City of London Is Far From Finishing Brexit Obstacle Course
The City of London averted one disaster with the draft Brexit deal announced Wednesday. But the resignation of Brexit Minister Dominic Raab showed the obstacle course is far from over.
Even if the U.K. Parliament clears the agreement -- and that’s still far from a sure thing -- negotiations on a new financial rulebook will continue well into 2020. The bottom line is that banks, brokers and asset managers continue to face talks going off the rails.
"Our message to businesses continues to be: prepare for the worst, hope -- and advocate vigorously -- for the best," Charles Brasted, a partner at the law firm Hogan Lovells, said in a statement.
The reaction highlighted the risks. Raab’s quitting -- saying he couldn’t "in good conscience" support the deal the cabinet grudgingly backed Wednesday -- underscored the peril facing Prime Minister Theresa May and the process itself. Meantime, the EU called a Nov. 25 summit to sign the deal.
“We’ll still be caught in a holding pattern because no one in the City can truly know which way this is going,” said Justin Urquhart Stewart, the co-founder of Seven Investment Management LLP, a London-based investment firm with 14 billion pounds ($18 billion) in assets. “We’ll all be sitting here staring at each other saying, ‘What’s going to happen next?’ and none of us will dare take a position. So we’ll do nothing, stay liquid, and hope some sanity eventually comes out of this process.”
The pound, little changed on Wednesday, tumbled Thursday, falling more than 1 percent to under $1.29.
In almost 600 pages of documents released late Wednesday, there were three short paragraphs devoted to financial services. Under the envisioned regime, the U.K. will be dependent upon EU goodwill; Brussels officials will have unilateral power to shut the door on short notice if they determine there’s not a level regulatory playing field.
While the new set-up -- known as "equivalence" -- creates friction (and expense), it avoids a total breakdown and gives the finance industry what it was expecting; it’s how the EU deals with countries such as the U.S.
“Negotiators have made great strides on the withdrawal agreement, as well as the future relationship," Miles Celic, head of TheCityUK industry association, said in a statement.
The European Central Bank and national financial regulators have made it clear they expect firms to establish full-service operations with boards of directors, risk-management teams, and compliance capabilities within the EU’s borders. That means institutions that have long used London as a gateway to Europe will have to continue relocating people, capital, and back-office operations.
Those conditions and the loss of London’s seamless access to the 27 remaining EU countries endangers the Square Mile’s status as the world’s No. 1 financial center -- not to mention its contribution to Britain’s budget. The U.K.’s financial-services sector paid the equivalent of 11 percent of total government tax receipts in the year ended March 2017.
While financial institutions have been bracing for the worst -- a divorce without a deal -- it won’t be easy or even desirable for them to suddenly change contingency plans they’ve been pursuing ever since the Brexit referendum in 2016.
Read the draft agreement’s language on financial services
Not a week seems to go by without news of yet another jump across the channel. CME Group Inc., the Chicago-based derivatives exchange, is moving its $240 billion-a-day short-term financing market to Amsterdam. Commonwealth Bank of Australia is also setting up a base in Amsterdam. Construction continues unabated on Bank of America Corp.’s new trading floor in a renovated post office in the heart of Paris.
"In some cases it’s going to be too late for the bank to change their plans,” said Jan Putnis, the head of the financial-regulation team at the law firm Slaughter and May in London. "Some of the banks are a matter of weeks away from moving massive amounts of business to the EU.”
London could ultimately lose 10,000 banking jobs and another 20,000 slots in financial services as clients move 1.8 trillion euros ($2.1 trillion) of assets out of the U.K. on Brexit, the Brussels-based think-tank Bruegel projects.
Still, it’s better than no deal at all. For months, the Bank of England and industry leaders have been sounding the alarm about disruption in the derivatives markets. London’s clearing houses, led by LCH Ltd., process trillions of dollars in contracts every day. Without a transition in place to ensure trades with EU-based counterparties continue uninterrupted, banks faced the costly and disruptive prospect of moving to clearing houses in Paris or Frankfurt.
City lawyers will now pore over the details of May’s plans to plot the next two years. As grinding a process as Brexit has been to get to this point, this is only a prelude to the main event.
After March 29, the U.K. government and the EU leadership will have to hammer out a trade agreement and other measures defining virtually every aspect of their economic relationship. As part of that process, this deal will have to morph from a non-binding stop-gap into a permanent rulebook for financial ties between the U.K. and the EU.
"The harder question in this context is what ‘equivalence’ will actually turn out to mean,” said Simon Gleeson, a partner at Clifford Chance.
And the clock is ticking. London and Brussels will have until December 31, 2020, to come to terms or face yet another cliff edge.
While this new reality would put all non-European banks on equal footing, Brexit could hit British banks hardest because of the likely impact on their home market. The International Monetary Fund already forecasts GDP in the U.K. will increase just 1.5 percent in 2019, the weakest performance of Europe’s major economies after Italy.
In an interview in August, Jes Staley, the chief executive officer of Barclays Plc, said the lender was tightening credit because of the prospect of an economic slowdown. But he also said the challenge was also an opportunity for trading profits.
“Brexit, I think, would bring back volatility," Staley said. "And volatility is good for us.”
©2018 Bloomberg L.P.