Whatever happens in the end in the negotiations on a Free Trade Agreement (FTA) between the United Kingdom and the European Union, the two parties are doomed to negotiate Brexit in Financial Services for years. This is because an FTA can only be modified by mutual agreement, but this is not the case in Financial Services, where the two parties believe they have the upper hand, have renounced a comprehensive agreement and have reserved the ability to unilaterally modify any partial agreement based on your interests. It will be a permanent battle, an endless divorce.
The key distinction is that, unlike trade, both London and Brussels will maintain their regulatory capacity in Finance. The British have imposed the most extreme ideological position of Brexit: sovereignty is above economic interest. Why? Because they believe that the City can walk alone for various reasons. One, because Europeans need the British financial industry more than vice versa (London controls 40% of European assets under management, 60% of capital markets, 78% of foreign exchange markets and 74% of derivatives ). Two, because the City’s business is geographically widely dispersed and it hopes to recover globally what it may lose at the European level. And, three, because when London modifies a regulation, its impact will be felt throughout the EU and not just in a specific area as can occur, for example, in a hypothetical conflict over olive oil.
Brussels has also emphasized sovereignty, in this case out of mistrust: out of fear that the United Kingdom will end up using it to promote financial deregulation to suit it.
All this has resulted in the decision of both parties to renounce the passport system that now exists and that guarantees that any financial company authorized to operate in a Member State can do so throughout the Community. Brussels because it sees it as a way for the City to remain in the Internal Market despite having left the EU. London, because the passport obliges you to comply 100% with any modification of the European regulatory framework.
Brussels has opted for the so-called equivalences, which allow it to authorize specific subsectors of the financial industry of a third country to operate in Community territory if it considers that its legislation, although different from the European one, has in practice similar effects (equivalent) to European rules.
The British are suspicious because it leaves power in the hands of Brussels (which can simply withdraw it with a month’s notice) but they accept it as a temporary fix. The equivalences are a very complex system that is applied to 49 different subsectors and that allows Brussels to modulate the generic maxim that “the more regulatory divergence, the less partnership”. If London modifies its regulation, Brussels may prevent the new rule from being applied in the EU. But London may not be thinking of Europe when it comes to modifying its financial regulations …
This being the case, should we expect financial chaos when the markets open on January 4, 2021? Not seem. “I don’t think there will be any sudden disruption because the financial industry has already put contingency plans in place and because many governments are already acting as if there is no agreement and will grant equivalency for cross-border operations that they consider necessary,” says John Springford, Deputy Director of the Center for European Reform think tank.
“I would not underestimate the risks,” warns William Wright, founder and president of New Financial, another think tank. “Half of the business of the British banking and financial services industry is domestic, a quarter comes from the EU and the other quarter comes from the rest of the world. We believe that between a third and a half of EU related revenue will have to be shifted. That means between 10% and 15% of the activity of the British financial industry, which is a huge turnover ”, he explains. The boss of an American bank in the City synthesized it like this: “It is a lot, it is significant, but it will not change our lives.”
A study by New Financial a year ago estimated that 330 companies have relocated to community territory “and I’m sure that now there are many more,” says Wrigh. And he explains that Barclays has already transferred more than 15% of its balance sheet from London to Dublin (“it is now the largest bank in Ireland”) and that JP Morgan announced the transfer of assets to Frankfurt for 200,000 million dollars.
Perhaps the most significant thing about these transfers is that they have gone to five different financial centers, depending on each subsector. “We are moving towards a multipolar and specialized model”, emphasizes William Wright, who emphasizes that each of the financial centers has monopolized companies in a subsector except Paris, where “a little of everything” has gone. The city that benefited the most is Dublin, which has captured a third of the transfers, especially asset managers. Vulture funds and private equity firms have chosen Luxembourg. The brokers have opted for Amsterdam. And the bank has taken refuge in Frankfurt.
David Blake, a finance professor at the Cass Business School under the City University of London, downplays these movements. “The day after Brexit we were told that the City would move 100,000 employees from London to the mainland. They have gone, mainly to Dublin, 7,500 out of a total of a million people employed in financial services in this country ”, proclaims this furious defender of Brexit.
“I don’t think the City has to be worried at all. You do business with people who want to do business, not people who want to put up barriers. We are not worried about Milan, Frankfurt or Paris. We are concerned about Shanghai and New York. We should be making deals with Singapore because that is where our business will be in the future. The global center of gravity is moving towards Asia. Europe is in decline. Do we have to be concerned about equivalence? About Barnier? No! ”, He concludes with a firmness in the background and a vehemence in the forms more typical of a Mediterranean than of a phlegmatic English.
“Europeans, and many people in this country, continue to think that Brexit was a mistake and believe that if they make it difficult for us, we will end up begging for reinstatement. They are resentful, ”says Blake. “Obviously we are facing a political process,” says John Springford with more courage. “The European Commission believes that if there is no trade deal before January, the UK will come back to the negotiating table later and wants to get as much advantage as possible in its hands. If there is no trade agreement, it will not grant equivalences in financial services apart from those sectors that may affect the financial stability of the EU itself ”. In fact, Brussels has granted equivalence for 18 months to the City’s clearing houses, although, in the opposite direction, investment banks will have to operate from within the community territory.
Within the EU there is a muted debate so as not to affect the unitary position of the Member States while they negotiate with London. Some, led by France, believe that the EU must have the long-term objective of repatriating the activity that is now taking place in the City of London. Others, led by the Netherlands and Scandinavians, “believe that the EU should be very cautious when it comes to diverging from the rules governing capital markets and should be as open as possible rather than have specific rules for the EU, ”explains Springford.
In other words, the financial Brexit is not just a battle between Brussels and London, it is also a conflict of models about whether it is better for Europe to remain in the City, or for the City to move to Europe.