The Hague (Brussels Morning) As we go through the last quarter of 2020, we witness the final act of the Brexit negotiation saga. The protagonists are back on centre stage, with a chorus of regulators in the background. What remains unclear is whether we are watching the closing act of a tragedy or a comedy.
Protagonists & Chorus
The Union’s chief Brexit negotiator, Michael Barnier, has been recently credited with bringing Boris Johnson’s government back to the negotiating table. That is misleading.
London’s financial sector’s prowess is institutionalized and leaves little room for political misunderstandings. The City of London is the only part of Britain over which parliament has no authority. In fact, the City imposes on the House of Commons a figure called “The Remembrancer” – an official lobbyist – who sits behind the Speaker’s chair – like a prompter – to remind him that whatever any MP might think, the City’s rights and privileges are protected.
In theatre there’s an old adage: everyone on stage matters.
You have your protagonist and antagonist in the spotlight. But however good the leads may be, if the supporting actors don’t deliver, the entire production suffers. The same is true in politics. And the final act in this play is “getting Brexit done.”
Getting Brexit Done
As Brussels and London drift apart, the spotlight is on the lead negotiators. But look closer and the plot is actually being driven by the chorus. It is not Barnier who brought back Johnson to the table.
Without a deal, a post-Brexit world will see the conduct and behaviour of financial institutions subject to the actions of regulators on either side of the Channel, whether they cooperate or not.
As a no-deal safeguard, EU and UK regulators have signed cooperation agreements to maintain reciprocal market access. It is unclear how long they will be able to sustain these arrangements. The clock is ticking and these regulators want, or rather need, a deal.
Enter the regulators
Away from the glare of the spotlight, European financial regulators have been increasingly bullish in their stance towards the future relationship between Kingdom and Union.
The European Securities and Markets Authority (ESMA) announced in October that it is working on a ‘‘Plan B”, just in case the two antagonists do not manage to cut a deal.
The message is plain to see: clearing of Euro-denominated derivatives will have to move to the continent, come what may. A similar statement by ESMA is expected towards December on swap trading. To this end, the regulator will provide firms with a blueprint to assist relocation en bloc, with little need for much negotiation. It will happen, no matter what what transpires on stage.
The importance of these activities to London cannot be overstated. To date, the vast majority (nearly 80%) of derivative clearings take place in the UK (Figure 1).
Figure 1: Derivative transactions of Euro-area clearers, and counterparty location
Source: the European Central Bank.
The world’s top clearing house, LCH, is a London Stock Exchange subsidiary and accounts for 33% of the group’s profits (2019 Annual Report). It owes the shine to its luster to euro-denominated swaps and repo trades.
The ESMA and UK counterpart have agreed that “come what may” business will continue as usual for 18 months following the 31 December deadline. After that, London’s transition arrangements expire.
The show must go on indeed. But once it reaches the end of the run, the business will go elsewhere.
A different scene
The ESMA is not alone in threatening its showy protagonists with a transfer to another theatre altogether.
In fact, the securities regulator is building on the European Banking Authority’s summer warning about the systemic risks of Euro-based transactions being exposed to the turbulence of the UK financial market.
The European market will be a European market. To this end, the EBA wants financial institutions to fully execute their plans to serve EU customers before year’s end. This show is coming to an end, irrespective of whether or not all those on stage have got the plot.
The banking authority’s sentiment is shared by the European Central Bank as well. This past March, the Frankfurt-based institution made it abundantly clear that “mutual equivalence” – market access in financial lingo – is not forever and firms must “be ready,” meaning set the stage in the EU.
This will be tricky, as the new scene comes with new operational requirements set by the European Central Bank. It’s a different show.
UK financial operators will not be able to pretend they are in Europe while doing all their real business backstage in London. Their presence in the EU must match the size of their operations in the EU. There will be no virtual reality.
Without a fully-fledged Brexit deal, UK firms will have to make hard decisions in prioritizing market strategies. Those that can’t relocate will be hard hit.
In case of a no-deal conclusion to the Brexit negotiation, actors may have to switch move casts.
Costs rise with entry barriers, pushing operators to divide their EU and non-EU activities, between the Union and the Kingdom, up to the point where it no longer makes sense. You can’t keep two shows running.
This is true for banks as well as other “supporting acts.” But there is no scene like London.
It is likely that the big show of the City will breakdown into small productions spread across the European continent, from Frankfurt to Paris and from Amsterdam to Madrid. Post-Brexit financial infrastructure will be fragmented in different financial theatres.
Although this devolution may yield more stability, London will hope for an encore at least until one city, somewhere, manages to put together a show as big as New York and Singapore. Meantime, Europe has no stage like London. For the moment.