The EU-UK Trade & Cooperation Agreement (‘TCA’), signed at the end of last year did not cover financial services. Commentators had been sanguine about the potential impact on the City of London as a global financial centre. Figures showing that only 7,500 jobs had been re-located to the EU (out of the approximately 1.1 million who work in the sector) and that already this year, four companies have floated on the main London stock market, with two more on Aim, seemed to dispel any fears that London might lose business to the EU.

However, the news that Amsterdam had overtaken London in volumes of shares traded, has shaken that conviction. London trading averaged €14.56 billion a day in December. In January, London’s average daily share volumes were only €8.62 billion, whilst Amsterdam’s were €9.22 billion. This is in addition to the €6.5bn of deals which moved to the EU when the Brexit transition period concluded at the end of last year.

Some commentators have interpreted this shift in trading patterns as a symbolic early indication of the direction of travel for what may await the City post-Brexit.

And it’s not Just Shares…

As part of the TCA, the UK left the EU’s Emissions Trading Scheme (ETS) and lost its EU equivalence. As a result, trading in those permits, with a nominal value of around €1 billion per day has also moved to Amsterdam. And London lost out in January to EU and US venues (the European Commission has declared the US equivalent for derivatives trading) in Euro-denominated swaps – the UK market share fell from 40% to 10 percent in January and the EU’s increased from less than 10% to 25%.

Whilst Amsterdam has been the main beneficiary of Brexit, also picking up activity in swaps and sovereign debt markets that would typically have taken place in London before Brexit, Paris and Dublin also enjoyed increases in business at London’s expense in January.

What Is Going on?

The shift in trading locations is caused by the failure of the European Commission to (so far) recognize the UK’s oversight regime as ‘equivalent’ to its own, on the grounds that, after Brexit, the UK could diverge from EU standards in the future. With some justification, the UK Government notes that the requirement placed on the City by the EU is not a requirement that the EU has made of other financial centres before awarding them an equivalence decision.

But until the UK government does outline its plans for future regulatory changes, the two sides seem likely to remain in a tense stand-off, which will influence the nature of the MoU currently under negotiation (see below). The fact that the UK has allowed Swiss shares to trade in London in an effort to partially offset the losses to EU financial centres will not improve the mood: Swiss shares were not previously traded on the LSE because the Commission withdrew their recognition of the Swiss regulatory system in 2019 (a withdrawal the Commission unofficially acknowledges as a mistake).

The UK surrendered its leverage by granting the EU an early equivalence decision and the EU is in no hurry to reciprocate. The Commission may calculate that the longer it leaves its equivalence decision, the greater the drain from London, the more entrenched the location of those new dealing rooms will become and the harder it will be to reverse the migration of trading. The EU’s delay is in any event, consistent with its policy since 2016 to try and entice financial services away from the UK as part of a drive to ‘onshore’ financial services, create a capital markets union and position the Euro as the back-up global reserve currency to the Dollar.

These objectives are, of course, very long-term and there are significant economic frailties in the Eurozone (which spiraling deficits caused by Government spending to counteract the Coronavirus Pandemic have exacerbated) which make achieving these goals even harder.

What about the MoU?

Negotiations on the UK-EU financial services MoU are due to conclude by March.  The two sides have diverging objectives: whilst the EU will want to use it as an instrument to oversee (and anticipate) the UK’s regulatory strategy; the UK will view it as a testing ground for specific equivalence determinations. In practice, the MoU seems more likely to be an acceptance of the need for close mutual cooperation, than a legally-binding agreement setting out a formal cooperation framework.  And it seems unlikely that the EU will use its launch to grant assurances on equivalence just yet.

So is that it for London as a Global Financial Centre?

London continues to enjoy a number of advantages over its neighbours which suggest its reign as pre-eminent global financial centre is far from over. No single other EU city that has the infrastructure or depth of historic experience at handling sustained the high trading volumes that London’s enjoys. The UK’s legal system marks it out from its competitors – it is no coincidence that the main market agreements (e.g. ISDA, GMLRA, OSLA, ISLA) are governed by common law, with its recognition of the importance of Trusts. And London assembles the supporting business and financial services in one location in a way that no other market can do – splitting elements of the financial services system up across numerous EU capitals risks both regulatory and market fragmentation – as the Governor of the Bank of England pointed out.

Looking beyond the EU, there are genuine possibilities for the City of London in the rest of the world. The UK government has signed two new trade deals since leaving the EU, as well as a further 32 rollover deals. These deals open the enticing prospect of financial service opportunities for UK companies around the world. Of particular interest are possible opportunities in China, India and Japan. The UK’s rapprochement with Switzerland (noted above) also offers a new market for UK financial service companies.

There is no question that the UK’s departure from the EU will change existing and established practices. But it also opens new markets and new opportunities. These changes are challenging for financial services companies and we look forward in Covington to helping clients navigate these new and sometimes choppy waters.