3 ways the City of London can beat Brexit — and 1 way it can’t

This article is part of the special report Brexit and the City.

British politicians and financiers are sanguine, even enthusiastic, about life after Brexit for the U.K.’s “crown jewel” industry of financial services.

The sector is estimated to account for some 10 percent of Britain’s tax income as well as 2 million mostly high-skilled jobs. And as the U.K. economy adapts to life after Brexit, the importance of the financial sector is only expected to grow.

Still, London’s finance business has taken a hit from recent rules adopted by Brussels to restrict Britain’s access to wealthy EU corporate and individual clients.

In January, Amsterdam overtook London to become the largest share trading hub in Europe, and in the run-up to Brexit over €1 trillion in banking assets were booked out of the U.K. and into newly-opened subsidiaries of international firms on the Continent at the behest of the European Central Bank.

So why aren’t London’s policymakers more worried about the post-Brexit future? Here are the top reasons.

1. Regulatory competition

So far, just over 7,500 jobs in the financial services sector have been lost to Brexit, according to the consultancy EY, compared to 2016 estimates of around 80,000 potential job losses.

That’s largely because the U.K. is able to “diverge” from EU rules to make itself more attractive to business and highly-paid executives. So while billions of pounds in trading and assets have moved over to the bloc, the people managing that money have largely stayed inside the U.K.

The U.K. is also set to be quicker on its feet than countries in the EU. With new powers being handed to British regulators such as the Financial Conduct Authority and the Bank of England this year, the U.K. will be able to change rules quickly to adapt to new risks or seize new opportunities — legal processes that can take years in the EU27.

The U.K., for example, has already eased its “dark pool” stock trading rules to attract more business from the EU, while the bloc is still stuck debating whether to strengthen them. The U.K. banking and insurance sectors are also in for a shake-up that will allow smaller players to hold less capital in reserve and invest in riskier infrastructure projects, compared to EU rivals who can’t.

Meanwhile, the government is in the process of overhauling the fintech, asset management and stock market regimes — and keen to prove the utility of Brexit and the agility of the new rulemaking model.

While “complacency is definitely a risk,” the U.K. financial sector is in a good position to benefit from the new post-Brexit reality, said Bim Afolami, a Conservative MP with a previous career in investment banking, in a phone interview.

“Regulatory flexibility, the ability to change policy quickly as times change, is extremely important for a financial center, and we now have it in a way that wasn’t there before Brexit,” he said.

2. Inbuilt advantage

The U.K. has long been the home of international commercial law, as most contracts in global trade are based on the English legal system. Coupled with its world-renowned universities sector, the domination of the English language in global business and a time zone that allows for business to be carried out simultaneously with Asia and the Americas, the country is in many ways well-placed to continue as a hub of global business, where finance plays a big role.

The agglomeration effect provided by London’s status as a finance, science, technology, policy and culture hub is also hard to replicate, giving the U.K. an advantage.

As the finance industry becomes increasingly reliant on software and data, employees are moving seamlessly from banks to big consultancies, law firms, tech companies and vice versa. Because they don’t have to also move home when changing homes, much of that talent in staying in London.

"We have confidence in our fundamental strengths," said Catherine McGuinness, head of policy for the City of London Corporation. "We see a deep commitment to London from industry, so we are not afraid of competition."

3. Industrial policy

The British government has crowbarred data transfer chapters into its recent trade deals, including ones with the European Union and Japan. The hope is that through these nonlocalization agreements, London could become a bridge between Europe and Asia in financial and professional services as well as connected industries such as technology and law.

Government officials argue that the overarching policies of liberalizing data flows, promoting basic standards for green finance and cooperating closely with regulators overseas will make London the obvious go-between for companies with global operations.

Westminster is also riding high on the success of its vaccines program, which brought private industry, the civil service and politicians close together, forcing them to collaborate. A similar strategy could be deployed in some types of financial services, especially green finance, according to experts.

“Unlocking the trillions needed to invest in the net-zero transition at the pace dictated by climate science requires close collaboration between the policymakers and financial markets. The U.K. government clearly recognizes this," said Rhian-Mari Thomas, chief executive of the Green Finance Institute, a private sector organization promoting green finance policy.

The government has made it its objective to cast London as a world capital of green finance, building on the international clout afforded it by playing host to this year’s COP26 climate talks.

Chancellor Rishi Sunak has also recently changed the remit of the Bank of England to account for sustainability when pouring stimulus into the economy, and mandated large corporations to disclose their impact on the environment. The U.K. is also among the first countries to adopt a firm net-zero carbon policy, outline plans to ban fossil fueled cars and issue green bonds to the general public.

“We have been pleased by the post-Brexit response from government,” one financial policy official briefed on Sunak’s thinking said. The official added that since the U.K. left the EU in January, financiers and policymakers have been “on the same page for the first time in years.”

“We are realistic about losing access to the EU consumer. The U.K. is focusing on its strong wholesale markets,” he said, pointing to investment management, currency and debt trading, efforts to raise capital for infrastructure projects, as well as commodities, derivatives and, increasingly, digital asset trading.

The key to remaining successful will be for London to “stay more open and liberal to foreign trade in wholesale markets than the EU, U.S. and China,” he said.

“You have to have somewhere where the international, cross-border part of the financial markets happens. That’s London.”

-1. Trading loss

Despite these potential windfalls, London is losing out in one major area: euro-denominated derivatives trading.

The total EU derivatives market was worth €681 trillion in 2019, dwarfing other trading such as equities trading. And it’s a sector that’s likely to keep growing — albeit outside the U.K.

“Business areas like equity and derivatives trading have seen substantial shifts to EU financial centers,” Bundesbank board member Joachim Wuermeling told German media.

By the end of 2020, financial institutions moved holdings worth €675 billion from the U.K. to Germany. “According to banks’ current plans, asset relocations will rise to €1.2 trillion by the end of next year alone,” Wuermeling said.

Derivatives trading is set to spread across the Continent. “The location hinges on the underlying asset,” said Hubertus Vaeth, who heads the lobby group Frankfurt Main Finance. “Paris is leading in corporate bonds, Amsterdam is the first choice for shares and Frankfurt has good prospects for interest rate swaps.”

Funds will continue to shift until mid-2022, according to Vaeth. By then the so-called equivalence regime that gives London-based banks equal access to European markets will most likely end. 

There have already been some notable trading moves. Britain’s share of euro interest rate swaps trading has fallen from 40 percent to 10 percent between July 2020 and January 2021, according to data from IHS Markit. Market shares in the EU rose from less than 10 percent to 25 percent in the same time period.

Not all business is going to the Continent. Brexit also gave a boost to euro-denominated interest rate swaps trading in the U.S., which benefits from a standing equivalence agreement.

But if losing out to New York rather than EU locations after Brexit may be easier to stomach politically, London is still losing — especially if, in the long-run, New York cements its role as global financial center ahead of London.