Europe’s financial rules are shifting under the feet of Brexit negotiators, as the EU moves to harden its regulatory regime in ways that could shut out the City of London after the UK leaves the union.
Brussels will on Wednesday release its first batch of financial proposals since Britain’s EU referendum, giving an insight into how the bloc’s regulatory landscape may evolve without the UK.
All the signs point towards more fragmentation in the oversight of global financial activities, as the EU and other jurisdictions strengthen their external frontiers and increase the sunk costs for foreign companies operating in their market. For Brexit Britain, that means the risk of higher entry barriers to overcome. “It is all becoming very hard indeed,” said Simon Gleeson, a financial services lawyer at Clifford Chance.
One example of a more protectionist policy drift will come when the European Commission proposes tit-for-tat bank measures against the US, which would force foreign lenders to have additional capital in the EU so their subsidiaries can better withstand a crisis.
Seen in pure Brexit terms, if non-EU banks need to create a separately capitalised holding company in the eurozone, London could look a less attractive headquarters for European operations.
Separately, officials are re-evaluating how Brussels grants EU market access to overseas financial companies, potentially making it harder for the City to use the bloc’s “equivalence” arrangements as a Brexit fallback option.
Charles Grant, director of the Centre for European Reform, said commission officials insist “not entirely convincingly” that this tightening is unrelated to Brexit. But “France is driving this hard line on financial services and nobody is resisting”, he said.
A third leg to the consolidation could come through more explicit “location” policies, restricting where EU-related financial activities can take place. Next week, for instance, the commission will issue proposals on the recovery and resolution of clearing houses. This includes no additional territorial restrictions affecting the lucrative clearing of euro trades in London. But France, Germany and many MEPs support the relocation of euro clearing to the eurozone; proposed amendments to this effect are likely as the legislation is debated.
Dirk Schoenmaker of the Bruegel think-tank said: “The internal market is rife with location rules. If you are inside you don’t see them. It is when you are out that you feel the pain. And these location rules will be reinforced. There is no love lost with the UK on financial services. The positions are hardening.”
EU officials insist Brexit is not a consideration in any reorientation of policy. But the shifting position highlights an underlying clash of interests that will make agreement more difficult.
Stephen Adams, partner at Global Counsel, the advisory group, said: “In some ways this is a reminder that there is a basic asymmetry in the EU-UK relationship. It is their market and they will set the terms for accessing it.
“Clearly, not everybody in the single market believes that London’s place as Europe’s financial centre is inevitable or eternal.”
True to their historic instincts, British policymakers are trying to solve the problem partly by looking upwards. Wary of becoming “rule takers” as a price of access to the EU single market, the Treasury and Bank of England want to help build more flexible equivalence arrangements, co-ordinated under the umbrella of the Group of 20 leading economies.
But this comes at a time of growing transatlantic tensions over financial regulation. Part of Britain’s success as a financial centre has been from straddling the regulatory regimes of Europe and the US. “The problem for the UK is keeping one leg in each boat as they float further apart,” said Mr Gleeson.
The EU and US are taking increasingly divergent positions, for instance, over reforms to global bank rules put in place after the financial crisis. Next week’s meeting in Chile of the Basel Committee on Banking Supervision may provide the crunch. Valdis Dombrovskis, the EU’s top financial regulator, has said the EU is ready to walk away from proposals to curb the use of internal bank models that would hit European lenders disproportionately.
In London some officials hope the EU’s position will soften once the collective costs of retrenchment become clear. Sir Jon Cunliffe, deputy BoE governor, has warned that fragmenting a “complex financial ecosystem with very deep and liquid capital markets” would inevitably put up finance costs across Europe.
The risk is that both Britain and the EU lose out as barriers go up. Global banks that use London as a base to access the rest of Europe are already having to weigh their future strategies because of Brexit. About 20 per cent of financial services undertaken in London is cross-border business with the EU.
Sir Jon told a House of Lords committee: “Investment banking in the EU is not making stellar returns at the moment, and in some cases it may be that a business does not move; it just stops because there is less depth of financial services available.”