The key UK financial services sector faces an anxious wait to learn on what basis it can keep dealing with Europe. This is after being largely omitted from the trade deal along with services in general, which account for 80% of Britain’s economy.
While market players hope that years of preparations since Britain voted to leave the European Union means the transition of most euro-denominated assets like shares and derivatives out of the country will be relatively smooth – the long-term impact remains unclear.
While the landmark trade deal agreed last week set rules for industries such as automotive, fishing and agriculture, it did not cover Britain’s much larger finance sector, meaning automatic access to the EU’s financial markets came to an end on 31 December.
Split trading pools
The EU wants to reduce reliance on the City of London for financial services and see more euro-based trading in Frankfurt, Paris, Amsterdam and other financial centres in the bloc.
That will split Europe’s stock, bond and derivatives markets into two separate trading pools, raising concerns that investors will get less competitive prices.
EU banks must trade euro-denominated shares inside the bloc from 4 January, forcing them to switch from platforms run by the likes of Cboe Europe, Aquis Exchange, London Stock Exchange’s Turquoise and Goldman Sachs in London, to EU hubs they have opened in Amsterdam or Paris.
Most shares are still traded on their home exchange, but between them London platforms account for nearly all cross-border trading in shares in the remaining 27 EU states.
That amounted to €8.6 billion ($10.4 billion) a day collectively in October, or a quarter of all European trading, Cboe data shows. David Howson, president of Cboe Europe, said almost all cross-border European stock trading will switch overnight.
The last time there was such a rapid shift in volumes was in 1998 when trading in 10-year German Bund futures by dealers on the LIFFE exchange floor in London was lured by cheaper electronic screens to Frankfurt.
“It’s the biggest single share trading shift in the last two decades at least,” Howson said.
Swaps & Derivatives seek equivalence
Another of London’s top money spinners is its trade in trillions of euros in derivatives. This anomaly, which dates back to 1999 when Britain opted out of the euro’s launch, has seen a dominant share of trading in euro-denominated swaps take place in the capital.
On 9 December 2020 the International Swaps and Derivatives Association wrote to the EU urging them to grant equivalence for UK derivatives trading venues. The letter was sent after EU regulators announced rules on 25 November that will prevent London-based derivatives traders at EU banks from continuing business seamlessly after Brexit is completed.
The Bank of England has warned that trade in interest rate swaps worth around $200 billion could be disrupted, because banks operating in Britain and the EU must trade inside their own jurisdiction, or on approved platforms in New York.
It may force Britain at the last minute to ease its restrictions on swaps trading to minimise disruption.
Erik-Jan van Dijk, Achmea Investment Management’s head of treasury and derivatives, said regulators have already taken steps to mitigate some of the risks by allowing EU banks to continue clearing their derivatives in London temporarily.
But trading will have to move, and some counterparties with existing swaps contracts in Britain were reluctant to shift them before they absolutely had to.
“We may leave some existing positions in the UK and we might choose not to do business with those UK counterparties in future,” van Dijk said.
Bank of England standing by with “armoury” to hand
Bank of England Governor Andrew Bailey has said he will have all its “armoury” at hand, although so far regulators say they do not expect any threats to financial stability.
Bob Wigley, chair of UK Finance, the trade association for financial services firms, said there was more work to be done.
“It will be important to build on the foundations of this trade deal by strengthening arrangements for future trade in financial services,” he said in a statement. “This can be achieved by building on the longstanding regulatory dialogue and supervisory cooperation between UK and EU authorities and reaching agreements on all appropriate equivalence determinations as soon as possible.”
Catherine McGuinness, the policy chair of the City of London, the council which manages London’s financial district, said the free-trade agreement is positive news.
“We hope it can lay the foundations for a collaborative future partnership,” Ms. McGuinness said in a statement. “We also urge both sides to continue to work on other outstanding issues, including agreeing a framework for regulatory and supervisory cooperation.