pulled up’.26

  • 27 Szalay E., ‘How London won the race for the renminbi’, The Financial Times, February 8, 2019.
  • 28 TheCityUK, Key Facts about the UK as an International Financial Centre, October 2018.
  • 29 Ibid.

28At the same time, this example shows how the financial sector as a whole is probably in one of the strongest positions to manage Brexit. Whatever arrangements are ultimately adopted between the UK and the EU, taken collectively, financial services have the human and capital resources to adjust. The big global players will restructure their operations as required, to counter the effects of Brexit. What exactly this means for UK-based financial activities over the long-term is of course an open question. At the time of writing, few commentators are predicting a very dark future for London, arguing that London did not lose out when the UK decided not to join the Eurozone in the late 1990s, and pointing to the City’s historical capacity for reinventing itself. Much is made of the “eco-system” of not just financial services but all other types of complementary professional services (legal, accounting, IT, etc.) which cohabit in London and which will allow UK-based financial services to go after other markets across the globe. And there is truth in this : for example trading volumes of Chinese renminbi in London surpassed those of the pound against the euro at the end of 2018, following a deliberate strategy by British governments to attract international trading in the Chinese currency, which the Chinese authorities are seeking to promote as an international currency.27 The UK is also Europe’s and the world’s leading non-Muslim centre for Islamic banking for example.28 Similarly, Britain continues to attract strong investment in financial technology or FinTech : in the first half of 2018, the UK received more than $ 16 billion in FinTech investment, representing 28 % of total global investment in FinTech companies (with a value of $ 57.9billion), ahead of the United States which booked $ 14.2 billion in investment.29

  • 30 Gapper J., ‘Why European banks repeatedly fall short on Wall Street’, The Financial Times, February (...)

29That said, the loss of automatic market access to the European Single Market and the relocation of business by international financial institutions, in particular to the rest of Europe, will surely weaken Britain’s and especially London’s competitive edge, not so much in the rest of Europe, but with respect to New York and the major financial centres of Asia. Even leaving Brexit aside, the major US financial conglomerates have managed to outpace their European rivals since the financial crisis, and there are pressures from investors in banks like Barclay’s and Deutsche Bank to withdraw from investment banking on Wall Street and retreat into the more domestic activities of retail banking.30 Brexit and the fragmentation of the European markets could further weaken the global competitive position of European banks and so impact London.

30Moreover, the nationalism which has driven Brexit, and its attendant anti-immigrant discourse could well reduce the attractiveness of London as a global destination for talent seeking to work in financial services. Britain and especially London were global before the Brexit referendum : being a member of the EU has never prevented others from operating in global markets. Such openness to the world was part of London’s lure as a destination where foreigners were welcome to make it and is being tarnished by the whole Brexit process. Again, London will not be immediately threatened by any clear European rival, but its international edge will be chipped away as high-skilled footloose labour looks for other places to go.

31Turning to Europe, the challenge of Brexit is likely to persist for a long time. If we leave aside the temporary measures being adopted to preserve financial stability in the face of crash-out Brexit or look beyond the transition period in the case of a Deal, then the costs of finance will certainly rise throughout the European Union as automatic passporting is lost. These costs, in terms of less easy access to capital, higher interest rates, higher fees etc. will be borne across the board. There may also be regulatory consequences, as British expertise in finance is lost (at least in part) in the evolution of regulation across the European Union. A recent article by Bob Diamond, the controversial former CEO of Barclays, recalls for example how when he was working for Morgan Stanley in the early 1990s, he had been on the team which underwrote the first European currency bond issue by the Bank of England. This was one of the innovations which opened capital markets for financing government and then business operations. Brexit could well weaken financial innovation and regulatory design in the rest of the EU.

32Nor is another single European city likely to challenge London in the future. For the moment, the relocation of business out of the UK is moving to several other European cities, including Frankfurt, Paris, Dublin, Luxembourg and Amsterdam. As a result, no centre is likely to develop the ‘eco-system’ or benefit from what economic geographers call ‘agglomeration effects’ which characterise London. There will be a price to pay for this in terms of lower efficiency and so higher costs.

  • 31 A recent summary of these arguments was given by Howard Davies, formerly Director of the London Sch (...)

33However, it may not all be bad news. The British economy has been skewed for a long time by the massive importance of financial services and the London area. A more balanced distribution of financial services across other European cities has the advantage perhaps of not distorting national economic structures. Similarly, the outsized growth of finance in the UK, and more generally in the global economy, is a mixed benefit. Finance is widely described as being better at extracting wealth from other economic sectors and populations rather than creating new wealth, and as a result being detrimental to broad-balanced growth.31 A more fragmented and less powerful financial sector in the European Union may bring with it certain benefits in terms income and wealth equality.

Conclusion

34The worst risks of Brexit leading to financial stability will likely be avoided, as regulators in the UK, the EU and perhaps elsewhere have been examining them in the event of a no-deal crash out. Unexpected problems may still emerge, but there has been forward planning by regulators, mirroring the way the Bank of England appeared to be the only body in the UK to have planned for a pro-Brexit referendum result in June 2016. The idea behind such measures is to ensure contract continuity and to allow temporary, continued access of to financial services providers across the Channel, especially access to the euro-denominated derivative markets in London.

35Everything else however seems open. As Britain will leave the Single Market, automatic access by UK-based financial services to markets throughout the EU via passports based on the principle of mutual recognition will end. The British position seems to be to seek continued access to the European market, based on enhanced ‘equivalence’ procedures which mean that both parties will except each other’s financial market regulations as being equivalent to their own and hence provide market access to each others’ financial companies. While such regulatory equivalence will obviously be easy to prove on Day 1 of the UK quitting the Single Market, it is unlikely to be applied to certain financial services by the EU (notably banking), and more generally will require continued surveillance of regulatory changes. This new regime, even with the best of good will, is likely to be far less favourable than membership of the EU.

36Over the long term, the EU will have to adapt to losing its main financial centre and the UK will have to adapt to losing some of its EU customer base. There will be losses all round in the process. The UK, and London in particular are likely to see their international competitive edge eroded vis-à-vis the world’s other major financial centres (notably New York), although Britain will likely succeed in developing other areas of international business. For Europe, the costs of finance will likely rise all round, affecting public and private borrowers. However, it is possible that services within the Eurozone will expand, in a more fragmented and hence dispersed way. This will likely mean higher costs, but perhaps help with more balanced growth and development in the EU.

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Bibliographie

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Directorate-General for Internal Policies, ‘Third-country equivalence in EU banking legislation’, 12 July 2017, available at : http://www.europarl.europa.eu/RegData/etudes/BRIE/2016/587369/IPOL_BRI(2016)587369_EN.pdf, retrieved 11 February 2019.

European Central Bank, press release, Statement : ‘ECB and BoE convene joint technical working group on Brexit-related risks’, 27 April 2018, https://www.ecb.europa.eu/press/pr/date/2018/html/ecb.pr180427_5.en.html, retrieved 2 February 2019.

European Commission, Press release, ‘Brexit : European Commission implements “no-deal” Contingency Action Plan in specific sectors’, Brussels, 19 December 2018, at http://europa.eu/rapid/press-release_IP-18-6851_en.htm, retrieved 4 February 2019.

Ganesh, J., ‘Brexiters who bully central banker Mark Carney will target others’, The Financial Times, October 31, 2016.

Gapper, J., ‘Why European banks repeatedly fall short on Wall Street’, The Financial Times, February 15, 2019.

Hantzsche, A., Kara, A., and Young, G., The Economic Effects of the Government’s Proposed Brexit Deal, National Institute of Economic and Social Research, 26 November 2018.

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Mayor of London, ‘Future of London’s Euro clearing business on agenda’, 12 November 2018, Press release, at https://www.london.gov.uk/press-releases/mayoral/londons-euro-clearing-business-on-agenda, 15 February 2019.

Mersch, Y., ‘Euro Clearing – the open race’, Keynote speech at the Frankfurt Finance Summit, Frankfurt, 29 May 2018, at https://www.ecb.europa.eu/press/key/date/2018/html/ecb.sp180529.en.html, 15 February 2019.

Noonan, L., Jenkins, P. and Morris, S., ‘Bank of America says no going back on its $ 400m plans for Brexit move’, The Financial Times, February 13, 2019.

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Wyman, O., ‘The Impact of the UK’s exit from the EU on the UK-based financial services sector’, October 2016, http://www.oliverwyman.com/content/dam/oliver-wyman/global/en/2016/oct/Brexit_POV.PDF, 7 November 2016.

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Notes

1 See the definition of ‘passporting’ Note 24 in Martine Azuelos’ contribution.

2 Britain is set to leave the EU at 11 pm London time on 29 March, a Friday.

3 HM Treasury, Banking, insurance and other financial services if there’s no Brexit deal: technical notice on financial services regulatory framework, updated 8 January 2019, at >https://www.gov.uk/government/publications/banking-insurance-and-other-financial-services-if-theres-no-brexit-deal/, retrieved 3 February 2019.

4 Central securities depositories hold assets (shares and bonds) so that their change of ownership does not entail longer delivery times when they are traded.

5 European Commission, Press release, ‘Brexit: European Commission implements “no-deal” Contingency Action Plan in specific sectors’, Brussels, 19 December 2018, at http://europa.eu/rapid/press-release_IP-18-6851_en.htm, retrieved 4 February 2019.

6 ECB, press release, Statement: ECB and BoE convene joint technical working group on Brexit-related risks, 27 April 2018, https://www.ecb.europa.eu/press/pr/date/2018/html/ecb.pr180427_5.en.html retrieved 2 February 2019.

7 The Financial Conduct Authority (FCA) came into force on 1 April 2013, following the Financial Services Act 2012. It succeeded the Financial Services Authority and is part of the new regulatory structure of financial services in the UK. The FCA acts independently of government, though it works with and alongside the Bank of England which has overall responsibility for regulating financial services.

8 Brunsden J., Binham C., ‘UK and EU financial regulators to examine hard Brexit impact’, The Financial Times, April 27, 2018.

9 As Janan Ganesh of the Financial Times noted later, when the Governor was being widely attacked by Brexiteers: ‘Into [the] eerie void, equipped with a lectern and baritone that suggested Morgan Freeman as the soothing US president in a disaster movie, Mark Carney appeared’, to reassure markets that the Bank was making £250 billion available to financial institutions if necessary. Ganesh went on to observe that, ‘[i]t takes some craft to play down a shock while making handsome provisions for it”, Ganesh J., ‘Brexiters who bully central banker Mark Carney will target others’, The Financial Times, October 31, 2016. Mark Carney’s short speech, ‘EU referendum result - Statement by the Governor of the Bank of England’ on 24th June 2019 can be viewed at: https://www.youtube.com/watch?v=IK3By6uQ8gU, 4 February 2019.

10 HM Treasury, ibid.

11 Prime Minister, The Future Relationship between the United Kingdom and the European Union, Cm 9593, July 2018, pp 25-31.

12 Ibid.

13 Ibid.

14 Hantzsche A., Kara A., Young G., The Economic Effects of the Government’s Proposed Brexit Deal, National Institute of Economic and Social Research, 26 November 2018.

15 Department for Exiting the European Union, Political Declaration Setting Out the Framework for the Future Relationship between the European Union and the United Kingdom, 25 November 2018.

16 The Directorate-General for Internal Policies summarises the equivalence regime in a Briefing entitled ‘Third-country equivalence in EU banking legislation’, 12 July 2017, http://www.europarl.europa.eu/RegData/etudes/BRIE/2016/587369/IPOL_BRI(2016)587369_EN.pdf retrieved 11 February 2019.

17 An excellent summary of the difference between mutual recognition/passporting and equivalence is given by Tarrant A., Holmes P., Kelemen R. Daniel, ‘Equivalence, mutual recognition in financial services and the UK negotiating position’, Briefing Paper 27, January 2019, UK Trade Policy Observatory (UKTPO), University of Sussex, at http://blogs.sussex.ac.uk/uktpo/publications/equivalence-in-financial-services/, 14 February 2019.

18 Ibid.

19 J.,Brunsden J., Stafford P., ‘What is London’s clearing market and why is Brussels worried?’, The Financial Times, June 13, 2017.

20 Mayor of London, ‘Future of London’s Euro clearing business on agenda’, 12 November 2018, Press release, at https://www.london.gov.uk/press-releases/mayoral/londons-euro-clearing-business-on-agenda, 15 February 2019.

21 Mersch Y., ‘Euro Clearing – the open race’, Keynote speech by Mr Mersch, Member of the Executive Board of the ECB, at the Frankfurt Finance Summit, Frankfurt, 29 May 2018, at https://www.ecb.europa.eu/press/key/date/2018/html/ecb.sp180529.en.html, 15 February 2019.

22 Stafford P., ‘Why clearing matters to the City of London’, The Financial Times, December 15, 2016.

23 Barker A., Stafford P., ‘Victory for UK over eurozone clearing houses’, The Financial Times, March 4, 2015.

24 I heard this point being made by Olivier Guersant, the Director-general of Financial Stability, Financial Services and Capital Markets Union (European Commission) at a conference on ‘Financial Regulation and Stability after Brexit’organized by the LabEx ReFi and the Centre Emil Bernheim of the Université Libre de Bruxelles, in Brussels on 21 November 2018.

25 Wyman O., ‘The Impact of the UK’s exit from the EU on the UK-based financial services sector’, October 2016, http://www.oliverwyman.com/content/dam/oliver-wyman/global/en/2016/oct/Brexit_POV.PDF, [retrieved 7 November 2016].

26 Noonan L., Jenkins P., Morris S., ‘Bank of America says no going back on its $400m plans for Brexit move’, The Financial Times, February 13, 2019.

27 Szalay E., ‘How London won the race for the renminbi’, The Financial Times, February 8, 2019.

28 TheCityUK, Key Facts about the UK as an International Financial Centre, October 2018.

29 Ibid.

30 Gapper J., ‘Why European banks repeatedly fall short on Wall Street’, The Financial Times, February 15, 2019.

31 A recent summary of these arguments was given by Howard Davies, formerly Director of the London School of Economics and today chair of RBS, ‘The High Cost of High Finance’, Project Syndicate, October 18, 2018, at https://www.project-syndicate.org/commentary/high-price-of-financial-centers-by-howard-davies-2018-10, 16 February 2019.

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Référence papier

Nicholas Sowels, « Managing Brexit in Financial Services », Observatoire de la société britannique, 24 | 2019, 141-159.

Référence électronique

Nicholas Sowels, « Managing Brexit in Financial Services », Observatoire de la société britannique [En ligne], 24 | 2019, mis en ligne le 01 mai 2020, consulté le 28 octobre 2020. URL : http://journals.openedition.org/osb/3332 ; DOI : https://doi.org/10.4000/osb.3332

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Auteur

Nicholas Sowels

Maître de conférences à l'Université de Paris 1 Panthéon-Sorbonne

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