51吃瓜

The United Kingdom鈥檚 exit from the European single market on January 1 has sent trade in goods  amid much . By contrast, Brexit was carried out in an orderly manner in the financial sector, despite significant movement of trading in  and  away from the City of London.

The Brexit Deal Presents Opportunities for a New Partnership

READ MORE

After five years of radical uncertainty, it has become clear that the European Union and the United Kingdom will be taking separate paths on financial regulations 鈥� a financial 鈥渄ecoupling鈥� that means a significant loss of business for the City. Whether the EU financial sector can gain much of what London loses will depend on the EU鈥檚 willingness to embrace further financial market integration.

Smart Sequencing Ensured an Orderly Brexit

As with the Y2K problem, the Brexit transition could have gone worse. It took more than luck to avoid financial instability along the way.

First, financial firms on both sides of the English Channel (and of the Irish Sea) worked hard and were able to preempt most of the operational challenges.

Second, despite all the recurring high-stakes drama between the UK government and the European Commission, the technical cooperation between the authorities actually in charge of financial stability, primarily the Bank of England and the European Central Bank (ECB), appears to have run smoothly.

Third, the negotiators phased the process in a smart way. The Brexit Withdrawal Agreement of January 2020 helped reduce uncertainty by ensuring that the UK government would meet its financial obligations to the EU, avoiding what would have been akin to selective default. That agreement kept the United Kingdom in the single market during the transition period beyond the country鈥檚 formal exit from the European Union on January 31, 2020. It also set a late-June deadline for the British government to extend the transition period beyond December 31, 2020. As London decided not to do so, that left six months of effective preparation.

To be sure, whether an EU-UK Trade and Cooperation Agreement (TCA) would be concluded remained unknown until late December. But that mattered comparatively little for financial services, since trade agreements typically do not cover them much. By one , the 1,259-page TCA (which is still  by the European Union) contains only six pages relevant for the financial sector.

The resulting legal environment for financial services between the European Union and the United Kingdom is unlikely to change much any time soon. Contrary to  in the United Kingdom, no bilateral negotiations on financial services are going on, except for a  of understanding expected this month that is not expected to bind the parties on substance.

From the EU perspective, the United Kingdom is now a 鈥渢hird country,鈥� in other words an offshore financial center, following decades of onshore status. UK-registered financial firms have lost the right, or 鈥減assport,鈥� to offer their services seamlessly anywhere in the EU single market. From a regulatory standpoint, they have no better access to that market than their peers in other third nations such as Japan, Singapore or the United States.

Equivalence Status for UK Financial Market Segments

Some segments of the financial sector in these other third countries actually have better single market access than British ones, because they are covered by a category in EU law allowing direct service provision by firms under a regulatory framework deemed 鈥渆quivalent鈥� to that in the European Union. The equivalence decision is at the European Commission鈥檚 discretion, even though it is based on a technical assessment. As a privilege and not a right, equivalence can be revoked on short notice.

So far, the European Commission has not granted the UK any such segment-specific equivalence, except in a time-limited manner for securities  until mid-2021 and clearing  until mid-2022. For the moment, the commission appears to be leaning  making the latter permanent. In most other market segments, the commission will not likely grant equivalence to the United Kingdom in the foreseeable future. This may appear inconsistent with the fact that almost all current UK regulations stem from the existing EU of law. But the UK authorities ( the Bank of England) have declined to commit to keeping that alignment intact.

The commission鈥檚 inclination to reduce EU dependence on the City of London is understandable. No comparable dependence on an offshore financial center has existed anywhere in recent financial history. Such dependence entails financial stability risk. In a crisis, UK authorities would not necessarily respond in a way that preserves vital EU interests. Think of the Icelandic crisis of 2008, when Reykjavik protected the failing banks鈥� domestic depositors but not  ones. It is hardly absurd for the European Union to try to reduce such a risk, even if 鈥� as appears to happen with  鈥� some of the activity migrates from the United Kingdom to the United States or other third countries as a consequence, and not to the European Union.

At the same time, the  that keeping EU liquidity pooled in London is more efficient than any alternative is unpersuasive given the European Union鈥檚 own vast size. In addition, the European Commission also follows mercantilist impulses to lure activity away from London, even though these generally do not make economic sense. Added up, these factors provide little incentive for the commission to grant equivalence status to more UK financial market segments, unless some other high-level political motives come into play. None are apparent  now.

The UK Is Unlikely to Regain Lost Advantage

How the European Union and the United Kingdom will decouple will not be uniform across all parts of the financial system. Regulatory competition between them may become a 鈥渞ace to the bottom鈥� or 鈥渢o the top,鈥� depending on market segments and the circumstances of the moment, without a uniform pattern. In any case, such labels are more a matter of judgment in financial regulation than in, say, tax competition.

In some areas, the European Union will be laxer, while in others, it will be the United Kingdom, as is presently the case between the EU and the US. For example, the European Union is more demanding than the United States on curbing bankers鈥�  but easier when it comes to enforcing securities laws or setting capital  for banks. At least some forthcoming UK financial regulatory decisions may be aimed at keeping or attracting financial institutions in London, but they are still not likely to offset the loss of passport to the EU single market.

All these permutations suggest that the medium-term outlook for the City of London is unpromising, although the COVID-19 situation makes all quantitative observations more difficult to interpret. Once an onshore financial center for the entire EU single market, and a competitive offshore center for the rest of the world, the City has been reduced to an onshore center for the United Kingdom only and has become offshore for the European Union. That implies a different, in all likelihood less powerful, set of synergies across the City of London鈥檚 financial activities.

The few relevant quantitative data points available reinforce this bleak view. Job offerings in British finance, as tracked by consultancy Morgan McKinley, have  alarmingly since the 2016 Brexit referendum. The ECB (as bank supervisor) and national securities regulators coordinated by the European Securities and Markets Authority are tightening  for key personnel to reside mainly on EU territory rather than in the United Kingdom.

As by Financial Times columnist Simon Kuper, many financial firms鈥� Brexit policy until this year had been to 鈥渟it tight and do nothing until post-Brexit arrangements for finance forced [their] hand.鈥� That phase has ended. Firms that drag their feet face regulatory disruption, as happened to broker  in late January. Tussles between regulators and regulated entities, rather than between the European Commission and the UK government, are where most of the financial-sector Brexit action is likely to be in 2021. These disputes typically happen behind closed doors, and the regulators typically hold most of the cards.

For all the optimistic in London of 鈥淏ig Bang 2.0 or whatever,鈥� the United Kingdom鈥檚 comparative advantage as the best location for financial business in the European time zone is unlikely to recover to its pre-Brexit level. The macroeconomic losses could be moderated or offset by cheaper currency and less expensive real estate in London, making the city a more attractive place to do nonfinancial business. Even so, a gap will likely remain for the UK government, which has for years depended heavily on financial sector– tax revenue.

The European Union stands to gain financial activity as a consequence of Brexit. How much and where is not clear yet. As some analysts had , Amsterdam, Dublin, Frankfurt, Luxembourg and Paris are the leaders for the relocation of international (non-EU) firms. Dublin and Luxembourg  in asset management, Frankfurt in investment banking and Amsterdam in trading. But EU success in terms of financial services competitiveness and stability will depend on further market integration, the pace of which remains hard to predict.

The European banking union is still only half-built because it lacks a consistent framework for bank crisis and deposit insurance. The grand EU rhetoric on 鈥渃apital markets union鈥� has yielded little actual reform since its  in 2014. Events like the still-unfolding  saga may force additional steps toward market integration, even though a proactive approach would be preferable.

The one near certainty is that London鈥檚 position in the European financial sector will be less than it used to be.

*[This article was originally published by  and the .]

The views expressed in this article are the author鈥檚 own and do not necessarily reflect 51吃瓜鈥檚 editorial policy.