The European derivatives market is huge, the notional amount outstanding in q4 2019 was EUR681tn, down a little on a year earlier when it peaked at EUR715tn. London’s dominance of the clearing market for these derivatives is impressive, with 82% of all trades by value involving a UK-domiciled counterparty.
The ‘pinks’ were citing concerns in the run-up to the end of 2020 as to what might happen, without an agreement, to allow clearing for EU derivative trades to continue out of London. Clearly the EU market could not absorb the overnight loss of 82% counterparty capacity and whilst the EU might have liked to impose a hard Brexit on the market, the collateral damage to its own member countries would have been excessive.
Inevitably, a work-around has been found to allow time for more negotiation. The European Securities and Markets Authority (ESMA) has agreed to extend the current arrangements until the 22nd of June; thereby creating a ‘high noon’ for London on the longest day of the year. The ESMA is not setting out with the intention of keeping the market open for London. It is on record as wanting eurodenominated derivative trading to take place exclusively within the EU. It is taking the stance that London will only be able to continue to ‘play’ if it accepts “equivalent” regulations.
The reprieve on euro-derivatives trades arises out of a need for convenience and stability for Europe, rather than as a signal of intent.
Just as there were four and half years of heated discussion on a trade deal, the debate on equivalence for financial services also fulminated during that period, but without a resolution. The prospect of a future agreement looks bleak. That’s unless there is a fundamental shift on one side or the other over the definition of equivalency and the degree of latitude the EU will extend to the UK in charting its own regulatory path before it decides to pull the rip cord on any future arrangement.
The rest of the world
Whilst it could be argued that Brexit was about leaving the EU, it can also be argued that the UK has merely stepped out of the EU and into the rest of the World. Returning to equities and the loss to London of trading EU shares, we find an immediate example of this. In 2019 the EU banned the trading of Swiss shares in a dispute arising from botched trade negotiations. This cost London EUR1.2 billion a day in stock trading volume, however London and Zurich are working to clear a path for trade to resume by mid-February. The fact that this deal is being done lends further weight to the view that the UK intends to go it alone as far as financial regulation is concerned.
Whilst there are few who would celebrate losing EUR6.5bn to gain EUR1.2bn and most concede that the short term impact on London is not good, it should be taken against a backdrop of a GBP 134bn industry that is diverse and holds the intellectual capital of over a million workers in the UK.
Whist there has been much focus on the intra-European market, the Global market is much greater in size and the UK is opening itself into a greater share of that market where it is already a premier league player. As a global leader with huge embedded knowhow, London is very well placed to commence a new wave of dominance as it did after Big Bang in 1987.
Chancellor Richi Sunak has raised the prospect of Big Bang Two: rooted in a relaxation and refocusing of regulation, this could have the same effect as the first Big Bang. The UK has vast experience in reinsurance, derivatives and equities, as well as world class legal services.
Free to reset its regulations for the emerging new world of financial services, FinTec driven and price de-constrained, the UK has the opportunity to shape a financial revolution.
As financial services is inherently conservative, there will be a marked reluctance to relinquish the UK’s hard-earned reputation for high governance standards, and teasing out the standards which are truly gold standards and untouchable from those that are not quite right, such as MiFID 2, which will require some amendment to deliver its original aims, will require a finely balanced regulator with an ear for commerciality, stability and probity.
Happily, the skills, mindset and knowledge to achieve this are centred in the City. The political environment is more likely to impact the success or otherwise of the project.
The question of uncertainty
With the economic damage from the Covid-19 Pandemic far from over and the impact of the solvency of financial and trading institutions still largely unknown as financial reporting is slightly relaxed and many larger institutions are still assessing their true trading position, the potential for financial and systemic accidents stays high. In late 2019, there was speculation that a weakness in the Italian Banks could ripple out into a full banking crisis in the Euro zone. This never materialised. However, conditions have hardly improved for those banks, nor has the ability of the Euro zone to withstand such a shock been enhanced in the past 15 months. The US faces similar challenges, and there is a sense of political instability that is unfamiliar.
These factors make it difficult to predict how the world economy will develop, but also the relative strengths and motivations of the main players in the G7 may also flex and change as their economies and societies adapt to the current situation. The UK is certainly less fettered in morphing to the opportunities ahead, but is it strong enough to punch at this weight with these contenders without the EU at its back?
In future issues of IFA Magazine we will invite guest writers to explore more deeply the specific issues facing UK Financial Services as we continue to focus on the future for the sector in a post-Brexit world. In the meantime, we will watch with interest as the discussions and debates continue to take place as to what the future really does hold for this all-important sector which contributes so much to the UK economy in terms of income as well as employment.
