For Britain, its exit from the European Union is supposed to be the start of a new era as a “Global Britain,” an open, inviting and far-reaching country. For the European Union, Brexit is an opportunity to repatriate some business from across the English Channel and further bolster the Continent’s economic standing in the world.
And for the City of London, a hub for international banks, asset managers, insurance firms and hedge funds, Brexit is a political headache. Britain’s financial center has been caught in the middle of these two agendas, leaving the future of the City’s relationship with the rest of Europe fractured and uncertain.
Britain left the free trade bloc at the end of January but immediately entered into an 11-month transition period that has kept everything unchanged. What comes after Dec. 31, when this transition period expires, is being negotiated down to the wire. Hanging in the balance are things like fishing quotas, long lines for customs checks at ports and disruption to automakers and other manufacturers that have fine-tuned a “just in time” supply chain.
But the global financial firms with big operations in London already know they will lose the biggest benefit of Britain’s EU membership: the ability to easily offer services to clients across the region from a single base, known as passporting. This has allowed a bank in London to provide loans to a business in Milan or trade bonds for a company in Madrid.
After Jan. 1, that won’t be so simple. The ability of firms in Britain to offer financial services in the EU will depend on whether EU policymakers determine that Britain’s new regulations are close enough to their own to be trusted — a critical concept known as equivalence.
The problem is that some very common banking activities — taking deposits and making loans to companies and individuals, for example — don’t qualify for equivalence. The result will be a patchwork arrangement with large holes. That’s why thousands of people, primarily Britons, living in Europe who have British bank accounts have recently been told their accounts will be closed.
To ease the transition, Britain decided to copy some of the European Union’s regulations. In turn, it hoped that the EU would allow firms in Britain to keep doing business in the bloc. In early November, Britain’s chancellor of the Exchequer said his government would accept the EU rules in a number of areas, including capital requirements and credit ratings agencies.
But the EU hasn’t reciprocated. The bruised feelings raised by Britain’s divorce from the bloc continue to influence relations between the two. Officials in Brussels say they are wary that, over time, Britain will exploit its independence and weaken the restrictions on risk and other rules that banks don’t like.
That lack of a deal “should not be the starting gun for a race to deregulate,” Joachim Wuermeling, who is in charge of bank supervision at the Bundesbank, Germany’s central bank, said last month.
This has led to a political stalemate, in which London and Brussels remain at odds on several key pieces of financial regulation and unwilling to give market access to each other.
One such rule allows investment firms to offer their services and trade financial securities across borders to clients in the EU, under a piece of regulation called Mifid II. The bloc is updating its rules for cross-border securities trading and won’t grant Britain a stamp of approval until the revision is completed in the middle of next year.
That stance spurred an outraged response from none other than the governor of the Bank of England, Andrew Bailey, who in September complained to members of Parliament about Brussels’ behavior.
“I just do not see how we can have an equivalence process where the EU essentially says, ‘We’re not even going to judge equivalence at the moment, because our rules are going to change,’” Bailey said. “What does that mean, really? It means that they think this is a rule-taking process.” (The accusation of “rule-taking” is often the ultimate put-down in these talks, meaning that one side is dictating rules to the other.)
The disharmony is underscored by the fact that, unlike the rules that governed pre-Brexit, these regulatory decisions are made unilaterally and can be revoked with short notice.
The lack of agreements means London will lose financial jobs as a result of Brexit. Even before the year-end deadline, EU regulations are compelling banks to shift workers, and capital, to the Continent. The movement of decision-makers is important: In the event of a crisis, Europe’s bank overseers don’t want critical people to be somewhere offshore, even if it’s London.
Overall, since mid-2016, financial firms have shifted $1.6 trillion in assets out of Britain, according to Ernst & Young.
But the process hasn’t been completed. It has been delayed by the pandemic, which has made it difficult for people to move and some corporate clients have been more concerned with keeping their business afloat than signing new contracts.
“Some banks and their customers apparently want to wait until the last minute to make the actual transfers,” Wuermeling of the Bundesbank said. “They would be well advised to act now.”
JPMorgan has asked about 200 employees to move from London to other European cities, mainly Paris and Frankfurt, before the end of the year. Another 100 workers are expected to move next year. JPMorgan also plans to move about 200 billion euros in assets to Frankfurt. Goldman Sachs plans to transfer between $40 billion and $60 billion from its British operations to its German subsidiary by the end of the year. That unit held just $3.6 billion at the end of 2019, according to company filings.
All told, lenders with German licenses will move assets worth about 400 billion euros, or $475 billion, to the Continent because of Brexit, according to the Bundesbank. That will more than double the banks’ assets in the European Union.
The Bundesbank expects banks that have sought German licenses because of Brexit to bring in 2,500 employees, some of whom may be located in other cities like Milan or Amsterdam. That’s hardly the mass migration to the Continent predicted a few years ago. (Estimates reached as high as 75,000 jobs relocating out of London to the rest of Europe.)
Still, the moves keep alive a question that has been posed since the Brexit vote in 2016: Could another European capital unseat London as the region’s dominant financial center?
So far there has been no single big winner. Money has scattered to Luxembourg, Dublin, Paris and Frankfurt, Germany.
“London will remain by far the most dominant player,” said Michael Grote, a professor at the Frankfurt School of Finance & Management who has studied the effect of Brexit on financial services.
Regulators are confident that financial stability won’t be put at risk come January, because firms have taken the prudent approach of preparing for the worst. But, they say, there could still be some market volatility as the transition period ends.
Next year, Britain’s financial sector is still expected to be one of the largest in the world: The amount of money it manages is about 10 times the size of the British economy. The business that actually relates to clients in the EU, and would be threatened by regulatory discord, is relatively small.
“Not that much business in London and the United Kingdom’s financial center actually depends on equivalence,” Alex Brazier, the Bank of England’s head of financial stability strategy and risk, told members of Parliament in September. About 10% of the City’s 300 billion pounds in annual revenue from finance and insurance comes from clients in the EU, he said. Of that about a third, or 10 billion pounds, is from activities that could continue under equivalence rules, he added.
While London won’t lose its status as the financial capital of Europe, its primacy will be eroded. The market for financial services will become more fragmented.
Andrew Gray, the head of Brexit at PwC, said that dispersal of financial services around the Continent would create more friction in the system, adding to costs. “There is economy of scale of having it in London,” he said. “You lose that economy of scale.”