Rishi Sunak Is a Realist in Financial Dealings With Europe

As Kenny Rogers sang in “The Gambler”: “You’ve got to know when to hold ‘em, know when to fold ‘em, know when to walk away.”

U.K. Chancellor of the Exchequer Rishi Sunak has apparently taken that lesson to heart. On Thursday he called an end to the drawn-out negotiations with the European Union to agree on so-called equivalence, or common regulations on financial services in the post-Brexit landscape. The U.K. will be forgoing unfettered access to the bloc in order to set its own financial rules.

Back in January I argued that this horse has long since bolted. Equivalence was always a tricky and complex tug-of-war over rules, and whatever was decided would likely be inferior to the prior status of full recognition of each other’s rules. It was obvious early on that persuading Brussels to give up anything meaningful would be futile in the high-stakes game of claiming Brexit wins. (That is not to say there hasn’t been some mutual ground; both sides recently cleared the way for sharing data.)

The EU has always bristled at its lack of a truly viable financial industry. So much of the bloc’s myriad components of raising, trading and structuring money and deals have been centered in the City of London, and in recent years that dominance has only increased. Ultimately, that concentration of risk hasn’t been healthy for either side. Perhaps by walking away now, Britain is making it possible to strike a better deal in the future. 

Sunak’s latest proposals are about mitigating an obvious loss for the City. But his own work experience at Goldman Sachs Group Inc. and several hedge funds has shown him that there is still plenty of ingenuity in London, which is as well-placed as any major financial center to roll with the blows and create new business lines.

But the debate carries on. As the recent opening of JPMorgan Chase & Co.’s new Paris office shows, there is plenty of political mileage in attracting the big U.S. investment firms to conduct more of their business within the euro area. The relative gains for the EU so far have been minimal, but the risks for the EU playing hardball with the U.K. have just risen substantially.

That’s because the battlefield is going to shift away from banks and market infrastructure and toward those who control the money — i.e., asset management. Just look at the thorny issue of delegation: Currently, funds raised and based in the euro area can be outsourced and managed in London without too many hurdles. That situation could well change radically and is already creating ructions

The whole point of granting equivalence was to tie the City into the EU rulebook — which partially revolves around the excruciating process of MiFID II — albeit even the bloc is now relaxing constraints. By not engaging, the EU will face competition consequences with its next-door neighbor.

Europe could insist over time on all euro-denominated business being conducted in the euro area if it’s with an EU-based counterparty. This would no doubt transfer market share in the short-term, but it would also likely reduce overall volumes and most importantly liquidity.

This matters especially with derivatives. The pool could shrink if it becomes more expensive to trade euros within the bloc due to additional margin requirements at different EU central counterparty clearing houses.

Barely a quarter of euro-denominated interest-rate swaps have a EU-based counterpart on either side. The London Stock Exchange’s LCH clearing house dominates the process of matching these trades. And the European Securities and Markets Authority, based in Paris, is acutely aware of this Achilles heel.

The real long-term risk is if it becomes cheaper to transact in euros in an offshore euro market than in the bloc. That could be calamitous for EU companies’ affordability and access to financial markets. Nonetheless, there is relentless Brussels pressure to claw this business onshore and achieve the long-desired EU prize of control over its own financial markets.

The gorilla-sized third party watching all this, of course, is the U.S. While it has been content to pick up market share as the two protagonists squabble, it will draw the line firmly at anything that causes market instability. It has its own long history of dealing with EU authorities and has been robust in drawing the boundaries. 

The battle over financial services has barely got going, but at least we’ve now realized that a quick and simple solution was never going to happen. There’ll be many twists and turns before the final landscape emerges, but ultimately it is going to push up costs for market players to operate in euro financial markets. 

In the meantime, follow the money as to how the big banks and their clients shift their businesses. That is the price of Brexit for both sides. As Kenny said, “There’ll be time enough for countin’, when the dealin’s done.”  

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

©2021 Bloomberg L.P.

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