Brexit and the City: Where do we go from here?

By Gareth Jones

This month marks one year since the end of the Brexit transition period and when UK financial services firms began operating under the new post-Brexit regime. For those wishing to assess these past 12 months on UK financial services (including banking, capital markets, asset management and insurance sectors), and the future prospects of the City of London under this new era, it is fair to say that the evidence so far is not overwhelmingly positive, but it is not particularly clear cut either.

When the Brexit transition period ended in January 2021, UK-based firms lost their passporting rights to provide services across EEA countries. Other potential ways of ensuring market access were not agreed – such as ‘equivalence’ (whereby UK financial services could have continued to have EU market access on the basis that their regulatory regimes were deemed equivalent). In the end, the trade deal signed between the EU and the UK contained very limited provisions in terms of market access, meaning that UK firms wishing to provide financial services across the Continent face significantly greater regulatory restrictions – and have had to shift operations, establish branches inside the bloc or simply forego the services they previously provided.

There was, of course, some immediate consequences for this change on the City of London in early 2021. Amsterdam quickly replaced London as the primary location for European share trading, while Amsterdam and New York also took a significant portion of Euro-denominated derivative trading from London. However, the mass exodus of business and jobs to other European cities that some predicted has not yet materialised. According to the EY’s Financial Services Brexit Tracker, around 7,600 financial services jobs have moved from the UK to the EU since 2016. This represents a fraction of the hundreds of thousands of jobs that some predicted would be lost (and an even smaller fraction of total UK financial services jobs).

Despite the increased barriers to trade, London remains Europe’s dominant financial hub – and will do for the foreseeable future. EU financial hubs – Paris, Frankfurt, Amsterdam (and to a lesser extent, Luxembourg and Dublin) – have all made efforts to attract business from the UK, with various incentives for investment bankers, hedge funds and asset managers to relocate. However, these cities recognise that they cannot match the scale and liquidity of London’s markets. London will remain globally dominant in several markets, such as clearing, foreign exchange and derivatives, and remains the best place for raising equity in Europe.

London’s crown is unlikely to slip anytime soon, but that doesn’t mean there are not significant risks for the City. Some commentators, such as the Financial Times, describe the effect of Brexit as a ‘slow puncture’ on the City. Others, such as London-based financial services lobby group, TheCityUK, note that “the real risk (for London) is not a 'big bang' but a slow deflation as activity moves to other centres, most probably in the US or Asia”. In some ways, the past year has been a period of uncertainty – exacerbated by Covid – in which a clear picture UK financial services post-Brexit has yet to emerge. As to what happens next, there are a number of key policy drivers which are likely to be significant in shaping the City’s future.

The first concerns the actions of policymakers in Brussels. A key objective of the EU is to ensure ‘strategic autonomy’ - there remains discomfort that EU-based companies are largely dependent on centres outside the bloc for their capital raising, bank lending and fund management. At policy level, this means pushing ahead on initiatives such as the Capital Markets Union, which seeks to harmonise rules and ensure that EU firms are better able to raise capital within the single market. There have also been moves to limit the level of financial services activity that can be undertaken outside the bloc. The AIFMD review, for instance, contains measures that could limit how EU funds are managed outside the bloc, by imposing delegation rules. A concerted and successful programme to ‘re-shore’ financial activity could, of course, have significant consequences for London – however, there are doubts about how quickly this could be achieved and the appetite from the Commission and member states to push through necessary reforms. Valdis Dombrovskis, European Commission’s vice-president, recently stated that: ‘We need to take the long view here: developing deeper capital markets in the EU is neither easy nor quick to do.”

The second factor concerns the actions of the UK government and regulators to ensure a competitive environment for UK financial services. There remains a significant political incentive for the current government to push for regulatory divergence – given that regulatory freedom was positioned as the key ‘win’ from trade negotiations. Many leading Conservatives believe the fortunes of the City depend on seizing the opportunities in new and emerging areas of finance (such as fintech and green finance) and by building closer links with financial centres outside of Europe. Last July, the Chancellor, Rishi Sunak, used his Mansion House speech (and accompanying paper) to set out a vision for the sector. This included commitments to implement at least parts of two government-commissioned reviews: the Lord Hill review on the UK’s companies listing regime and the Kalifa review on Fintech. Legislation is expected in the coming year to implement these reforms.

The last factor is the potential for improved relations between the UK and EU, and a better deal to be struck on financial services – allowing UK firms a degree of market access across the single market (and vice versa). If this was to happen, it would most likely involve an agreement on equivalence between governments and regulators. At the beginning of 2021, discussions took place between the UK and EU, with a view to establish a memorandum of understanding on the issue. However, talks were quickly abandoned by the two sides, in part because of tensions arising from disagreements surrounding the Northern Ireland Protocol. This perhaps is no longer a surprise – UK financial services have often found themselves in the position where their priorities are deemed secondary to the more immediate politics of Brexit. The UK government does not appear to be in any hurry to revive talks on financial regulation and internal Conservative Party politics on Northern Ireland suggest that relations with the EU could get worse before they get better. However, the current weakness in the Prime Minister’s position does generate uncertainty about what lies ahead. It is also worth noting the Labour Party under Sir Keir Starmer have been explicit in stating they would “seek regulatory equivalence for financial services” as a policy position (under a broader programme of ‘making Brexit work’). It may be the case that a deal is there to be struck in the longer term.

With much uncertainty and the effects of the pandemic still lingering, it is possible that the City of London has not yet fully entered the post-Brexit world. London may not be losing its crown as Europe’s financial centre anytime soon but it will hope that policymakers can ensure it remains competitive to maintain its position for the years to come.