Martin Heneghan and Sarah hall find this Brexit has sparked a negative-sum game for European finance as activity shifts to more established centers across the world, particularly in the United States, which both have regulatory access to the EU via equivalence and deep capital markets.
The UK’s decision to leave the European Union sparked a scramble in Europe as rival EU financial centers competed with each other to lure financial services away from the City of London. The EU’s single market has made it easier for the city to access the provision of financial services across the EU through ‘passport fees’. These have made it possible to provide financial services on a cross-border basis to clients in the EU. It also allowed for the establishment of branches across the block rather than more expensive subsidiaries. Once it became clear that the UK intended to leave the single market, politicians in European financial centers saw an opportunity to attract international banks and other providers to their premises. However, to date, while some activities and resources have been transferred to the EU as a result of Brexit, there has not yet been the mass exodus that many industry players feared at the start of the outcome. of the referendum.
The first research on the new geography of European financial centers chartered the activities of EU political actors seeking to profit from the mess caused by Brexit. Some noted that while economic actors were committed to the status quo, political actors saw benefits in disruption to maximize gains for their districts. Paris in particular has campaigned aggressively for financial service providers to locate in the French capital. Likewise, Frankfurt sought to use its European Central Bank hosting to pretend it was the natural heir to London as a new European financial center.
In a recent article, we drew on this analysis to suggest that an emerging geography of fragmentation in the EU and concentration in the UK may be underway. In the EU, relocation activities suggested a regrouping of specific sub-sectors within European centers. Frankfurt was the main beneficiary of bank outsourcing, while asset management companies preferred Dublin and Luxembourg. Market infrastructures chose Amsterdam, while Paris benefited from a wider range of activities. Despite the loss of some staff and assets, there has not yet been a significant reconfiguration of financial services in the UK. Indeed, focusing on the movement of people can be a misnomer as the industry is likely to be changed by jobs that are never created rather than jobs that are relocated.
Past crises in the UK provide a framework for how Brexit can play out in the medium to long term for financial services in the UK. After the global financial crisis, a first contraction in London was followed by growth in employment and financial sector output in the capital as it reinvented itself and created new markets such as the internationalization of the renminbi . Employment and production in many of the UK’s regional financial centers, by contrast, contracted, especially in central cities such as Birmingham, Manchester and Leeds. This led to a process of concentration of financial services in the UK. While the pressures to reduce and consolidate were induced by the crisis, the back office functions were either relocated abroad or saved. The prestige of having an office in London shielded the capital from these pressures, despite the higher costs associated with employment in London.
A new dynamic has shifted since January 2021, at the end of the transition period, and the UK has lost its access to the single market. This has hampered the City of London’s access to certain transactions such as euro-denominated derivatives, which under EU rules must be executed on an EU trading venue. However, while European financial centers have been the beneficiaries of part of this, such as Amsterdam in equity trading, the United States has so far been the primary beneficiary of the new trading landscape. In the absence of passport fees, third countries must rely on an equivalence decision from the European Commission. This is where the Commission considers regulation to be equivalent to EU regulation. It is the poorer cousin of the passport as it is not as complete and can be withdrawn with 30 days notice. The City of London currently only has an equivalency agreement in two areas of financial services. The United States, meanwhile, has 22 equivalency agreements. In transactions such as derivatives, this has given it an advantage over other financial centers. In the absence of passport or equivalency fees, the City of London is unable to execute certain transactions. European financial centers have passport rights, but they do not have the deep and liquid capital markets of New York, which also has regulatory access to certain services through the equivalency agreement.
Brexit can therefore be seen as creating a negative sum game for European finance. Rather than relocating financial services across the continent in a zero-sum game between the UK and the EU, some activities are completely moving from the continent to other centers, particularly New York and Chicago. This is illustrated by the case of derivatives trading, where UK counterparties trading in-scope derivatives with EEA counterparties (and vice versa) may find that conflicting sets of rules apply and that ‘they cannot conform to both. The only workaround to this solution is to reroute them through a third country with an equivalence decision – like the United States.
The negative sum game of European finance should not necessarily be interpreted as a strategic miscalculation on the part of the EU. It just shows that there are broader factors at play than economic efficiency. The losses for the City of London have political advantages for the unity of the EU project, even if they do not materialize as economic advantages for the bloc. This makes the outlook bleak for the UK on an equivalency decision. These decisions have always been political as well as technocratic. In the case of Brexit, it seems likely that politics will trump technocratic and economic efficiency concerns.
about the authors
Martin Heneghan is a researcher at the University of Nottingham.
Sarah hall is Professor of Economic Geography at the University of Nottingham.
Photo by Zach Miles on Unsplash.