London For the London financial industry, 2021 started with a shock. Around six billion euros of daily trading volume migrated from London to Amsterdam, Paris and other EU locations on the first trading day of the year. The British financial center lost almost half of its stock trading in one fell swoop.
“A spectacular own goal,” said Alasdair Haynes, head of the London stock exchange operator Aquis Exchange, to the financial service Bloomberg. Europe has clearly won the battle for stock trading. David Howson, president of competitor CBOE Europe, agreed: “EU equity trading is gone and will not come back.”
That the loss was not unexpected is little consolation. It is the most visible price for Brexit to date. The market turmoil feared by some did not materialize, but sentiment in the banks and fund houses is depressed.
From an EU perspective, Great Britain has been a third country since the New Year. And the Commission in Brussels has decided to strengthen its own capital markets at the expense of London. EU market participants are therefore only allowed to trade shares in European companies within the EU. Parts of the derivatives trade have also shifted – to the EU and to EU-equivalent locations such as New York.
For the “City”, as the London financial sector is called, Brexit means the most radical change since then Prime Minister Margaret Thatcher unleashed the financial markets with the “Big Bang” in the 1980s. Deregulation was followed by a decade-long boom that catapulted London into a league with New York. In the Docklands arose with Canary Wharf a new glittering banking district that expressed London’s new role.
Government spreads optimism
Is the decline now beginning under Thatcher’s successor Boris Johnson – or will Brexit trigger the next wave of liberalization? Opinions differ in London. The government is spreading optimism. In a video link with managers last week, the prime minister assured that the financial sector was of strategic importance and that everything would be done to promote it.
Finance Minister Rishi Sunak even speaks of the “Big Bang 2.0”. Brexit will strengthen London as a global financial center, he says. You can do things differently and better now. He wants to make London a Mecca for fintech companies and sustainable financial products.
Some hedge fund managers are calling for the city to be transformed into a “Singapore by the Thames” and for companies to be attracted with low tax rates. However, that is unlikely. For one thing, the government cannot afford major tax cuts because of the huge corona deficit. Recently, there has been speculation about an increase in corporate and capital gains tax. On the other hand, there is a lack of political will for radical deregulation.
Instead, the government is only considering turning a few screws:
- There are discussions about lowering the minimum IPO requirements in order to attract more foreign companies to the London Stock Exchange. In the future, companies could only put 10 percent of their shares on the stock exchange – instead of the previous minimum share of 25 percent. However, the proposal is highly controversial among London’s institutional investors because they fear for their rights.
- The British government wants to allow trading in Swiss shares again in the first quarter – and thus partially offset the loss in EU share trading. In the summer of 2019, the EU withdrew its stock exchange equivalence from Switzerland in a dispute over an economic framework agreement. Since then, Swiss shares have no longer been allowed to be traded in the EU. London and Zurich now want to recognize each other as equals again.
- Following the example of Dublin and Luxembourg, the government could make investment funds tax-neutral in order to attract more funds to London and prevent fund managers from migrating to the EU.
- In the longer term, the abolition of the maximum bonus for bankers would also be conceivable. This was introduced by the EU after the financial crisis in order to contain excesses. From a banking perspective, it only increases the fixed salaries and thus the operating costs. Such a gift to the banks would, however, be unpopular among the population – and from the government’s point of view in the midst of the economic crisis it would also send the wrong signal.
These possible innovations pale alongside the disadvantages that Brexit brings. On New Year’s Day, the British financial service providers lost their “passporting” rights. Before that, they could travel freely in the EU and offer their services. Both are no longer automatically allowed. The qualifications of lawyers and consultants are also no longer automatically recognized. The professional groups must now seek national licenses in each EU country in which they want to operate.
Resources in Europe are being redistributed
The result is a redistribution of work within Europe. Bank employees are only allowed to serve their EU customers from their branches in Frankfurt, Paris or other European financial centers. For example, if a London broker wants to call a European customer, he has to ask a colleague from an EU office to do so.
The companies have therefore already increased their offices on the European mainland before Brexit. So far, 7,500 jobs and £ 1.2 trillion assets have moved from London to the EU, according to consultancy EY. Further relocations are expected.
European customers could only be served from London again if the EU Commission classifies the British regulations as equivalent. Depending on the count, there are up to 40 separate equivalence decisions for different financial areas such as trading venues, asset managers, investment banks and clearing houses.
It is the same legal framework that financial firms from other third countries such as Switzerland, the USA or Japan work with. The disadvantages: The EU can terminate internal market access at any time within 30 days. And only a limited number of services are covered. There is no equivalence for insurance or the traditional bank lending and deposit business.
EU is delaying equivalence decisions
From a British perspective, this system is therefore suboptimal. The government is pushing for a more binding agreement with more say. In the free trade talks that ended at Christmas, the financial sector was left out. However, it has been agreed to sign a “Memorandum of Understanding” on future cooperation by March.
The expectations of the paper are low in London. In the best case scenario, they will agree on a few regulatory principles, says Andrew Gray, partner at the consultancy PriceWaterhouseCoopers (PwC). However, he does not expect a timetable for the equivalence decisions of the EU Commission.
Since the British set of rules is currently identical to the European one, there is no reason in terms of content to refuse recognition. However, the Commission is in no hurry: it wants to reduce the dependence of the European capital markets on London and guide further activities into the EU. She officially justifies her waiting by saying that she first wants to see the British future plans before she can declare London to be equivalent.
Bank of England: Equivalence would be better for both sides
This argument is “problematic”, criticized Andrew Bailey, Governor of the Bank of England recently. After all, rules on both sides would constantly evolve. He pointed out that Great Britain had already made 17 equivalence decisions for companies from the EU. Conversely, the EU has only recognized two areas so far, including the systemically important clearing houses.
“It would be better for both sides to have equivalence because open markets are advantageous,” said the British central bank chief. But if the EU sets too many conditions, “we cannot get involved”. Great Britain cannot be permanently bound by EU rules, but must have autonomy in the key sector.
Most British firms have already established themselves in the new world. No further equivalence decisions are expected from the EU for the time being, says Conor Lawlor from the UK Finance Association. “Companies can be successful without equivalence,” says Gray. The transition since the New Year went smoothly because the companies were well prepared. But the duplication of structures and the fragmentation of the markets will cause damage.
PwC puts the total economic costs at 1.3 percent of gross value added for Great Britain and 0.3 percent for the EU per year if the current situation persists.
An imminent change of heart in Brussels is unlikely. “The EU only grants equivalence if it is in its interest,” says William Wright of the New Financial think tank. There is an 18-month permit for London clearing houses because there are no alternatives in the EU. However, this equivalence will also end as soon as enough capacity has been built up on the mainland.
From Wright’s point of view, one advantage of Brexit is that the European Capital Markets Union is now being accelerated. “The Brexit and Corona have created new pressure to act in the EU,” he says. The European capital markets are underdeveloped and only account for 87 percent of economic output. In London they correspond to 171 percent of economic output so far.
Moving capital and expertise will narrow the gap, says Wright. For London, however, he does not see black: the city is big enough to cope with some losses.
More: Brexit bureaucracy is wreaking havoc in UK businesses.