London has been the unrivaled king of European finance for more than three decades. Brexit is starting to change that.
Billions of dollars worth of stock and derivatives trading has already vanished from the British capital after the United Kingdom completed its exit from the European Union on Jan. 1, shifting abroad to financial hubs in Amsterdam, Paris and Frankfurt.
And the threat of more lost business hangs above the city, home to dozens of the world’s biggest banks, hedge funds and insurance companies. Financial services were not included in the UK-EU trade deal agreed by British Prime Minister Boris Johnson on Dec. 24, putting Brussels in a position to decide how much access UK-based companies will have to the vast EU market.
“I’m not predicting the end of London as a major financial center, but I think it’s in the most precarious state it’s been in for a long time and cannot be complacent,” said Alasdair Haynes, the CEO of Aquis Exchange, an upstart rival to the London Stock Exchange and the CBOE.
Trouble for London means trouble for the United Kingdom.
Financial services are the source of almost 11% of government tax revenue, according to PwC research. In 2019, the sector contributed £132 billion ($185 billion) to GDP, or nearly 7% of the economy’s total output. Half of that was generated in London, where more than a third of the sector’s 1.1 million jobs are located, according to the Office for National Statistics.
While more than half of Britain’s finance sector revenues are domestic, any loss of tax receipts, jobs and business to rival financial markets deals a blow to the UK economy as it emerges from its worst recession in more than three centuries.
In the absence of a deal with the European Union on financial services, there are already signs that London’s undisputed position as Europe’s top financial city is at risk.
Within days of the Brexit transition period ending at midnight on Dec. 31, London lost its ranking as Europe’s largest share trading center to Amsterdam because EU financial institutions can no longer trade euro-denominated shares on UK exchanges.
An average €9.2 billion ($11.2 billion) of shares were traded daily in the Dutch capital in January — a more than fourfold increase from the previous month. The daily average across all shares in London fell by nearly €6 billion ($7.3 billion) to €8.6 billion ($10.5 billion) in January, according to data from CBOE Europe.
Huge volumes disappeared instantly. More than 99% of Aquis Exchange’s European share trading moved from London to its Paris venue immediately following Brexit, according to Haynes. “Almost never do you see liquidity shift overnight,” he told CNN Business.
London’s share of trading in euro-denominated interest rate swaps, which are used to hedge against moves in interest rates, also collapsed from nearly 40% last July to about 10% in January. EU trading facilities accounted for about a quarter of the market in January, up from less than 10% in July, according to data provider IHS Markit. Trading on US venues doubled to 20%, in a sign that New York could also stand to gain from London’s woes.
Analysts caution against reading too much into these early losses, but acknowledge they could be the start of a slow erosion of London’s supremacy. Already, EU policymakers are taking steps to understand whether the clearing of euro-denominated derivatives such as swaps, the bulk of which still takes place in London, could move to European venues, Reuters reported this week. London’s big clearing houses stand between buyers and sellers of financial instruments to ensure trades are settled.
Bank of England Governor Andrew Bailey said on Wednesday that Britain would push back against any attempt by the European Union to force activity out of London. “That would be highly controversial and that would be something we would have to and want to resist very firmly,” he said during a UK parliamentary hearing.
The loss of finance business in London looks more dramatic when compared with 2016, the year Britain voted to leave the European Union. International financial services firms have migrated £1.2 trillion ($1.6 trillion) worth of assets and relocated 7,500 jobs from Britain to the European Union since the referendum, according to data tracked by EY and published in October.
“We see this as a first wave,” William Wright, managing director of London-based think tank New Financial wrote in January. It’s plausible that about 35,000 jobs might move in the medium term, according to Wright. “The bigger threat for the UK in the medium term is that the EU tries to force more business to relocate,” he added.
The level of EU market access granted to UK companies will shape London’s future. And in European capitals, there is a desire to reclaim some of the territory lost to London and deepen the continent’s own financial markets.
Despite its huge importance to the economy, the UK government did not include financial services in Brexit trade negotiations as it raced to meet a self-imposed deadline for a deal to avoid jeopardizing trade in goods.
That’s left London’s banks, insurers and asset managers without the unfettered access to European markets they previously had, forcing companies such as JPMorgan Chase (JPM) and Morgan Stanley (MS) to relocate jobs and assets to Europe in order to keep serving clients.
The best that companies based in Britain can hope for now is the same market access rights that other non-EU countries have, which are determined by a patchwork of “equivalence” agreements. As things stand, the United States, Canada and Australia currently enjoy better access to EU financial markets than the United Kingdom.
London and Brussels have committed to agreeing a Memorandum of Understanding before the end of March, which will spell out how regulators cooperate going forward and form a basis from which equivalence agreements can be reached.
But the European Union is not in a rush. “It is not about restoring market access rights that the UK has lost. We will consider equivalence decisions where they are in the EU’s interests,” Mairead McGuinness, the commissioner for financial services, told the European Parliament last month.
While the loss of share trading is an “embarrassing own goal at such an early stage,” it doesn’t mean London has “lost the match or the tournament,” said Haynes.
For starters, 70% of global secondary bond market trading happens in London and the city handles 43% of global foreign exchange trading, according to data from the London Stock Exchange and the Bank for International Settlements.
London also has established competitive strengths in highly lucrative areas of finance, such as insurance and asset management, as well as a leading position in digital payments and expertise in green finance, which is growing rapidly as companies commit billions to projects that tackle the climate crisis.
The London Stock Exchange is home to the first certified green bonds issued by companies in China, India and the Middle East and the first sovereign green bonds from Asia and the Americas.
The United Kingdom remains one of the world’s largest asset management centers, second only to the United States, according to the Investment Association. And it is the world’s biggest net exporter of financial services when insurance and pension services are taken into account, according to TheCityUK, a lobby group.
Its position and extensive infrastructure in these industries, rooted in London, has been built up over years and comes with a formidable ecosystem of specialist lawyers, accountants and regulators that can’t be easily replicated. It is also underpinned by the global legal system of choice when it comes to commercial dispute resolution.
The fact that lost business has splintered between several different European capitals — with banks choosing Frankfurt and Paris, asset managers favoring Dublin and Luxembourg, and insurers leaning towards Brussels — makes it less likely that any one location will replace London as Europe’s financial capital.
“London as a global financial center is extremely powerful,” said David Durlacher, the UK and Ireland CEO of Swiss wealth manager Julius Bär. “There is a lot of established markets activity that is unlikely to shift materially. It may shift in the margins,” he added.
Some European firms are even bolstering their presence in London. Around 1,500 EU financial services firms have applied for regulatory permission to operate in Britain, with more than two thirds planning to open their first UK offices after losing access because of Brexit, according to Financial Conduct Authority records obtained by consultancy Bovill.
“These numbers are a good indication that the UK financial services sector will continue to be in a strong position post-Brexit,” Bovill managing consultant Mike Johnson said in a statement this week.
Some industry insiders say the United Kingdom should use Brexit as an opportunity to enhance investor-friendly policies, while developing financial services trade with the United States and Asia, which now has a bigger share of global finance activity than Europe.
“Forget about equivalence,” said Haynes of Aquis Exchange. “Change the rules in such a way as to make yourself attractive,” he added, pointing to the current UK listings review as an opportunity to reinvigorate London’s moribund IPO market.
“While the EU is (not unreasonably) defining what business must be done in the EU, the UK should concentrate on being a financial center where people want to do business,” added New Financial’s Wright. “Brexit dents but does not fatally undermine the many factors that over decades have helped make London a dominant financial center.”