Concerns that the might of the UK’s financial sector would crumble post-Brexit seem not have been justified – so far. Can treasurers rest easy? Chris Biggs, Partner, Theta Global Advisors, offers his views on what the future holds.
Love it or loathe it, Brexit has brought about some major changes in the relationship between the UK and the European Union (EU). However, one of the most important discussion points that is yet to be resolved, since it was not part of the ‘deal’, is how the UK’s financial services sector will work with the EU’s own market to keep business flowing.
For many, this prolongs the uncertainty that has hung over the two trading partners since the initial Brexit referendum in 2016. One of the key points of this debate is whether or not the UK’s financial services sector will agree to regulatory equivalence with the EU. So far, it has remained a political football.
However, while Biggs feels the protracted wrangling is more political posturing than constructive negotiation, he believes it should not negate the innovation that the City of London has always demonstrated during the rise to its current status as a global financial hub.
What’s more, the promised exodus of jobs that once threatened to undermine the UK’s position has proven minimal, which should be seen as a vote of confidence. Although Biggs notes that Amsterdam has overtaken London as Europe’s largest share trading centre, he cites EY’s report that only 7,600 financial service roles have been moved from Britain to the EU since 2016. According to UK government figures, there were 1.1 million financial services positions in the UK in Q1 2020, so just 3.2% of all jobs have moved.
Both PwC and KPMG have expressed confidence that London will retain its status as a core financial hub, with or without equivalence. The Bank of England is certainly confident enough to say it will remove certain complexities for prudential policies for smaller lenders.
However, Biggs senses among financial market participants “considerable frustration” that this sector’s passporting of activities was dropped as part of the Brexit negotiations. Even with the issuance of a memorandum of understanding to guide negotiations, there seems to be little or no will on the part of the politicians on either side to find a quick solution, he says.
With around 25% of the UK’s financial services business EU-bound, the remaining business with the rest of the world has had to become a focus for the UK banking sector while the political posturing continues. This refocus may prove to be a lifeline. “There’s been a bit of a dent in the UK’s business with the EU, but London will survive and may even emerge the better for it,” comments Biggs.
The headline-grabbing predictions of an exodus of UK financial institutions (FIs) to the EU has, in reality, seen a number of players set up minimally staffed offices to take care of the business, with some even creating little more than a brass-plate office in the region, notes Biggs. Compared with the huge trading floors and back-office operations still in London, he says the reports have at times appeared somewhat sensationalist.
That said, it still could change. “I think people were under the impression that this would be resolved extremely quickly, so the movements were only ever seen as a temporary thing,” he says. “But while I think most have now settled into the understanding that this is going to take quite a bit longer, the ‘end-of-the world’ scenario where every bank in London shuts its doors because it can longer trade is still not going to happen.”
Although he feels that the inconvenience for FIs is far from over, and that some clients have already been lost, he admits that “it would be better to resolve this as quickly as possible to give stakeholders certainty”.
But what if there is no equivalence agreement; will it prove disastrous for both or either side? Biggs believes part of the reason why it is dragging on is that the British Chancellor of the Exchequer, Rishi Sunak, more than a little inadvisably, said that the UK wants to do things differently in the banking sector. This naturally forced the EU to consider exactly what he meant in terms of implementing equivalence.
If the UK decides to take a light-touch regulatory approach, for example, it could capture new business. But for Biggs, doing so may not ultimately serve the UK well. He explains that, for hundreds of years, the UK has been an exemplar of good governance in the financial world. If it now opts for minimal restraint on financial activities, it could damage its standing as a trusted location, not least in the eyes of investors.
For instance, emulating the recently sanctioned use in the US of special-purpose acquisition companies (SPACs) as a way of lightening the regulatory burden for company initial public offerings (IPOs) would, he feels, be a mistake. “Listing requires a huge amount of work, but it’s demanding for a reason; it gives consumers and investors confidence that the market is working as it should be.”
While Biggs acknowledges that there’s “a certain amount of current regulation that the UK can do without”, he does not believe major changes are necessary by the UK “to ensure easier trading while retaining its expertise and reputation for being a safe place to do banking business”.
Indeed, the UK still has a “huge role to play alongside the EU in trying to stabilise the rules across the regional market, and also on a global footing”, he notes. For this reason, while compromise on equivalence is almost inevitable, he says that “despite the politics, I’m sure business sense will soon kick in”.
The banking sector has been preparing for Brexit fallout for the past few years as a way of avoiding the cliff-edge scenario. It is fully aware that market stability calls for equivalence, and that the UK financial sector benefits hugely from trading across borders into the EU using the passporting approach. For Biggs, it’s therefore unlikely that the sector will ever lobby to become a cheap, low-tax offshore centre, preferring instead the gravitas that comes with its status as a global hub.
For the corporate treasurer, the level of impact created by Brexit and the equivalence debate depends to an extent on financial instruments being used and operational markets. But, notes Biggs, it is possible that the single prime banking relationship in London that managed everything is no longer possible. Instead it may be necessary to set up a separate counterparty in the EU.
While this is not a serious threat in itself – credit shrinkage is unlikely as a result, for example – the effort of managing a new counterparty on a day-to-day basis is real. From a regulatory and risk management perspective too, it means having to keep track of any and every regulatory divergence between the UK and the EU. The resulting corporate response must then be incorporated into treasury policy, and any potential significant impact must be acted upon. It adds up to more work.
Of course, the ultimate aim is to keep business flowing. Biggs accepts that “it won’t be as easy as if we had got everything agreed on day one of Brexit, but the UK market will continue and will find new opportunities to replace lost revenues”.
In the meantime, he has a clear solution. “I wish the politicians, regulators and authorities would get round the table now and just sort this out. That way we can all move on because the UK is as valuable to the EU as the EU is to the UK, and ultimately it will not be the banks that suffer but the banks’ customers.”