In the weeks since the Brexit free-trade deal was announced on December 24, people in the UK have been coming to terms with the fact that “free” does not mean completely free. But while much of the focus has been on the Northern Irish border and the row over vaccines, the financial services sector, centred around the City of London, is also going through substantial upheaval.
The sector contributed £132 billion or 7% of the UK economy in 2019 and employs over 1 million people, half of them in banking. It came out of the talks with what is essentially a “no deal”, since services were not covered at all.
During the announcement, the UK prime minister, Boris Johnson, said that the deal “perhaps does not go as far as we would like” for financial services. This was primarily a reference to “equivalence”, which is the way that EU regulators grant market access to firms from a country outside the bloc, on the basis of deciding that the financial rules are similar to their own (and will remain so).
There was no such commitment to equivalence in the deal – only a memorandum of understanding that talks would stay open and there would be an agreement on financial services regulation by March 31 that would hopefully include equivalence. The City of London has been calling on Brussels to grant equivalence in these negotiations, but there is not much optimism that it will happen either in that timeframe or in any comprehensive way.
One major consequence is that UK financial institutions must trade euro-denominated shares and bonds from within the euro-bloc. Some temporary measures are in place to keep trades moving, such as the UK’s Financial Conduct Authority allowing UK companies to trade EU derivatives until June, but this business will also probably be lost after that.
One estimate from October 2020 suggested that even back then, £1.2 trillion in assets and 7,500 jobs had been moved in anticipation of what was to come. On the first day that trading shifted back to continental bourses on January 1, the volume amounted to nearly €6 billion (£5.3 billion).
There are still no signs of a mass exodus, however. For example, Deutsche Bank initially suggested that it may move up to 4,000 jobs to Frankfurt, but now that number looks more likely to be in the low hundreds. This could reflect a “wait-and-see” approach from financial institutions, or perhaps the benefits of being part of a cluster with a large support network of lawyers, accountants, risk specialists and so on, whose practices have evolved over decades to become world class.
Nonetheless, jobs relocated due to lack of equivalence are unlikely to come back if it is granted for particular market segments later, because routines and practices become settled. This could combine with the prospect of the “all-in-one-place” benefits of locating in London being diminished by the pandemic – if Zoom meetings are increasingly the norm, is being part of a cluster of connected businesses in one area still as important?
But it’s not all bad news. One major City segment unaffected by Brexit is currency trading. While shares and bonds usually trade in the market where they are issued, currency trading takes place globally – mostly involving US dollar pairs, followed by pairs involving the euro and yen.
The UK has 43% of the global forex market, and this has increased by six percentage points in three years. The next highest is the US, with 16.5% and declining, while the Asian centres of Japan, Hong Kong and Singapore have predominantly been static.
In forex, London has several important advantages. The location and timezone are a midpoint between the US and Asia. It has scale in having such a significant number of international banks in one city, plus the network of supporting services. By comparison, EU expertise is scattered among centres such as Amsterdam, Frankfurt and Dublin. London also has the infrastructure required for state-of-the-art high-frequency trading, not least the transatlantic cabling landing stations and data centres.
So London will probably continue to dominate this market, and is well placed to benefit from a likely rise in the trade in emerging markets currencies. Their total trade now exceeds the yen, with the Chinese remnimbi the largest. Outside Hong Kong, more remnimbi are traded in London than anywhere else – more than £300 billion worth in 2019. London has also seen an increase in the issuance of remnimbi-denominated bonds issued outside of China (known as “dim sum bonds”).
In important areas like these, London will be competing much more with Asia than with Europe. London is also likely to continue to be a world leader in providing a place where disputes can be resolved and best practices can be monitored and maintained.
The right approach to the future
The pre-eminence in finance that London enjoys because of its cluster of specialists points to a vital issue as the UK emerges from Brexit: the key to the future is to maintain and enhance standards and regulatory oversight so that major firms continue to have confidence in London as a place to do business, resolve disputes and so on. Get this right and they will continue to invest.
No longer having to coordinate and agree with 27 EU countries should enable the UK to be more nimble in this regard, which could be a big advantage in attempting to corner emerging areas such as green investment and fintech. This could include developing and regulating new financial products that allow investors to positively engage with climate-change finance and cryptocurrencies. This would be a more beneficial approach to taking the financial sector forward than to focus on deregulation in a “big bang 2.0”.
The unavoidable reality is that financial services business and jobs will continue to be lost as a result of Brexit. But with a thoughtful, future-focused approach to managing the sector, there is also plenty of scope for it to rebound.