Since the Euromarket began in the 1960s, Europe’s capital markets have grown up, based increasingly on London. The City’s rise continued even after the creation of the euro in 1999, which left it outside this huge, innovative currency bloc. Now the UK is trying something still more radical: withdrawing from the EU. Is Brexit the death knell for the City?
For the managers of investment banks active in EMEA, and for many other financial firms, the central question in 2018 will be: what happens to the UK’s status in Europe’s financial markets — and how should we respond?
London owed its original pre-eminence to its long history of empire, commerce and finance, coupled with a flexible legal system and the right language for Americans. But at that time each country had its own regulatory system — business could form a hive wherever it found most attractive.
Modern financial markets are quite different — minutely regulated, and on an international basis. London owes its present strength in capital markets to serving the European Union, according to rules set in Brussels. It is clear to all that if Brexit is rough and chaotic, it could become very hard to supply financial services to EU clients from London.
“A smooth transition is critical,” says a senior banker at a UK bank. “If you take the worst possible outcome of a cliff edge Brexit — no trade agreements in place, no passporting, no equivalence — that is an issue for the UK and London as a financial centre. That is a lot of transactions that won’t be able to be carried out.”
Prime minister Theresa May’s deal on December 8 to open negotiations on the future relationship between the UK and EU delighted many, after nearly 18 months during which the chances of a hard and disorderly Brexit only seemed to be increasing.
But the deal sheds no light for financial firms trying to work o kames ut what they should do in this highly unstable situation.
“The Brexit outcome is still very uncertain,” says Sean Taor, head of debt capital markets and debt syndicate at RBC Capital Markets in London. “We don’t know if it will be a hard or soft Brexit. We don’t know if there will be a transition period. So it is hard to plan today for what might happen tomorrow.”
Banks have spent 2017 in energetic contingency planning and taking extensive legal advice. Some have applied for licences and subsidiaries on the Continent. But bankers still have no clarity on what they will need to do.
Taor says RBC has “options available to cover all eventualities, so that we can continue to service our clients under any scenario.”
Passport control
Passporting is the normal way for financial firms regulated in one European Economic Area country to gain permission to offer their services throughout the EEA, without needing to be separately regulated in each country.
Research by New Financial, a capital markets thinktank, found that 76% of all firms using passporting are located in the UK. If, as seems likely, the UK leaves the EEA when it leaves the EU on March 29 2019 — and passporting is no longer allowed — all these firms will have to find an alternative.
There is some reason to think the EU will be lenient. Firms authorised in the EEA will be affected when trying to do business in the UK, which remains the largest financial market in Europe on many measures.
But reformatting passporting arrangements is of paramount interest to all capital markets participants.
Investors face similar challenges to banks. The Undertakings for Collective Investment in Transferable Securities Directive (Ucits) allows investors to be passported through the EEA.
However, many UK fund houses already use a range of fund structures on the Continent. “We have a Dublin-based fund range,” says Adrian Hull, co-head of fixed income at Kames Capital in Edinburgh. “Having Luxembourg or Dublin-based funds is seen as an orderly arrangement in our industry.”
House-hunting
Unsure about passporting, banks are leaning towards a different, and costlier, solution. They will relocate some or all of their business into one or more EU states, to preserve access to the whole EU market. The complexity of staffing such locations means banks have already made extensive plans for this contingency.
“It’s difficult to put an absolute timeline on when banks will start putting their plans into place,” says Mark Lewellen, co-head of global debt capital markets and risk solutions at Barclays in London. “But clearly they don’t want to be implementing plans in the days running up to March 29. You can easily see a six to nine month lead time.”
RBC has a branch in London and RBC Europe Ltd is based there, but of its 5,300 staff in Europe, 3,000 are already outside the UK, in over 10 European cities. Taor says: “We have made some internal decisions on locations and premises, that are not public knowledge, to cover hard Brexit and the need to make swift decisions. We expect to get more clarity in regard to Brexit over the coming months and then a transition period.”
Bankers say the regulators in various countries are being helpful and engaging in dialogue with them.
“We get a lot of comfort that several regulators are very active in their discussions and are trying to make any potential transition as smooth as possible,” Taor says.
This is not just a business issue — there are personal considerations involved, too. “It’s frustrating,” says Taor. “We have a lot of European nationals who would like clarity. And many who would prefer to remain in London. However, I do think the messaging I read in the press around numbers of staff having to relocate is exaggerated — because at this stage I do not think anyone actually knows.”
Harmony wanted
Even if having an EU-based branch or subsidiary is a way to gain access to the EU market, there will still be challenging issues of how to serve the whole European client base, including the UK.
Ideally, market participants would like an agreement that would enable them to use similar working practices as those they have now. But there is no hard evidence for believing this will happen.
Sir Jon Cunliffe, the Bank of England’s deputy governor for financial stability, told a House of Lords committee in November: “For the main banking services there is no equivalence, there is only the passport. And our assumption was, once we left, a whole range of possibilities from nothing to everything was possible.”
It is at least expected that the capital markets regulation built up by the EU over many years will be the standard both sides commit to immediately after Brexit. That equivalence should allow for a smoother agreement of free trade in capital markets.
However, what happens when one regulator decides to change its rules?
Hull at Kames believes that may occur sooner than some people think. “What is the point of going down the route of Brexit and having the same regulatory regime for the next 10 years?” he says. “As politicians allude to, separation will offer the opportunity for competitive advantages to develop and using regulation to achieve that is certainly an option.”
Others reckon access to the EU market will be so important for the UK that it will hug European regulation as closely as possible.
Whatever happens, firms are determined not to let Brexit interrupt their business. “From a client perspective, none of this should be relevant,” says Hull. “It is up to us to provide an environment where a client doesn’t need to recognise any changes. There will be more work to be done to ensure that, and this will come at a cost, but the client experience is of the utmost importance.”
Taor is confident, too. “We might not get the plan or the Brexit we want, and it will likely come at some cost, but we’re fortunate we’re sized rightly that I do not think it will be too disruptive for our business,” he says.
“There will be an internal cost of dealing with these organisational and regulatory challenges, but you need to bear that to do business in the right way,” says Lewellen. “The most important thing for us as an institution is to be able to offer the same services to the same clients with the same level of quality.”
Financial firms, especially large ones, have the skills and resources to be able to cope with a changed environment. Sadly for London — and the UK economy as a whole — it cannot relocate. If business has to move away, it will be London’s loss.
Euro clearing tensions promise to continue into 2018 |
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| The skirmish over where euro derivatives should be cleared is so far the hottest battle in the coming Brexit wars over financial services. European regulators and policymakers alike have revived calls to seize the activity from clearing houses in London. In the firing line is LCH, the clearing house controlled by the London Stock Exchange Group, which clears more than 90% of all cleared interest rate swaps. A European Commission proposal, unveiled in June, could introduce more stringent oversight of foreign clearing houses. If passed, it could also forcibly relocate some “systemically important” foreign clearing houses to the European Union, with the permission of the relevant central bank and the European Securities Markets Authority. What European regulators may not have counted on was the intervention of Christopher Giancarlo, chairman of the Commodity Futures Trading Commission, the US derivatives regulator. Since being confirmed by the US Senate in August, he has been very outspoken on the issue, complaining about what he sees as the Commission’s attempt to impose “unilateral” change in the regulatory relationship between the EU and US. The two parties had signed an equivalence agreement on supervising clearing houses in 2016. This could be invalidated by the new EC proposal, which Giancarlo has said he would consider a “breach of trust”. If the two jurisdictions continue on their collision course, participants could suffer from market fragmentation. Christopher Arnold, partner at Mayer Brown in London, warns that the devil is in the detail. “The June proposal in its current form allows discretion among European institutions as to who goes on the list of the most systemically important central counterparties,” he says. “That is where Brexit politics could come into play, where clearing houses in London, and not the US, are identified as systemically important.” Giancarlo’s statements could be a way of showing his European colleagues that trying to apply the regulation to the US will not go down well. There will no doubt be more brinksmanship in the months to come. |
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