For someone who started their career working on the floors of the London Stock Exchange, the hours following the UK’s exit from the single market could hardly have been more wrenching.
In a single day, Alasdair Haynes, chief executive of Aquis Exchange, a UK share-trading venue, watched virtually all share-trading business that he had courted over eight years being unceremoniously yanked out of London and transferred in January 2021 to EU exchanges.
The stunning shift, which affected €6bn of trading in European shares that day, seemed emblematic of the blow by Brexit to the City of London’s status as Europe’s dominant financial capital — a harbinger of lost business for London and fresh opportunities for rival centres such as Frankfurt, Paris and Amsterdam.
A year down the road the story looks less dramatic and clear-cut, says Haynes, whose customers moved to an EU-domiciled subsidiary in Paris. The manner of the UK’s departure was undoubtedly “an own goal” by London, he says. But the EU is struggling to map out a winning strategy of its own to build up its capital markets.
“In Europe, different centres are all fighting each other . . . to get business back at any cost,” says Haynes, who has held senior trading roles at Morgan Grenfell, UBS and HSBC in his 35-year career in the City. The UK fared better than some expected in 2021, while the EU’s plans to date “have not been very impressive.”
As the City marks the anniversary of its divorce from the single market, bankers and officials confirm that broader picture. Rather than experiencing the big-bang shift of swaths of financial sector business from the UK to the EU that some predicted, the City is enduring a slow puncture that will take years or decades to play out.
The EU’s efforts to reduce its reliance on the UK and build up a financial sector commensurate with its economy have remained slow-moving and inconclusive, in part because of a lack of political focus in big capitals.
Brussels is likely, for example, to confirm early this year that it has ditched hopes of rapidly pulling the systemically sensitive job of clearing trillions of derivatives transactions from London into the union, instead embarking on a much more gradual process with an uncertain destination.
“We need to take the long view here: developing deeper capital markets in the EU is neither easy nor quick to do,” acknowledges Valdis Dombrovskis, European Commission executive vice-president, adding that the EU has made good progress rolling out legislation. “We still have barriers to knock down.”
London loses its sheen
The post-Brexit trade deal struck in late 2020 made precious little provision for financial services, and since then Brussels has refused to offer London anything like the same market access arrangements — or equivalence — that financial centres including New York, Tokyo or Hong Kong enjoy.
A memorandum of understanding on regulatory dialogue has sat unsigned gathering dust on the shelf — a casualty of EU anger over the UK’s demands to redraw the Northern Ireland protocol. The notion that the UK will lure in large amounts of financial activity after a wide-ranging regulatory bonfire has proven to be an illusion.
EU financial capitals have meanwhile reported a surge in activity as firms are forced by regulations to shift business from the City of London. Two dozen large financial services firms have announced plans to move £1.3tn of assets from the UK in the aftermath of Brexit, according to research from EY.
Paris has been one beneficiary, as the French capital seeks to lure bankers and financial firms with tax breaks and other incentives. It has attracted 2,800 UK employees since Britain voted to leave the EU in 2016, according to EY.
The bulk of roles are in trading, as France capitalises on the existing expertise of its main banks in many derivatives markets. A number of US banks have also chosen Paris as one of their EU bases, among them JPMorgan, which is due to grow its staff from some 250 to 800 people in France this year.
A further 20 to 30 per cent of the new jobs are linked to investment funds — hedge funds such as Citadel have set up shop or expanded their teams in Paris — while the rest are made up of fintech and insurance companies, according to Arnaud de Bresson, the managing director of lobby group Paris Europlace.
“You can see the transfers happening and they are real,” says Stéphane Rambosson, co-founder of Vici Advisory, an executive search firm.
London has meanwhile lost its crown as the main hub to trade shares in Europe to Amsterdam as tough rules from Brussels curbed cross-Channel dealings. Euronext, the EU’s largest stock market operator, is moving the data centres that house all its trading from Basildon in Essex to Bergamo in Italy.
The EU sovereign debt market, including hundreds of bank employees in sales and trading, has slipped out of London. Officials hope that increasing issuance of bonds collectively backed by EU governments — which has ramped up dramatically with the €800bn NextGenerationEU debt issuance programme — could give the EU market a further boost and ultimately provide a eurozone-wide safe asset that aids capital markets integration.
Europe’s fragmented financial sector
Despite all this, the City of London remains the continent’s most important financial hub across swaths of activity. Brexit-related job moves from the UK to the EU total less than 7,400, according to EY figures tracking announcements up to December — far short of the tens of thousands predicted after the 2016 referendum.
Relative to gross domestic product, EU financial markets — incorporating pensions, asset management, equity markets, bond markets, private equity and venture capital — were just half the size of the UK’s in April 2021, according to New Financial, a think-tank.
London employs more than 418,000 people in financial services, UK government data shows, and it remains the dominant hub for trading currencies and derivatives, clearing, insurance and private equity funds. London is still the main place to raise equity in Europe and has just enjoyed its strongest year since 2007.
Chris Woolard, the recently departed interim head of the UK’s Financial Conduct Authority, who now heads EY’s regional regulatory practice, argues that the commission is currently “reconciled” to the idea that in the short term the UK has a relative competitive advantage because of the scale and liquidity of its markets.
But that does not mean Brussels is content to let matters stay as they are. The union is embarking on a project to bolster its self-reliance across a range of industries ranging from semiconductors to hydrogen, medicines and high-end batteries. That agenda will take on even greater urgency in the coming months as France holds the rotating EU presidency and seeks to build up the “strategic autonomy” initiative.
Financial services post-Brexit should in theory sit within this plan. The idea, says Dombrovskis, is not to grab market share — contrary to what some UK and industry executives claim — but to address the “systemic risks” of being heavily reliant on financial infrastructure such as clearing houses that are not under the supervision of EU authorities. “I am confident that we will gradually start seeing real changes in the share of capital markets and investments financing of EU companies,” he says.
The problem is that this is proving to be a very gradual process and key capitals have not been focusing their political energy on the EU financial agenda. The union has for decades been pursuing efforts to bolster its financial centres via a project currently dubbed the “Capital Markets Union” — turning the EU’s hodgepodge of smaller financial centres into a world-class system and lessening its reliance on bank lending.
CMU now ought to be assuming greater urgency post-Brexit, as the EU seeks to wean itself off being overly reliant on a financial capital sitting outside the single market.
Christine Lagarde, president of the European Central Bank, has argued the harmonisation of the region’s capital markets also needs to be accelerated to help provide the €455bn of extra annual investment needed to fund the region’s climate, energy and digitisation targets. Europe has an opportunity that is “too good” to pass up in green finance, she says, with 60 per cent of all green bonds issued globally last year coming from the eurozone.
Nevertheless, leaders made only a brief mention of CMU in their euro-summit statement last month, and the project was absent from commission president Ursula von der Leyen’s “state of the union” address to the European parliament in September setting out her top priorities.
“I’m not sure at the EU level there really have been huge incentives to drive the relocation of activity into the EU,” says one senior executive at a large US bank. “The EU is keen to reduce reliance on the US and the UK in key areas of capital markets . . . The EU has to really develop local capacity to do that.”
Clearing is the most obvious area where the EU is treading water. A clearing house stands between two parties in a trade, acting as a counterparty and ensuring one side is paid if someone defaults on payment. The business is not particularly lucrative, but it needs billions of dollars of collateral to support trades that are open for months.
EU politicians have long wanted to pull clearing of euro-denominated derivatives from London, where the majority of the €90tn business is handled. But the huge costs involved in transferring positions means the market has barely moved — even though an EU deadline that allows EU banks to use London is due to expire in June 2022. The commission is expected to announce a further extension to the permit that allows EU banks to use UK clearing houses — probably for an even longer grace period than the previous one.
Esma, the pan-European securities regulator, wants the commission to consider measures such as tougher bank capital requirements to force firms to park more business in the eurozone. “What we intend with this is that the clearing volumes will migrate from the UK to the EU clearing houses, and as such the huge dependencies are reduced,” says Froukelien Wendt, a member of Esma’s clearing house supervisory committee.
Brussels is planning renewed efforts in the coming months to narrow the legal and regulatory gaps between its financial centres, including an overhaul of EU listing rules and — crucially — a new attack on one of the most stubborn barriers to greater integration, the sharply differing national insolvency regimes.
Financial services commissioner Mairead McGuinness also recently unveiled reforms to boost cross-border capital flows, including a pan-EU database of easily accessible corporate financial information and a “consolidated tape” of capital market transactions — a common feature of US markets for decades.
But some argue the steps to date remain too modest. “There’s a lot of savings out there but we fail to put it into [European] capital markets. If we have a very simple and accessible trading landscape it can help bring people to capital markets,” says Rosa Armesto Plaja, deputy director-general of Fese, a trade association for stock exchanges in Europe.
Executives say momentum on CMU will continue to be lacklustre as long as attempts to consolidate the bloc’s fragmented banking sector remain stuck, entrenching a reliance on lending rather than capital markets. The EU’s half-completed Banking Union project has also drifted for years with no deal on the most contentious remaining aspects — including pan-European common deposit insurance.
“We’ve kind of given up a bit on Banking Union. It just doesn’t seem to be moving forward and it feels like the EU has got this really strong group of blocking member states,” says an executive at a large international bank. “Until we get more consolidation and modernisation in the banking sector, we’re still going to see an overreliance on bank lending.”
None of this means that London’s position in Europe is somehow unassailable — far from it. The modest trickle of migration from the City to other European financial capitals is in part a reflection of the Covid-19 freeze on executive relocations, and it could easily accelerate.
One likely driver is the work of bank supervisors, who, allied with European Commission officials, are quietly tightening the screws on banks that want to do a lot of business in the single market without maintaining substantial physical operations there with plenty of staff.
Bank executives, lawyers and supervisors say that the ECB is increasingly forceful in its demands that lenders move more resources to the EU to run their European businesses, requiring banks to add hundreds of extra staff and billions of euros of additional capital to their operations.
While banks have moved close to €1tn of assets from the UK to the EU in recent years, many of them still rely on complex structures to run their European operations out of London, such as so-called back-to-back models, which allow the risk of EU trades to be transferred to the UK.
Banking supervisors are seeking to complete a “desk-mapping” exercise assessing how lenders manage their EU operations, after which the ECB is expected to step up its demands for firms to move staff and capital to the euro area.
That effort has been complemented by new legislative proposals from the commission in October that will enable supervisors to force banks to convert larger branches into fully capitalised subsidiaries in the EU.
At the same time, it will become more difficult for non-EU banks to sell services in the single market without having a branch or subsidiary there under the new rules.
Officials have dismissed fears that the proposals amount to a sweeping prohibition on any markets or investment banking activity being sold from outside the EU — although some observers including Simon Gleeson of Clifford Chance believe the reforms could make European market less attractive to foreign banks.
“A number of banks are going to turn around and say, can I be bothered to do business in the EU?” he says.
EU financial markets activity is likely to remain spread across at least five major financial centres, each with its own specialism, such as banking in Frankfurt, trading in Paris, investment funds in Dublin and Luxembourg, and market-making in Amsterdam. This kind of physical fragmentation has arguably become less debilitating given increased digitalisation and the shift to online working, which was accelerated by Covid-19.
In Brussels the overriding view is that the status quo needs to change — even if achieving this will be a project that takes years. As one senior EU official puts it, the goal is not to stop doing business with the City of London, but rather to do it “on a sustainable basis”.
“We put a lot of eggs in the London basket, which made sense when the UK was part of the EU,” says the official. “But now a lot of our key infrastructure is outside the union, which is not a comfortable place to be in the long term.”
Additional reporting by Martin Arnold in Frankfurt and Sarah White in Paris