Monday, January 14, 2019

Why the Government’s Brexit deal is bad for British financial services

The Withdrawal Agreement renders UK Financial Services vulnerable to over-eager EU regulations, with French and German politicians in particular looking to seize the opportunity to introduce a financial transaction tax that would see business move to New York. Meanwhile the forecasts of a mass exodus from the City have been revised down considerably as the institutions and regulators have got down to the business of actually working out what is necessary to manage the change.

We urge MPs to vote against the Prime Minister’s proposed Withdrawal Agreement (WA) for the future prosperity and protection of Britain’s largest and highest employing and exporting industry. 

Recall that the government's deal is not actually the deal. It is only the withdrawal agreement (WA). It provides for a transition period until 31 December 2020 (extendable by mutual agreement until 31 December 2022). During this time the UK will remain in the customs union and single market, but without a vote, voice or veto.

A cynic might suggest that it is no coincidence, then, that French and German politicians have recently renewed calls for a Financial Transaction Tax (FTT). During the transition period the UK would be compelled to go along with EU directives on the matter. The tax would increase costs (ultimately born by pension funds) and have the effect of driving business offshore, with the US being the likely beneficiary.  In the 1980s the Swedish government introduced a series of financial transaction taxes with the end result being that by 1990 more than 50% of all Swedish trading had moved to London.

The FTT is something the UK government has vetoed several times before. It was first put forward in 2013 by the European Commission.  The idea was revived in December 2017 as a pet project of French Finance Minister Bruno Le Maire  and raised yet again by French President Emmanuel Macron in July 2018. More recently Olaf Sholz, German Finance Minister, called for a FTT in a speech in November 2018 (the same speech in which he is reported to have called for France to relinquish its UN seat to the EU, a Eurozone budget and an EU army).

We have already seen the negative effect of the EU's tendency to continually increase and centralise regulatory oversight to the detriment of the UK: Consider, for example, the Markets in Financial Instruments Directive II (MiFID II). Intended to enhance transparency, the increased regulatory burden led to ICE moving 245 futures and options contracts from London to the US.  It thus had the perverse double whammy of driving business overseas and reducing oversight within the EU.

While the relocation of business from the UK to the US is unlikely to be of concern to the US investment banks, it should be a concern to Her Majesty’s Government.

Is this, however, a cost worth paying to avoid a "cliff edge"scenario? In truth, the height of the cliff has been vastly overstated. Added to which, banks and regulators have been prudently implementing plans to mitigate any negative impacts for over two years.

Conversations between UK and EU regulators to minimise systemic risks have sensibly made good progress. For example, on 13th November 2018 the European Commission released a paper setting out how EU firms will be able to continue to access UK clearing houses, which stated:
“Should no agreement be in place, the Commission will adopt temporary and conditional equivalence decisions in order to ensure that there will be no disruption in central clearing and in depositaries services. These decisions will be complemented by recognition of UK-based infrastructures which are therefore encouraged to pre-apply to the European Securities and Markets Authority (ESMA) for recognition.”
The Bank of England has issued similar advice on how it will recognise non-UK CCPs, subject to reciprocity.
We can expect further agreements in the coming months, as there is now insufficient time for the EU to prepare the necessary legal framework or build the required capacity to support the moves that had been feared. Smaller financial firms (both in the UK and in the EU) are more likely to have deferred changes and will benefit most from such agreements. These agreements will be both with the EU and with individual member states. For example, the French Government is currently implementing legislation that will allow UK financial firms to continue their activities in France and also ensure French firms may work with UK firms as a third-country entity.

Estimates of job losses have been drastically revised down as banks have dealt with the realities. The focus has been on establishing EU27 legal entities. Job relocations have been few as EU employment laws and lack of local talent motivated firms to make minimal operational changes. The story hasn’t really moved much since 2016, and where it has, it has moved in favour of leaving on WTO terms.

There is clearly a good deal to be had with the EU, but the government has not played its hand well and has created significant risks for the financial services industry. WTO terms are not optimal, but are manageable and preferable to the current proposal from Westminster.