Sarah Hall / Feb 2021
The City, London's financial district. Photo: Shutterstock
Since 1 January 2021, the UK financial services sector has essentially been operating under a no-trade deal Brexit despite the EU-UK Trade and Cooperation Agreement being agreed on 24 December 2020.This was not unexpected. Whilst financial services, in common with services more generally, are included in the deal, the deal contains a prudential carve out. This is important because in practice, it means the UK and the EU can unilaterally set requirements in areas such as ongoing supervision, which in turn can significantly restrict financial services trade.
The seeming neglect of financial services is striking given their strategic importance in the UK economy.
The comparative neglect of financial services is also important because the EU’s single market goes much further than is typical of free trade agreements in supporting cross border services trade. This greater market access had been used by UK based financial services to develop significant EU export markets using passporting arrangements. Passporting allows financial firms registered in the UK to access the single market without the need to obtain additional regulatory clearance and licenses in EU member states.
Since 1 January 2021 and the end of passporting, UK financial services firms have been reliant on a very limited set of equivalence decisions, to access the single market. These unilateral determinations allow market access for third countries if regulatory standards are deemed equivalent by the EU. They were legally separate from the trade negotiations.
To date, the EU has only granted time limited equivalence decisions for derivatives clearing and settling Irish securities. Without further equivalence decisions, UK financial services will continue to have a more limited single market access than their counterparts in New York and Singapore, for example.
Even those limited equivalence decisions do not offer the permanent access rights of passporting – the EU is able to revoke equivalence with 30 days’ notice. As a result, during the trade negotiations a number of financial services firms relocated parts of their UK operations to EU financial centres including Paris, Frankfurt, Amsterdam and Dublin.
During the trade negotiations, it had appeared that a Brexit trade deal would make further equivalence decisions from the EU more likely. However, since the deal came into operation, this sentiment has changed and there are few signs that the EU is seeking to prioritise making such decisions. This comes despite it identifying equivalence as one of a number of unilateral EU measures available within a wider set of “pillars of cooperation” between the UK and the EU.
The TCA includes a non binding agreement that the UK and the EU will agree a Memorandum of Understanding relating to financial services regulation by March 2021. However, this seems most likely to address the procedures for regulatory dialogue, particularly in relation to financial market stability. As such, whilst the UK’s financial services sector is now trading outside the single market, how it will trade with the EU in the future remains uncertain.
As time passes, in many ways the prospects for further EU equivalence determinations diminishes and the value of equivalence itself declines. As firms operate without it, by moving assets and/or employees out of London to other European financial centres for example, the prospect of these organizational strategies being reversed if a new equivalence determination is made decreases. For example, a significant shift in Euro-denominated share trading moved from London to Europe, particularly Paris and Amsterdam in early January 2021 - an area in which London has dominated.
Part of the EU’s caution with respect to equivalence reflects its preference to learn more about how the UK may use its new-found regulatory sovereignty in financial services. Some early indications can be found in the UK’s approach to equivalence.
The UK has adopted an outcomes-based approach, something it proposed during the 2020 trade negotiations but was rejected by the EU. This means that financial services activity can be deemed equivalent even if specific regulations diverge as long as they achieve a similar outcome. This represents a more flexible interpretation of equivalence than that adopted by the EU, with the aim of promoting London as a global financial centre.
Given the outstanding equivalence decisions and the fact that the UK is only in the early stages of setting out its own approach to financial services regulation, it is not clear what the medium- and longer-term implications of the new post Brexit regulatory financial landscape will be. If the EU successfully develops financial services capabilities in areas where it has historically relied on London, such as in investment services, the City could face a decline in its relative dominance as a European financial centre. However, the EU has already sought to replicate some of the financial markets that are real strengths of London, notably its capital markets, with only limited success. If this trend continued, it would be more likely that London may retain more of its dominance in Europe whilst also developing its global financial relations.
The full report ‘Brexit and Beyond’ can be found here