Can Brexit Displace London as Financial Capital?

When it comes to Brexit, many people are now beginning to see the cracks this initiative has caused economically, politically and socially. It has caused a big mess and one that has to be cleaned up in time. For almost fifty years, the UK has been integrated with the European Union. Many forex traders will remember how the European Securities and Markets Authority (ESMA) introduced sweeping changes to Forex and CFD regulations in 2018. Regulation has dramatic implications for forex brokers and investment firms.

Many laws, legislations and policies covering all areas of governance have been designed in alignment with the European Union or those laws have been enacted by the EU parliament and are therefore effective across the entire European Union. The arrangement was ideal for conducting trade and business freely across the second-largest economy.

Many policies will be dissolved post-Brexit. Everything from the European Convention on Human Rights, EU Roaming Regulation, Drinking Water Directive and the right to free movement throughout the Union. 

More specifically, Brexit will render many laws associated with capital markets obsolete. These include the regulation on Prudential Requirements for Credit Institutions and Investment Firms, which governs capital requirements for banks. Another significant loss will be passporting rights for providing financial services across European Union member states without needing to acquire licensing from national regulators.

Financial services passporting rights

One major problem arising from Brexit is the loss of cross-border passporting rights, which is a term related to financial services, not travel. For the current members of the EU single market it means that if a firm is authorised to undertake certain activities by the regulator of one EU member state, it can apply for a ‘passport’ to do business throughout the EU without needing further authorisation. However, post-Brexit UK-based firms lost the automatic right to do business across the EU. The UK is currently in the midst of looking for an equivalence decision from the EU to grant permission to UK-based financial firms to continue to serve EU customers while remaining based in the UK. Further to this problem that financial services firms are feeling, there are also other pressing issues that need resolving too.

Expat Bank accounts are being shut down 

A large number of British ex-pats living in EU countries have received notifications from banks that their accounts will be terminated as a direct result of Brexit unless they can provide accurate UK addresses. Banks doing this include the likes of Barclays, Lloyds Bank, and NatWest which owns Coutts have basically given their loyal customers and horrific ultimatum. Financial experts have commented on the situation by saying it is because lenders will lose their EU banking rights, which means that if they were to continue to operate within some counties, it would become too costly. Their answer to this? Simply cut the dead weight.

This links back to the passporting problem for UK-based firms, where they have lost the right to do business throughout the EU, without the right banking licenses. Some banks have come to the conclusion that the size and scale of their ex-pat client base are too small to carry on doing business. Despite this terrible news for so many people, there is a glimmer of hope as HSBC and Santander who have said that they have no plans to close British ex-pat accounts in the EU. 

Effect on investment firms

The Brexit fallout has had a knock-on effect with several financial services firms, based within the financial district of London. Banking giant JP Morgan has since declared that they are looking to move over £183 billion from the UK to Frankfurt. A vote of no confidence over now Prime Minister Boris Johnson’s inability to come to an arrangement for financial services to trade within the EU has caused the banking institution to reconsider its headquarters. Moving their headquarters to a location within the EU will allow them to keep operating within the EU, as well as the ability to keep trading with European clients. 

A move like this will undoubtedly benefit Frankfurt as it could potentially become the new financial hub of Europe, attracting more and more investment firms. The possibility of London being displaced as the financial services powerhouse is a very likely scenario, and one the mayor of London Sadiq Khan is very much against. But with the will of the British public leading Britain’s financial future, what can we expect? JP Morgan CEO, Jamie Dimon has expressed his feelings about the UK’s post-Brexit prospects, and they aren’t good. He added that a no-deal Brexit would be a disaster for Great Britain.

Adding further pessimism to the already bleak view on the fate of London no longer being the financial powerhouse it once was, Credit Suisse has applied for a banking license to set up an investment banking hub in Madrid, after Britain has left the EU. The Swiss bank applied for the license from the Bank of Spain and the European Central Bank in July 2020, in order to upgrade its brokerage in the country to a bank. Their decisions to move part of its operations to Madrid was believed to have been made after considering costs, employees’ preferences, as well as other factors.

However, Credit Suisse has stated “Over the last three years, we have added to our existing capabilities in Spain, Germany and Luxembourg to provide this continuity for our clients. London will remain a key part of the bank’s strategy and footprint after the UK’s exit from the EU”. Maybe there is a glimmer of hope for London after all. Banks are certainly hedging their risks, which is to be expected.

Effect on capital markets

London is well known as a major centre for clearing foreign exchange transactions. According to the Bank for International Settlements, in 2019, the average worldwide daily trading volume of foreign exchange reached a total of US$6.6 trillion. Of that sum, US$3.58 trillion per day was cleared via London (UK). Meanwhile, just US$1.37 trillion was cleared via New York (USA). During the same period, the UK cleared an average of US$1.29 trillion in Euro transactions each day out of the total daily average of US$2.13. Clearly, the country benefited drastically from its membership within the European Union and the already well-established position London had in the global financial markets before joining in 1973. 

Currently, London dominates the European clearing and settlements market; unfortunately, that position is under threat. Naturally, the European Union doesn’t see the value in having a non-EU country having such an influential role in its financial services ecosystem. 

The European Commission has said EU-banks have until mid-2022 to reduce their “excessive exposures” to London’s derivatives clearinghouses. The Commission said in a September 21st Statement:

“The heavy reliance of the EU financial system on services provided by UK-based CCPs raises important issues related to financial stability and requires the scaling down of EU exposures to these infrastructures..”

So far, ESMA has given LCH (London Clearing House), LME (London Metals Exchange) and ICE (Intercontinental Exchange) temporary equivalence permissions until mid-2022. However, the EU’s Supranational financial services regulator has stated it is working on a plan b.

Will the City hold its dominance in the financial markets sector?

Brexit has become an incredibly turbulent topic between the EU and the UK. For years, negotiations have been taking place, but as of yet, no deal is in place, and the deadline is fast approaching. Relationships between the two parties are not great, as the EU accused the UK of negotiating in bad faith. 

The European Union definitely wants this insane amount of business to migrate to a European member state, such as Germany. However, Frankfurt doesn’t yet have the infrastructure to absorb this amount of business. For the time being, it seems to make sense to leave things how they are.

A primary driver for Brexit has been to allow the UK freedom to govern its own laws and be exempt from EU interference. As the UK leaves the EU, most things will remain largely the same. However, when ESMA or the European Parliament introduce new laws that are not aligned with the EU, that is when the business will need to start moving to the continent.