With a post-Brexit agreement made just a week before the transition period between the UK and EU came to an end, industry experts highlight the “lack of focus” on the financial services sector.
The word ‘fish’ appears almost three times as often as ‘financial services’ (16 to six references) across the 1,200 pages of the new trade and cooperation agreement (TCA) the UK signed with the EU just before Christmas.
Finance and its associated professional services sector collectively represent about 12 per cent of the UK economy – it is the UK’s biggest export segment and runs a huge trade surplus.
Consultant Tony Freeman said: “It's widely assumed that the government posture is driven by two factors: banks are very capable of looking after themselves and, crucially, there are very few votes garnered in standing up for bankers.”
The lack of focus on this highly successful sector has been very evident for some time which, according to Freeman, has led to the sector taking steps to prepare for both a managed or hard Brexit.
Tej Patel, partner and regulatory practice lead, Capco, also highlighted that services, in general, were not the focus of Brexit negotiations.
On 1 January, UK financial services firms lost their passporting rights to sell services into the EU from within the UK unfettered by any need for further regulatory clearances.
As a result, Patel explained that UK-based firms are effectively now operating under their no-deal/hard Brexit scenarios.
In a statement, the Financial Conduct Authority (FCA) affirmed: “Passporting between the UK and EEA states has ended and the temporary permissions regime (TPR) has now come into effect for those firms and funds that notified us that they wanted to enter this regime.”
This allows EEA-based firms that had been passporting into the UK to continue new and existing regulated business within the scope of their previous permissions in the UK for a limited period, while they seek full authorisation from the FCA, if required.
It also allows EEA-domiciled investment funds that market in the UK under a passport to continue temporarily marketing in the UK.
Alongside the TPR, the government has created the financial services contracts regime (FSCR).
According to the FCA, this allows, for a limited period, EEA passporting firms not in the TPR to continue to service UK contracts entered into prior to the end of the transition period (or prior to when they enter FSCR) in order to conduct an orderly exit from the UK market now that the transition period has ended.
Immediate impacts
In terms of immediate impacts, it has been reported by the Financial Times that London’s financial sector started to feel the full effects of Brexit on the first trading day of 2021 as nearly €6 billion of EU share dealing shifted away from the City to facilities in European capitals.
It was further reported that business on London hubs for euro-denominated share trading, including Cboe Europe, Turquoise and Aquis Exchange, shifted to their new EU venues set up late last year to cater for the end of the Brexit transition.
Some industry participants suggested that although there has been a shift in trading Euro-denominated stocks onto EU platforms, the majority of staff at Aquis, Cboe, and Turquoise will remain in London.
The London Stock Exchange Group (LSEG) launched its new pan-European share trading platform Turquoise in Amsterdam as part of its Brexit contingency plans in November.
LSEG explained the difference between Turquoise Europe and the existing Turquoise in London is that Turquoise Europe only has available the European economic area listed securities for trading on its platform.
London-based Turquoise continues to have both the UK and European listed securities that it has always had, so there is no change in that offering there.
“The immediate impact, already visible, is that trading in European stocks has moved from UK exchanges to newly created platforms domiciled in the EU. These are electronic trades and the physical impact - on jobs for example – will be limited. The new subsidiaries are bridgeheads into the EU27 – it doesn’t mean that exchanges have moved their main operations away from London. However, this won’t stop politicians claiming that the EU has successfully repatriated business from London,” highlighted Freeman.
Other immediate impacts relating to Brexit include the European Securities and Markets Authority’s (ESMA) announcement to withdraw the registrations of four UK-based trade repositories (TRs) and six UK credit rating agencies (CRAs).
Longer term impacts
With no equivalence granted for UK financial services, the longer term impacts of a no-deal Brexit will potentially be more significant.
The European Commission’s EU-UK TCA, stated: “The agreement does not cover any decisions relating to equivalences for financial services.”
“Nor does it cover possible decisions pertaining to the adequacy of the UK’s data protection regime, or the assessment of its sanitary and phytosanitary regime for the purpose of listing it as a third country allowed to export food products to the EU. These are and will remain unilateral decisions of the EU and are not subject to negotiation.”
Freeman explained that the absence of equivalence is a problem but was anticipated.
He said: “Equivalence is a flaky, politically skewed process that most firms do not want to rely on. Its scope is also limited – it does not cover all business segments. Banks and investment managers have therefore created new EU entities to trade with clients and counterparties inside the EU27.”
“The very clear objective of EU27 policymakers, both nationally and in Brussels, is to use regulatory standards to build local presence – meaning a transfer of jobs from the UK.”
Freeman suggested that for investment banks the primary issue will be what standards local supervisors take on the issue of “substantive presence”.
“Today, this is undefined. For fund managers the crucial issue is delegation: will they continue to be allowed to manage funds in a globally flexible model, or will the fund have to be managed within its legal domicile?” he added.
Capco’s Patel noted that the TCA does not provide certainty with regards to the outstanding areas of equivalence which still remain unresolved between the UK and EU.
The further information being requested by the EU, to support its decision making, will be a challenge for the UK government as they have yet to determine detailed plans for regulation in the future, which Patel said “puts us [the industry] into a ‘Catch 22’ scenario”.
Patel explained that the EU has granted time-limited equivalence decisions for derivatives clearing (18 months) and settling Irish securities (six months).
“Beyond that, the Joint Declaration – non-binding, it should be noted – that sits alongside the TCA commits the UK and the EU to future cooperation around financial regulation. However the Memorandum of understanding that will facilitate this cooperation is not set to be finalised before March 2021,” Patel commented.
Given that negotiating permissions across individual EU states could be complicated and expensive, equivalence is seemingly the way forward for firms.
Patel highlighted that it will inevitably be a downgrade from what firms previously enjoyed in terms of activities covered.
While equivalence determinations were slated to be confirmed by mid-2020 under the terms of the 2019 UK-EU Political Declaration, that deadline passed without resolution.
To date, the EU has granted temporary equivalence only to UK clearinghouses. In September, ESMA confirmed that LCH, ICE Clear Europe, and LME Clear will be recognised as third country central counterparties (CCPs) from January 2021.
At the time, ESMA explained the 18-month period will provide the opportunity to conduct a comprehensive review of the systemic importance of UK CCPs and their clearing services or activities to the EU and take any appropriate measures to address financial stability risks.
Patel noted that the equivalence to UK clearinghouses is due to the sheer volume (trillions of dollars of derivative contracts per day) that flows through these venues.
“That said, this does provide some kind of platform to build towards future regulatory equivalence/cooperation between the UK and EU,” added Patel.
GoldenSource’s regulatory expert Volker Lainer stipulated that for those in the financial services industry, the failure to agree equivalence will carry on having an important impact on their day-to-day activity for some time going forward.
“While some key elements of financial market structure have been agreed – for now – the different approach of the FCA and ESMA to market rules and regulations may result in divergence in the near future,” Lainer said.
As a result, Lainer believes that firms operating in both jurisdictions will need to have better data segregation to respond to the split regulatory reporting.
Lainer commented: “The recovery from 2020 will be tricky enough and market participants can’t rely on any agreement in early 2021 to resolve the issues stemming from this.”
Also weighing in, Freeman said: “These issues will be a slow-burn process and facts will be hard to discern. But the trend is clear. However, the City of London is creative and extremely adaptable. It believes that the growth in its overall business – green finance, derivatives/risk management, non-EU markets - will more than compensate for the loss of business into the EU. Only time will tell.”
