Changing times: Brexit’s impact on the EU’s financial services market

March 3, 2021

Following the end of the transition period nearly two months ago, with an EU-UK Trade and Cooperation Agreement (TCA) that largely left out financial services¹, it is unsurprising that the UK is forging alliances elsewhere. Even less surprising, then, is that one such ally should be another European nation well known for its financial sector. Following extensive preliminary conversations between the UK and Switzerland, the two nations recently announced their intention to deepen cooperation on financial services.² Their plan is to create a mutual recognition agreement that would allow for reduced costs and lower barriers to entry for UK firms accessing the Swiss market and vice versa. Switzerland has had its own experience in attempting to negotiate a common institutional framework with the EU that are supposed to replace more than 100 bilateral agreements. Meanwhile the EU withdrew Switzerland's status of financial equivalence in August 2019.³

The UK-Swiss agreement - which will cover a wide range of sectors such as insurance, banking, asset management, and capital markets - will be negotiated over the coming months.⁴ For financial services firms already operating in Europe, or looking to establish a presence there, these developments are noteworthy as financial services firms continue to operate in markets that are challenged by COVID-19 and operating in a state of prolonged pandemic preparedness while looking at how to kick-start the economic recovery.⁵ Financial services firms are also having to adapt to a much faster pace of digitalization and an overall transition to a 'New Dynamic'⁶ along with greater supervisory scrutiny and more complex regulatory rulemaking.

Brexit-driven extension of deadlines are not new. However, the decision on February 23, 2021 to extend the provisional application of the TCA, which the EU was set to ratify by February 28, to a new deadline of April 30, 2021 means that any work on EU-UK financial services market access rights will slow to a pause. A technical working group of the TCA Partnership Council has been tasked with putting a plan forward of what any mutual rights might look like. The original plan and timeline was to put in place a memorandum of understanding on financial regulation topics by end of March. This does not look manageable and current details suggest it will fall short of granting equivalence but instead focus on setting up a forum for dialogue amongst policymakers. Where memoranda of understanding do already exist amongst EU and UK authorities, some of these terms and dialogue may be more limited than what their terms call for.⁷

This most recent delay also puts off any prospects of an equivalence decision, at a time when banking groups are being asked about their plans to shift euro-denominated derivatives clearing to the continent⁸ (a plan that has been proposed since 2016 ).⁹ At a Treasury Select Committee meeting on February 24, Andrew Bailey, Bank of England Governor, warned the EU of what he considers to be a very serious escalation over UK financial services, and added that 'there's a point beyond which the deal is not worth having'. The temporary equivalence for UK clearing houses and CCP to be able to clear euro denominated trades ends mid-2022.

February 2021 has therefore shown that the sensitivities on financial services still continue post-Brexit. For all types of financial services firms, regardless of their post-Brexit operational readiness, these developments matter as they impact structuring and resourcing options, as London's European business flows to a more multi-financial center based model.

The financial hubs' entente: Recent changes to the European financial services landscape

Lack of progress between the UK and EU stands in contrast to another important post-Brexit development, i.e., the UK's decision to grant equivalence to Switzerland's share trading venues. Now that the UK has left the EU, it is no longer bound by the EU's ban on trading Swiss stocks; a measure imposed in 2019 following a dispute concerning EU-Swiss trade talks.¹⁰

The UK's decision to recognize Swiss exchanges has seen the Alpine nation return the courtesy after previously deeming EU venues as non-equivalent in response to the bloc's measures. This has seen Swiss shares, - including institutional investor favorites such as Nestlé, Novartis and Roche - return to trade in the UK in the amount of €250 million a day; a figure expected to increase to €1 billion.¹¹

The UK and Switzerland's recognition of each other's trading venues, and their plans for a mutual recognition agreement, may help offset some of the business that has left the UK since January 1, 2021. The financial services sector was largely left out of the UK and EU's Brexit trade deal, meaning that, with certain exceptions,¹² the EU no longer recognizes UK financial services regulation, nor its exchanges and trading venues, as equivalent.¹³ This has made it more difficult for some UK institutions to effectively serve customers in the EU-27 in the same way as it did during the Transition Period, which ended December 31, 2020.

These issues have seen Amsterdam, the world's oldest stock exchange center, overtake London as Europe's largest share-trading venue.¹⁴ In January 2021, London lost an average of €8 billion a day in trading to the bloc.¹⁵ A large part of this has shifted to Euronext Amsterdam and the Dutch divisions of CBOE Europe and Turquoise, which cumulatively trade €9 billion a day on average; a 400% increase since 2020. London's average daily trading, meanwhile, decreased to €8.6 billion,¹⁶ i.e., less than half of its 2020 average.¹⁷

Similar to the equity securities market, the UK interest rate derivatives and credit default swaps market have also experienced a decline.¹⁸ Indeed, January 2021 saw 25% of euro-denominated interest rate swaps trade in Amsterdam and Paris, compared to 10% just six months ago.¹⁹ Over the same period, London's share of the euro swaps market fell from 40% to 10%, whilst US exchanges, deemed equivalent by the EU, doubled their trading to 20%.²⁰ Furthermore, CBOE Europe plans to set up a derivatives trading business in Amsterdam in the first half of 2021 whilst US-based Intercontinental Exchange plans to move the carbon emissions trading market, which trades up to €1 billion per day, to the Netherlands.²¹

Further, as many as 218 UK-based companies have relocated to/established a new branch in the Netherlands as a result of Brexit, with the Dutch Foreign Investment Agency currently in discussions with another 550 entities.

The UK's financial services market

Many stakeholders across various sectors in the City of London have long been clear about the potential negative consequences of the UK leaving the EU's Single Market without adequate provisions in place for financial services.²² By UK Finance's calculations,²³ the UK is the world's top net exporter of financial services, with a trade surplus of £60.3 billion in 2019.²⁴ Financial services contributed almost £76 billion, or more than 10%,²⁵ in tax receipts to the UK Treasury last year.²⁶

A global financial hub in its own right, London's paramount position was nevertheless boosted by its role as a gateway to the EU-27. It is now set for a more global repositioning and the UK's pending strategy review may well boost further new revenue streams from new markets. In response, the UK is looking to increase global convergence in financial standards, allowing financial services firms to operate across different jurisdictions with greater ease.²⁷ Specifically, the UK hopes to gain market access for financial services in jurisdictions such as Japan and the US through the mutual recognition of equivalence of regulations, as it is planning with Switzerland.²⁸

UK Finance recently released a report proposing an approach of 'regulatory diplomacy.'²⁹ This would see UK financial regulators work with their global counterparts to improve market access.³⁰ UK Finance proposes that the UK should 'promote international co-operation in areas such as artificial intelliegence, cyber security and FinTech',³¹ as well as using 'its position within international bodies such as the Financial Stability Board and Basel Committee to push for global convergence in financial standards.'³² This would make it easier for UK firms to operate across various jurisdictions.³³

Whilst these proposals may help the UK to carve out a new, global role for itself and offset some of the losses caused by Brexit, a financial services arrangement reducing the barriers between the EU-27 and Britain would nonetheless be an enormous boon for Britain as well as the bloc. Having a robust bridge between London and EU-27 financial centers that are looking to press ahead Capital Markets Union 2.0 certainly makes sense for all stakeholders - much of that however relies on the direction of the overall relationship under the TCA.

The future EU-UK relationship

The EU has stated that it requires further information concerning the UK's regulatory intentions before it can grant an equivalence decision.³⁴ Such a decision may be granted where the UK's regulatory regime is deemed sufficiently robust to 'equal' the EU's. However, even where the UK meets all necessary criteria, the decision is ultimately at the EU's discretion.³⁵ The UK has stated that is has supplied the EU will all necessary paperwork, adding that it is 'one of the world's most pre-eminent financial centers, with a strong regulatory system.'³⁶ However, concerned about divergence from EU rules, the European Commission (as the key decision maker) intends to discuss equivalence with the UK 'progressively' and on a case-by-case basis.³⁷ Recent events, such as the Financial Conduct Authority's failure to spot serious red flags prior to London Capital & Finance's 2019 collapse, may further compound the issue amongst EU policymakers.³⁸

There are also substantial political issues at play extending far beyond the UK's regulatory regime. Tensions have repeatedly abounded between the UK and EU over discussions concerning future arrangements.³⁹ Whilst the EU and UK have announced their intentions to finalize a memorandum of understanding covering financial services in March 2021, this is increasingly unlikely to include provisions on equivalence.⁴⁰

A swift solution does therefore not seem likely. Whilst an eventual compromise is probable, the accompanying uncertainty and delays will result in further changes, notably in relation to corporate restructuring, that cannot easily be undone. Further, if the EU and UK reach an agreement allowing for extensive equivalence in the financial services domain, their tense political relationship may make businesses hesitant to rely on such an agreement's stability and longevity. One need only look at the EU and Switzerland's 2019 change in tone to see how quickly recognition can be withdrawn.

Ultimately, unless action is agreed, the current market fragmentation will likely increase, resulting in greater regulatory divergence. It is vital that businesses understand the impact of this on their operations in the UK, EU and beyond in what is likely to continue to be a multi-center financial services ecosystem. Consequently, companies should stay abreast of Westminster and Brussels' negotiations and engage in regulatory contingency planning so as to maximize their benefits under any cross-border compromise between the UK and the EU. These contingency plans should also consider the respective efforts for the UK and the EU to each grant equivalence and market access to other global financial centers, and increasingly, to FinTech centers, that are themselves reshaping⁴¹ the notion of what a financial center actually is.

As FinTech becomes more prevalent, technology centers will gain in importance, while financial centers without FinTech may lose out. This has the power to increase the concentration in the financial services sector as opposed to reducing to it. With the accelerated digital development in the New Dynamic caused by COVID-19, perhaps decentralization provides a new opportunity altogether.⁴²

Our Eurozone Hub lawyers are here to assist you with the wide-ranging effects that Brexit may have on your business. If you would like to discuss any of the topics mentioned above, as well as how these developments fit into the 2021 supervisory priorities of EU financial services regulators, or how they may affect your business more generally, please contact our Eurozone Hub.

1. See coverage from our Eurozone Hub available here. ↩
2. 'UK and Switzerland to deepen cooperation on financial services', UK Government, 27 January 2021, accessible here. ↩
3. See coverage from our Eurozone Hub here. ↩
4. Idem.↩
5. See coverage from our Eurozone Hub available here.↩
6. Please see our New Dynamic Hub available here. ↩
7. See our series of coverage from our Eurozone Hub on the extent of UK and EU memorandums of understanding. ↩
8. And thus also help complete core parts of the Capital Markets Union project. ↩
9. See also coverage on this 'location policy' in: 'Clarity as opposed to just challenges: How to find opportunities in the EU's CCP Relocation Proposal,' Journal of International Banking Law & Regulation, October 2017↩
10. See coverage from our Eurozone Hub available here. ↩
11. 'Amsterdam displaces London as Europe's top stocks centre after Brexit', Reuters, 11 February 2021, accessible here.↩
12. With the exception of some specific areas, such as central clearing and temporary settlement.↩
13. Philip Stafford, 'Trading of Swiss shares in London expected to resume within days', the Financial Times, 2 February 2021, accessible here.↩
14. Philip Stafford, 'Amsterdam ousts London as Europe's top share trading hub', the Financial Times, 10 February 2021, accessible here. ↩
15. Philip Stafford, 'Trading of Swiss shares in London expected to resume within days', the Financial Times, 2 February 2021, accessible here.↩
16. Philip Stafford, 'Amsterdam ousts London as Europe's top share trading hub', the Financial Times, 10 February 2021, accessible here.↩
17. 'Amsterdam displaces London as Europe's top stocks centre after Brexit', Reuters, 11 February 2021, accessible here.↩
18. Idem.↩
19. Idem.↩
20. Idem.↩
21. Philip Stafford, 'Amsterdam ousts London as Europe's top share trading hub', the Financial Times, 10 February 2021, accessible here.↩
22. 'Amsterdam displaces London as Europe's top stocks centre after Brexit', Reuters, 11 February 2021, accessible here.↩
23. UK Finance is an organization representing British banks.↩
24. Daniel Thomas, 'UK banks push for ambitious financial services strategy', the Financial Times, 22 February 2021, accessible here.↩
25. 'Amsterdam displaces London as Europe's top stocks centre after Brexit', Reuters, 11 February 2021, accessible here.↩
26. Philip Stafford, 'Amsterdam ousts London as Europe's top share trading hub', the Financial Times, 10 February 2021, accessible here.↩
27. Daniel Thomas, 'UK banks push for ambitious financial services strategy', the Financial Times, 22 February 2021, accessible here.↩
28. See coverage from our Eurozone Hub available here.↩
29. 'International Trade in Financial Services: Defining trade policy for banking, payments and related financial services', UK Finance, 22 February 2021, accessible here. ↩
30. Daniel Thomas, 'UK banks push for ambitious financial services strategy', the Financial Times, 22 February 2021, accessible here.↩
31. Idem.↩
32. Idem.↩
33. Idem.↩
34. 'Amsterdam displaces London as Europe's top stocks centre after Brexit', Reuters, 11 February 2021, accessible here.↩
35. See coverage from our Eurozone Hub available here.↩
36. Idem.↩
37. Idem.↩
38. 'BoE Chief 'Angry' At Claim He Tried To Duck Blame For LC&F', Law360 UK, 8 February 2021, accessible here. ↩
39. See, for example, Raf Casert and Jill Lawless, 'EU-UK spat over Brexit deal clouds key trade talks this week', AP News, 28 September 2020, accessible here. ↩
40. Daniel Thomas, 'UK banks push for ambitious financial services strategy', the Financial Times, 22 February 2021, accessible here.↩
41. In the excellent compendium 'International Financial Centers after the Global Financial Crisis and Brexit' edited by Youssef Cassis and Dariusz Wojcik, the concluding comments on page 225 state that 'Markets are not just abstractions that exist 'out there' and operated by 'invisible hands'; they are spatially embedded and socially constructed. This statement seems to apply as much to fintech centers as it did to financial centers before the rise of fintech….Fintech facilitates the extension and fragmentation of financial services value chains, with parts of the chain becoming outsourced and offshored, and with some employment migrating from financial centers like London and New York to cities in India and Poland.' ↩
42. See coverage from our Eurozone Hub on Digital Nomads - Challenges and opportunities navigating the EU regulatory considerations for financial services firms. ↩

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