London’s dominance as European financial center threatened by post-Brexit politics and political wrangling.
Source: Bloomberg via GARP
(Bloomberg) — Talks on the post-Brexit future of European capital markets have largely avoided the toxic haggling of the broader negotiations — until now.
U.K. Chancellor of the Exchequer Sajid Javid and chief European Union negotiator Michel Barnier traded blows Tuesday as the two sides approach a self-imposed June deadline to make progress. The flashpoint is the very foundation of the future relationship: A policy called “equivalence” that would give U.K. firms continued access to the single market.
“I will have a bottle of champagne if the chancellor gets equivalence over the line,” said Alasdair Haynes, CEO of Aquis Exchange Plc, a pan-European equities venue in London. Without it, he said, “we will have a hard Brexit, costs will rise, we will all have to open offices in Europe and it will be very poor for business.”
Sparring over banking and financial markets now echoes the tensions in the whole EU-U.K. relationship. European Commission President Ursula von der Leyen warned Prime Minister Boris Johnson on Tuesday that Britain will need to go further in its commitments to the EU because of the “unique” level of access the nation would have to the bloc’s single market.
Whatever the outcome, any loss of efficiency in capital markets would lead to broad damage. The euro region’s economy is so fragile that the policy rate remains below zero. Across the channel, financial and related services account for about 8% of the British economy and approximately 11 pounds of every 100 in tax receipts, according to the CityUK lobby group.
Changing the Rules
The trouble is that the EU can withdraw equivalence in a matter of weeks, an unacceptably short window for policy makers and the international banks that have made London their regional hub. What’s more, EU officials are looking to amend the post-crisis financial rulebook known as MiFID II by walking away from concessions they made to the U.K. as a member, aiming to weaken the City of London.
Javid fired the first salvo Tuesday. He wants equivalence made permanent to ensure a “durable relationship.”
“We may choose to do things in the same way as the EU if it works for the U.K.,” Javid wrote in the CityAM newspaper. “But there will be differences, not least because as a global financial center the U.K. needs to keep pace with and drive international standards. Our starting point will be what’s right for the U.K.”
The EU’s rejection came within hours. “There will not be general, ongoing open-ended equivalence of the financial markets,” Barnier told the European Parliament in Strasbourg, France. “We will keep control of these tools, and we will retain the free hand to take our own decisions.”
Equivalence will replace the “passporting” rights that allow firms in London to operate freely across the 27 EU member states. In the aftermath of the 2016 Brexit referendum, supervisors recognized the potential for a “Lehman-like” meltdown if the U.K. left with no deal. For example, EU-based firms have derivatives contracts with a notional value of about 60 trillion pounds ($78 trillion) at U.K. clearinghouses. Regulators on both sides collaborated to prevent any such risk and lobbied lawmakers to take action.
Still, equivalence isn’t essential for the City’s survival. For some firms, the debate is moot: They had already moved operations and staff in anticipation of a no-deal Brexit. Others, such as hedge funds and insurers, would welcome the chance to escape what they see as burdensome regulation.
London’s Global Role
In addition to its role as the capital-raising destination for most companies in Europe, the Middle East and Africa, London is the heart of the world’s biggest interest-rate swaps market; the primary venue for trading aluminum, copper and other industrial metals; and home to Brent crude oil, a global benchmark.
The U.K. formally left the EU on Jan. 31. A trade deal must be concluded in less than 11 months in order to avoid a cliff-edge exit.
“Permanent equivalence is a pipe dream; the EU will never compromise its power to suspend unilaterally,” said Tim Maloney, a financial-services lawyer in London at Dorsey & Whitney. The EU will regard U.K. financial-services access “as one of its key points of leverage in the forthcoming trade negotiations,” he said.
Even before Barnier’s remarks, the Europeans were emphasizing that they will decide whether London firms get access to the EU market, and they intend to determine whether the U.K. rulebook is tough enough.
“There are going to be some challenging conversations to be had over the next few months,” said Catherine McGuinness, policy chair for the City of London Corp., which administers London’s financial district.
The U.K. Treasury wants an “outcomes-based approach,” meaning that the two sides should consider whether the rules produce the same results for the market and for oversight of firms, rather than being identical on paper.
The European Securities and Markets Authority, the Paris-based regulator for the bloc, is already keeping close tabs on whether Britain follows EU rules this year.
“The EU has been moving towards a stricter approach to equivalence,” said Peter Bevan, head of Linklaters LLP’s financial-regulation practice in London. Indeed, he said, the EU has taken steps recently to make the process “more rigorous and stricter.”
For all that, there are signs that compromise is possible.
A U.K. Treasury document suggested that potential “landing zones” could include selective equivalence, joint declarations on cooperation, and “extensive” memorandums of understanding — at the cost of not including a chapter on financial services in the post-Brexit free trade agreement.