EU Financial Services Equivalence is not Working Assumption for UK
Despite an imminent Memorandum of Understanding between the UK and EU, a wider stand-off on financial services is likely to last for several more months
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In recent weeks, the relationship between the EU and UK has been dominated by discord over Covid-19 vaccines.
Meanwhile, there has been an equally strong divergence of opinion on the less emotive subject of financial services. The sector accounts for 7% of the UK’s economic output and it has an important influence on many other areas of the economy, including demand for residential property.
Three months after the UK and EU signed a trade deal that excluded financial services, both sides appear close to agreeing a Memorandum of Understanding. But what does that mean and how long before we know what the post-Brexit financial services landscape in the UK will look like in the long-term?
The total number of jobs that have moved from London to the EU is around 7,600 according to accountant EY. However, the pace has slowed markedly, with the total increasing by just 100 between October and February. It is a small number compared to initial predictions and investor demand for London offices remains strong. Some £46 billion of capital is targeting the office market in the capital, according to Knight Frank’s London Report.
Huw Jones is the European regulations correspondent at international newswire Reuters and has been covering the sector for 20 years. He says the granting of equivalence by the EU would be beneficial as it would allow London to continue some euro-denominated trading. However, he estimates equivalence talks will only relate to around 8% of overall UK financial services activity.
He tells Knight Frank why more clarity around the future of London’s financial services sector will come in the summer.
What is the status of talks on the Memorandum of Understanding?
Both sides are working towards an agreement but it’s important to remember that it will essentially be a talking shop. Both sets of regulators will sit down from time to time to shoot the breeze. It can’t make binding decisions and nobody is really expecting market access to follow. It is a completely separate exercise from the granting of equivalence. Despite some recent tension around the movement of goods to Northern Ireland, I’m sure a Memorandum of Understanding will be reached to reassure financial markets and show everyone that both sides are grown-ups.
So, will equivalence follow?
The working assumption on equivalence now is that it won’t happen. The EU will go away to consider equivalence but it’s clear this will be a slow process. The EU is dragging its feet because it is in their interest to do so. The more baked-in the new world order becomes, with euro share and derivative trading happening in the EU and not London, the better for the EU. Once brokers switch location they don’t want to switch back because of the costs. There is very little chance of euro share or derivative trading coming back to London.
Does this suggest a strained relationship, as we have seen with the recent vaccine disagreements?
The vaccine situation is probably not going to poison the atmosphere in the long term. Both sides are trying to find their way in a new relationship after a divorce and to follow the metaphor through, they will have to work together for the sake of the kids.
One issue is that the EU is a juggernaut in global trade and is one of the few trading blocs that can stand up to the US and China, so it is used to having a big influence. But it has to establish a pragmatic trading relationship with the UK. Things will eventually settle down, both sides are currently going through the phase of testing out each other’s territory and a lot of what is being said is aimed at a domestic audience.
One area yet to be resolved is euro clearing. What could happen there?
Euro clearing is one of the few things it would be useful for London to retain. The UK currently has an extension until June 2022 and after that it might get selective permission. It’s clear the EU is hoping to get some “plain vanilla” trading, which are parts of the clearing process that can be settled more easily. However, there are more complex and costly parts of euro clearing that may stay in London.
When will there be more clarity?
The focus has moved from equivalence to what the Treasury will do next to help the City. People are looking to a second consultation this summer from Number 11 that will be about boosting the competitiveness of the City. In the meantime, the government is keeping its powder dry and making noises about what happens if the UK doesn’t get equivalence. The consultation will give whopping great clues as to how the Treasury is thinking.
What could we see in the consultation?
The UK may make it easier for institutional investors and banks to trade with each other via what some call dark trading. This would demonstrate a clear philosophical difference between the UK and EU.
While the EU has misgivings about trading that does not take place through a main exchange, the UK doesn’t have a problem with it and it currently happens in North America and some parts of Asia. I think the UK will do what it can to roll out the regulatory red carpet for wholesale professional investors to trade here.
As well as fast-track visas for fintech workers and the easing of listing rules, the funds sector is another area to watch. The UK is a big base for asset managers that run funds from the EU.
Funds can outsource asset management on the basis that local managers have better knowledge of their markets. The UK has started a consultation for funds to be listed here and not just managed from here.
On the other hand, one of the main considerations for the UK is that some rules are global and it will have to operate within certain parameters. It will also not be keen to do anything that upsets Wall Street banks ahead of trade talks with the US.