By Huw Jones
LONDON, July 24 – Direct access for Britain’s financial sector to the European Union after Brexit is increasingly under threat as political will for an industry deal fades and the bloc toughens requirements for recognising other countries’ financial rules.
The EU is the City’s biggest customer, with financial services exports worth 26 billion pounds in 2017. Ensuring the UK’s large financial industry could still operate across the bloc from its home base was one of the central issues during early divorce talks after Britain voted to leave the EU in June 2016.
But as the EU and Britain quashed the industry’s hopes of largely unfettered access to the bloc, banks began moving around a trillion pounds of assets from London to new EU hubs, while trading worth around 240 billion euros a day in euro zone government bonds has moved to Milan and Amsterdam.
Despite the preparations, maintaining direct access would mean the sector could continue to leverage cross-border efficiencies of scale and avoid passing on the costs to customers of maintaining two hubs, one in Britain, the other in the EU.
Any access would be through “equivalence” – whereby the EU deems Britain’s rules to be aligned closely enough to its own – but Brexit has already prompted Brussels to toughen up equivalence conditions.
“You can ask for whatever you like in equivalence, but the chance of the EU going down that line is zero until they decide they need it,” said Sharon Bowles, a former chair of the European Parliament’s economic affairs committee.
Equivalence is used by firms much further afield in the United States, Singapore and Japan, but was never designed for a whole global financial centre on the EU’s doorstep and does not cover core financial activities like banking.
The preparations already undertaken by financial institutions in the wake of the political impasse have to some degree lessened the need for alignment and some are keen to break free of what they consider restrictive rules.
UK insurance firms, for example, have long complained that EU capital rules are too inflexible, but despite pressure from lawmakers, the Bank of England has been loathe to make any unilateral changes while in the bloc.
“I think that City opinion is more divided than a year ago on the merits of equivalence because of the reality of what it will look like in practice,” said Jonathan Herbst, global head of financial services at Norton Rose Fulbright law firm.
Given that any EU-UK trade deal would likely be based on a series of compromises across all sectors, like fishing rights and autos, a divided but well resourced financial sector may give Britain’s finance ministry less incentive to push for equivalence-based access to EU capital markets.
Brussels has said it will grant temporary equivalence for the London Stock Exchange’s unit LCH to continue clearing euro derivatives until March next year to avoid disruption if there is a no-deal Brexit in October, something seen as more likely under Boris Johnson, who becomes Britain’s Prime Minster on Wednesday.
That has helped London to retain the bulk of euro clearing, ironically the main thing that EU politicians said they wanted moved out of Britain after Brexit.
But it is unclear if that will be for the long term, or if there will be equivalence for investment services like trading stocks and bonds, which are regulated by EU MiFID securities rules.
“Investment services under MiFID is the golden thread that would allow you to keep sales in London,” a fund industry official said.
The EU’s markets watchdog has ruled that under a no-deal Brexit, euro shares must be traded inside the bloc, a signal that Brussels may want to deepen its own capital markets union by being tougher in granting equivalence.
Three UK-based pan-European platforms in London, Aquis , Turquoise and Cboe have already opened hubs in Amsterdam and Paris for EU customers to trade shares listed on other exchanges.
A hard Brexit would damage the prospects for equivalence by eroding goodwill in Brussels, said Nicolas Mackel, head of Luxembourg for Finance.
It could even prompt the bloc to review its temporary reprieve for euro clearing.
“The EU might very well decide that past derivatives inventories stay where they are, but mandate the clearing of all new business to the EU,” said Xavier Rolet, former London Stock Exchange chief executive and now head of fund management firm CQS.
The decision by the EU to allow equivalence for the Swiss stock exchange to lapse last month showed markets can adapt to major changes without disruption, added Christian Voigt, senior regulatory advisor at trading software company Fidessa.
“It would be a step back for the City and increase costs for users, but it would not kill the industry,” Voigt said.
It would be hard for the EU to suddenly cut off London when it comes to bond underwriting for companies and governments, said Simon Gleeson, a financial lawyer at Clifford Chance.
PIE IN THE SKY
The Bank of England and Financial Conduct Authority of Britain have warned Britain must not become a permanent “taker” of EU rules to obtain market access, tying the hands of UK regulators, a sentiment share by the government.
To mitigate this risk, Britain has called for the EU’s equivalence system to be “enhanced” or made more transparent and predictable to make it more acceptable.
Bowles said it was “pie in the sky” to expect the EU to radically reform equivalence to Britain’s liking in the short term.
In a reminder to London of what’s at stake, the European Commission is due to announce that it has scrapped equivalence based access for the first time because countries refused to keep up with EU rules.
“It is going to be difficult not to be closely aligned with EU rules,” said David Wright, the former top civil servant for financial services at the European Commission and now with Flint Global consultants.
($1 = 0.8937 euros) (Reporting by Huw Jones; Editing by Kirsten Donovan)