Press play to listen to this article
Voiced by Amazon Polly
This article is part of the special report Brexit and the City, and was updated March 31.
The EU is losing its largest financial center and, along with it, global influence in regulating markets.
Once the Brexit deal was signed in the dying days of 2020, control over the City of London’s regulations was taken back by London. And however the relationship evolves, British politicians and officials have made clear they won’t become “ruletakers” and simply copy European financial measures in the future.
That's bad news for Brussels regulators. Until Brexit, rulemaking power over the world’s second-largest financial center gave the EU heft in setting global standards and swayed countries to align their rules with the bloc’s.
When Abu Dhabi and Dubai were setting their sights on becoming finance hubs a decade and a half ago, for example, they chose to closely replicate EU measures on market conduct and defining professional investors versus ordinary clients. The Middle Eastern city-states said the EU represented “international best practice” and offered a gateway to the global hub of London, explained a lawyer who has counseled the region’s governments on finance policy.
“It is what all the big banks and investors wanted,” said Mazen Boustany, head of the financial law practice for Baker & McKenzie in the United Arab Emirates.
In an interview, he said the U.A.E. financial centers also use a British-style legal system, relying on judges from Australia and Britain. This may lead the U.A.E. to keep U.K. rules if those diverge from the EU’s in the future.
European directives, often shaped by the U.K., have been influential in different ways. The EU’s main law for insurance companies set the template for global capital standards. Its regime for mutual funds — known as Undertakings for Collective Investment in Transferable Securities (UCITS), many of which are managed in London — has become an international quality mark, with UCITS sold in Hong Kong and the U.S.
In those and other areas such as securities law, the EU has gotten foreign jurisdictions on side by offering their firms easier terms of entry to its wealthy market, if they adopt “equivalent” rules.
Singapore and Hong Kong both adopted EU-compliant market regulations to be recognized by the European Commission, said Simon Gleeson, a lawyer specializing in international capital markets at British firm Clifford Chance.
“If you look at it from their perspective, it was clear they wanted access to London,” Gleeson said. “The question now will be, will they really care about access to Frankfurt and Paris enough to change their rules in the future?”
Weaponizing regulation
“Equivalence is definitely used by the EU as a soft power tool,” said Michael McKee, a partner specialized in financial regulation at law firm DLA Piper, who has advised governments in the Middle East and Africa on drafting rules to avoid conflict with European and U.S. guidelines.
In years past, the Commission often used its “equivalence” process as a way to work around regulatory differences and open up its market. Since the Brexit vote in 2016, it has taken a harder stance.
The handling of Switzerland’s market rules put the U.K. on notice. Just before granting equivalence, Brussels pulled back in the midst of a wider dispute on relations with Bern, which was triggered by a Swiss referendum to limit immigration by EU citizens.
The last-minute swerve meant cutting off EU investors from trading directly on the Swiss stock market, driving up their costs.
The U.K. offered its version of equivalence for Swiss stock markets this February, drawing a contrast intended to send a wider signal to global trading partners.
The U.K. has also already signed trade deals, including some provisions on financial services, with Japan and Switzerland. It is conducting talks with Brazil, India, China, the U.S., Singapore and others.
Europe rejected out of hand the idea of a financial services agreement with the U.K. even if the resulting obstacles after Brexit will raise costs for European companies seeking access to global markets via London. The two sides reached a deal last week that enables communication between regulators and politicians responsible for financial services policy, but the arrangements have been branded “a talking shop” by industry insiders, and do not reestablish EU market access for U.K. firms.
The EU meanwhile grew more assertive in using its equivalence powers during the Brexit negotiations, according to McKee. As disagreement escalated between the U.K. and EU over Northern Ireland policy earlier this month, EU commissioners and diplomats did not hesitate to threaten withholding equivalence decisions for the financial sector by way of retaliation against the U.K.’s perceived violations.
The Commission has refused to grant equivalence to the U.K. despite the Brits having transferred European rules verbatim on their statute books. It has only acted where needed to help its own companies adjust their arrangements for derivatives and securities trading.
“The EU has become more and more protectionist in recent years. But it will be tricky for them to build capacity quickly in financial services,” said a high-ranking British official in a private discussion. Refusing equivalence to London’s massive capital markets has motivated EU-related business to move to Amsterdam, making the Dutch city the largest share-trading hub in Europe. But it has also sent billions of derivatives deals to New York, which has equivalent status from Brussels.
Competing interests
The signs, however, are that the EU will not stop trying to influence global policymaking even if its weight in finance is diminished.
“Particularly with smaller countries it’s easier for the EU to exert pressure to change their laws,” McKee said, pointing to the examples of Switzerland as well as Australia, which is one of the biggest recipients of equivalence designations.
“The EU without the U.K. is nowhere near as large and developed a financial market. In some respects the U.K. is better placed to take on Europe competitively,” McKee said.
From the EU’s point of view, European Commissioner Mairead McGuinness told the Financial Times in 2020, “our interest is making sure that we are not captured by a system that we don’t regulate.” She added in the interview that she believed London has grown due to its membership of the EU.
“We are trying to take control of our system in a way that services our needs as Europeans, and also [ensures] that we’re not vulnerable,” she said, according to the newspaper.
Still, her comments about defending Europe reveal the change in circumstance for an EU that once projected its rules beyond its borders. That’s simply less realistic without the clout of London, according to Gleeson, the Clifford Chance attorney.
“Brexit is a massive blow to the EU’s extraterritorial ambitions, especially in financial regulation,” he said.
Want more analysis from POLITICO? POLITICO Pro is our premium intelligence service for professionals. From financial services to trade, technology, cybersecurity and more, Pro delivers real time intelligence, deep insight and breaking scoops you need to keep one step ahead. Email [email protected] to request a complimentary trial.
