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London: A City with A Future?


In the maelstrom of news over the past few weeks that has put final riddance to the idea that nothing newsworthy happens over Christmas, it is easy to forget about Brexit. It is even easier to forget how the Trade Deal can be distinguished from the earlier Brexit Deal. And most importantly, the implications on the financial services industry are highly unclear.

Indeed, some sectors of the British media are treating it almost like it is game over, that the UK Government can now move onto other, more pressing concerns, like “Building Back Better”, while European capitals can instead move onto ever further integration, or co-ordinating their Covid responses.

This would over-state the extent of the most recent Trade Deal. Unfortunately for the City, this deal focuses almost entirely on the trade of physical goods, and key crunch areas, such as fishing – the bulk of the UK’s economy, the service sector, and in particular, the financial services, have been barely touched.

Boris Johnson, in a candid admission, conceded in an interview with the Sunday Telegraph that it “perhaps does not go as far as we would like” with regards to financial services. We have not yet escaped future news-cycles of ever-delayed “Final Deadlines”.

So, what actually is the state of play for the financial services industry at the moment?

Well, it is not looking good. In short, the UK lacks recognition of equivalence – that is, EU regulatory bodies have not recognised UK regulatory systems as “equivalent” to their EU counterparts.

Of course, it is important to remember that the situation varies according to different sectors – while some cross-border financial services “happen” in London, and hence do not require EU agreement, others, such as retail fund management do.

The impact of this can be best seen in share-trading, where lack of equivalence has forced all euro-denominated business to happen within the EU. In the first full trading day of 2021, almost €6bn of EU share trading moved towards European centres, away from the City of London.

One city where this was particularly pronounced was Amsterdam, with one city firm, Cboe Europe, announcing that close to 90% of its total share flows (more than €3.3bn) now took place in Amsterdam, up from almost zero before Brexit. Nearly 30% of all European share trading had taken place in the UK before Brexit, showing the scale of this change.

An example of the importance of this equivalence framework is the credit rating industry, where the ESMA has withdrawn its registration of six UK-based agencies, such as Fitch Ratings LTD and Moody’s Investors Service Ltd.

If it were not for these firms obtaining an endorsement from another EU-domiciled agency, their ratings, the backbone of the global economy, could not be used within the EU.

On a more extensive level, the UK financial services sector has also lost the right of passporting. Passporting, removing the jargon, is what allows for the (incomplete) EU single market in financial services. These nine Passports allow firms that are registered in any EU/EEA state to sell their services and trade relatively freely with one another, removing the need for additional authorisation. This is a step beyond the equivalence framework mentioned earlier.

These have been political decisions – arguably aiming to punish the UK for leaving the EU, or alternatively, to seek to outcompete the British financial services industry and encourage firms to relocate in Europe instead.

By contrast, the UK has granted equivalence to the EU, meaning that they can still gain access to the UK financial markets.

In short, the result is that Britain has begun its relationship with the EU as an independent state with fewer equivalence rights, and hence less market access, than competitor firms in, for instance, New York and Singapore.

We could, therefore, see a transition, or rebalancing of business away from the UK and towards those other markets.

Can Frankfurt replace London as Europe’s financial capital?

UK firms have already tried to mitigate this, setting up subsidiaries in European capitals. Emma Reynolds of TheCityUK notes accordingly: “our members already knew that this was coming so they have already set up subsidiaries in other financial centres around the EU”.

One particular country that has benefited has been the Netherlands, which building on its reputation for proprietary trading has been able to benefit from a movement of trading operations from UK companies.

Indeed, the lack of equivalence for UK financial services in Europe might lead to countries increasingly decide to list in European centres rather than in London, with an according shift in the location of IPOs – if firms cannot achieve the breadth and depth of financing and liquidity of share-trading in London, then it might make more sense to be listed elsewhere.

This could have a profound impact on IBD – if more companies want to be listed in Europe or need to be majority-owned/directed in Europe (take, for instance, firms such as IAG), then Investment Banking firms in Europe might find it easier to win business than their counterparts.

Alternatively, given that cities like New York and Shanghai have, at the moment, greater access to European markets than London, than it may be these behemoths that could gain advantage.

Unlike Frankfurt and Paris, it is New York in particular that has the scale and breadth of financial services to really challenge London. In doing so, European capitals, by seeking to outcompete London, might find themselves more reliant on the US.

What is clear, however, is that another deal will be necessary. Bob Wigley of UK Finance comments: “It will be important to build on the foundations of this trade deal by strengthening arrangements for future trade in financial services”.

In the meantime, it is not yet game over for London

As a financial centre its capacity far exceeds European capitals such as Amsterdam, Paris, and Frankfurt. European and global firms will, therefore, still want to do business in London, if only because it is the best location to fulfil their financial needs.

It is important not to over-state British decline. In 2019, the UK’s financial services trade surplus (£60.3bn) was almost as much as the US and Switzerland combined, the next two largest countries.

More importantly, 65.7% of said exports were to non-EU countries, which will be less affected by the lack of passporting and equivalence rights than their EU counterparts.

The importance of London can be seen in the sheer range of services at which it excels – from being the leading Forex market (with 2x as many US$ traded than in the US), to having 7.1% of total global foreign listings in 2019, to the UK’s legal and professional services.

Foreign Exchange trading (% share) April 2019 – Source: TheCityUK calculations based on Bank for International Settlements data

Moreover, leaving the EU might give the UK more options – the ability to diverge from EU regulation might allow the UK to make London a more attractive financial capital, for instance with reforming regulations like MiFiD.

So, what’s the final word?

In 2020, the UK came 2nd in Z/Yen’s Global Financial Centres Index, beaten out only by New York. With the loss of equivalence and of passporting, Brexit puts the UK at a disadvantage.

But it will take more for London to lose out substantially to its European competitors, who, for the most part, lack the requisite depth of financial services.

However, this should not detract from the key point – that a future deal will be necessary to secure the needs of the UK’s financial services industry, to achieve equivalence and passporting rights for UK firms.

Without these rights, then London may see itself slip in comparison to New York, Shanghai, and Frankfurt.

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