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London’s Future Is in the Hands of the EU

Alexander Weber and Silla Brush

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London’s battle to remain a global financial hub now rests on a once-obscure process controlled by politicians in Europe.

The European Union will consider about 40 equivalence decisions this year, determining how much equity, fixed-income and other investment banking business can remain in London and still serve EU clients. The bloc’s politicians are under no obligation to maintain close ties with the U.K.’s finance industry.

Barclays Plc, Goldman Sachs Group Inc. and Bank of America Corp. are among those preparing for the worst by building offices in cities including Dublin, Paris and Frankfurt over the last three years. However, the world’s biggest investment banks have so far moved few executives and very little trading business out of the U.K.

“I think it’s going to be a difficult few months,” said Catherine McGuinness, policy chair of the City of London, which administers the financial district. “I would really hope that just getting basic equivalence, since we’re completely aligned at the moment, ought to be straightforward. I just worry that it may get politicized.”

European Commission President Ursula von der Leyen already took a tough stance, making clear that “all will change” in the City’s relationship with the EU. Britain is set to officially withdraw from the EU by Jan. 31 and the official transition period expires on Dec. 31.

Is this what the City wanted?

Financial firms in the U.K. originally sought a much broader agreement to minimize disruption. The bloc rebuffed these demands and said that its standard market-access system for foreign jurisdictions is all that’s available after Brexit -- meaning that for companies to easily access the single market, the regulations that govern them must be recognized as equivalent.

The problem with equivalence, from the U.K.’s point of view, is that it’s a unilateral decision by the EU’s Commission that can be withdrawn at short notice. In talks with member states on Jan. 10, the commission repeated that decisions on market access won’t be subject to negotiations and that it will protect its own interests.

On top of that, the equivalence process is a patchwork of dozens of rulings that can be taken under specific European laws, for only specific types of financial services and for one country at a time. The commission has taken over 280 equivalence decisions across the financial industry for more than 30 countries.

Which equivalence decisions matter most?

The core fixed-income and equities trading and banking business rules are high priority.

Top of the list are cross-border investment services offered from London to professional clients in the EU. The revised EU Markets in Financial Instruments Directive, or MiFID II, allows for equivalence for services such as portfolio management, investment advice, underwriting and trade-execution.

Since MiFID II began in January 2018, no foreign country has won this kind of equivalence. Access could be given to all services recognized by the law or only parts of them.

Meanwhile, banks, stock-traders and clearinghouses like the London Stock Exchange Group Plc are pressing for the bloc to allow EU-listed shares to be traded on London platforms and cleared in the City. The EU has granted equivalence to clearinghouses, but only on a temporary basis.

What isn’t covered by equivalence?

Core banking activities like deposit-taking, investment services to retail clients and syndicated and other cross-border lending services aren’t covered by any equivalence provision.

If banks want to continue, they’ll most likely need to do the business out of their new offices in the bloc. That could eventually require more capital and staff to move.

But won’t a free trade agreement solve everything?

The EU hasn’t shown any willingness to include financial services in a free-trade agreement with the U.K. in any meaningful way. Even if it did, a deal to replicate the level of access offered by EU membership would have to break new ground in many areas and may be hard to finalize by the December deadline that Boris Johnson has set for trade negotiations.

In slides presented to member states, the commission confirmed that the free trade agreement won’t do much to open doors for cross-border financial services. That leaves equivalence as the remaining route.

The issues of equivalence and a trade deal could still be linked by politicians looking to score points, as Switzerland recently experienced.

Will the U.K. succeed?

The latest tweaks to the EU’s equivalence framework indicate that London is facing an uphill battle. Since the Brexit referendum, policy makers in Brussels have tightened the rules to prepare for the U.K.’s departure. For example, the EU now has greater powers to inspect and scrutinize derivatives clearinghouses, addressing the fact that British firms handle the bulk of euro-denominated contracts.

The commission has also indicated that the country can expect a rigorous assessment of its regulations as well as close monitoring once equivalence has been granted, to make sure that frameworks don’t drift apart.

Winning EU recognition for British rules should be viewed as a first step toward a more ambitious relationship, said Conor Lawlor, director of Brexit at the U.K. Finance lobbying group.

“Both sides should consider how they can build upon current equivalence frameworks to establish a long-term mechanism for cross-border trade in financial services,” Lawlor said.

To contact the reporters on this story: Alexander Weber in Brussels at aweber45@bloomberg.net;Silla Brush in London at sbrush@bloomberg.net

To contact the editors responsible for this story: Dale Crofts at dcrofts@bloomberg.net, Marion Dakers, Ross Larsen

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