Article by Shaun Cheung, SOAS University of London
Although European cities have been steadily incubating respectable financial hubs of their own, the City of London has long dominated the financial services sector in the continent. In the days of yore, when the UK was still an EU member, the trading bloc was content with the status quo and enjoyed the comparative advantage brought about by the concentration of financial services. However, since getting spurned by its erstwhile companion, the Union has resolved to bolster financial services in its own territory and reduce reliance on London. To what extent has the financial industry in the UK diminished as a result? And to what extent will it diminish further? These are questions that are of concern to aspiring commercial lawyers in the UK and questions this article seeks to answer.
The EU’s policy agenda
For decades the EU had been building up its fledgling financial centres in cities such as Frankfurt, Paris, and Amsterdam into a world-class system in a project dubbed the Capital Markets Union. More recently, the common market has embarked on a strategic autonomy initiative to increase self-sufficiency in various strategic industries. Post-Brexit, both of these strategies, along with the concomitant political, economic, and social headwinds, have played a part in the redistribution of capital markets activity from the City to the up-and-comers in the EU.
In terms of strengthening its financial centres, the EU has renewed efforts to harmonise its capital markets, narrow legal and regulatory gaps, and tabled reforms to boost cross-border capital flows. It aims to overhaul EU listing rules to make it easier for small companies to tap public markets and chip away at the differences between national insolvency regimes. It also seeks to implement a pan-EU database of easily accessible corporate financial information and a ‘consolidated tape’ of capital market transactions.
With regard to strategic autonomy, EU officials have become wary of the systemic risks of relying on financial infrastructure that is not under the supervision of EU authorities. As a result, efforts have begun to absorb the clearing of euro-denominated derivatives, among other services, from London to the Union. To this end, there will be more burdensome bank capital requirements to force firms wishing to conduct business with the EU to park more capital in the EU. There will further be additional rules that incentivise foreign banks selling services in the single market to maintain substantial physical operations and staff in the EU.
Tangible blows to the City of London
In the nearly two years since the UK withdrew from the EU, firms have buckled under regulatory pressure to shift operations from the City to the EU. Two dozen large financial services firms have announced plans to migrate £1.3 trillion assets; Euronext, the EU’s largest stock market operator, is relocating its data centres from Essex to Bergamo in Italy. Around 3000 UK employees migrated to Paris since the Brexit vote amid wider Brexit-related migrations numbering about 8000. US firms have chosen Paris as opposed to London to set up its EU headquarters – JP Morgan is said to be increasing Paris staff from 250 to 800 this year, while hedge fund Citadel will also expand its team in the French capital. Amsterdam has overtaken London in trade volume, snatching away the coveted number-one spot in Europe.
Reports of London’s death have been greatly exaggerated
In contrast to the gloomy state of affairs the preceding facts may portray, the City of London’s status as the continent’s preeminent financial hub has proven obstinate. Across a wide swath of activities, including trading currencies, trading derivatives, clearing, insurance, private equity, raising equity, and international banking and borrowing, The City has thus far retained its edge as the leader in Europe. The EU had initially permitted European banks and fund managers to use UK clearing houses until June 2022. But it recently extended the deadline by three years to stave off market instability; much to the EU’s ire, 90% of euro-denominated derivatives are still traded in London. More than 400 thousand people are employed in financial services in London, and Brexit-related job migration, though numbering 8000, is significantly lower than the predicted tens of thousands. The UK’s financial markets as a portion of GDP is twice that of the EU.
Why London refuses to budge
Several factors contribute to London’s continued short to medium-term dominance.
Firstly, entrenched businesses and infrastructure in the UK have built up over decades and are costly to move. Transferring derivatives positions are estimated to cost several billion euros. Banks who have moved assets to the single market still rely on complex structures in London, such as the so-called back-to-back models, to run their operations. Correspondingly, the EU still trails the UK market in scale and liquidity, so reducing its reliance on the UK is challenging.
Secondly, there is a lack of political focus from the EU. Despite the aforementioned moves, some officials believe that more could be done. While Brexit created an excellent opportunity for the Capital Markets Union project to assume greater urgency, the idea was only briefly mentioned in the 2021 euro-summit statement. Also, the European Commission president Ursula von der Leyen left it out of her top priorities in her state of the union address in the same year. Moves to consolidate the bloc’s fragmented banking sector remain at a standstill due to strong groups blocking member states, the consequence being that reforms to expand from debt markets to including capital markets are yet to take place. An ongoing banking union project is also gathering dust on the shelf with no resolution on contentious remaining provisions, including pan-European common deposit insurance in sight.
Thirdly, fears of damaging market stability have slowed the pace of the transition.
The future
As the EU drags its financial sectors towards relevance, regulators are submitting proposals that will strongarm foreign banks into converting larger branches in the EU into fully capitalised subsidiaries and increase the required proportion of EU derivatives trades to use EU clearing houses. There will be no more extension of the permission for EU banks to use UK clearing houses after 2025.
The future is unwritten, but as things stand, Brexit has set the City of London on a course from being the centre of gravity for Europe’s financial sector towards becoming one of many co-orbiting stars. However, this relative decline may prove more sluggish than anticipated and could take years, if not decades, to pan out.
Sources
Sam Fleming and Philip Stafford and Laura Noonan, ‘ The EU vs the City of London: a slow puncture’ (Financial Times, 10 January 2022) <https://www.ft.com/content/f83ddf05-e7a1-4c9b-83ad-e82a54c71afa> accessed 28 November 2022.
Sam Fleming and Philip Stafford, ‘ EU plans 3-year extension to UK clearing system access’ (Financial Times, 18 January 2022) <https://www.ft.com/content/7bacef7c-60ac-4c0c-94df-a544fb9109d4> accessed 28 November 2022.
Sam Fleming and Philip Stafford, ‘ Brussels demands share of London derivatives clearing’ (Financial Times, 23 November 2022) <https://www.ft.com/content/da41d878-2e60-42ca-9b34-945efbef8af4?emailId=0c143e8e-b375-40b0-8857-4063fa1e8424&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22> accessed 28 November 2022.
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