Article Published February 14th, 2020

The UK has the same rules as the EU at this instant – but EU rules are evolving continuously under the pressure of technological change. The main Directive about trading securities is about to be examined later this year – as part of the normal review cycle. The UK will not be at the table when the EU debates reversing a key concession to the UK after the Great Financial Crash. Very technical – Yes, but very significant!


The significance of financial services to the UK economy – two handy factoids:

1. Importance of tax revenues: Britain’s financial services sector contributed a record £75.5bn in tax in 2019, according to a new report on behalf of the City of London Corporation, amounting to 10.5 per cent of all government tax receipts.

2.  Importance of exports of financial services: in 2017, there was a surplus in financial services trade of £44 billion (43% of financial services exports went to the EU) .  Even after this surplus, the UK still recorded an overall deficit of £73 billion on the balance of international payments that year (or 3.5% of GDP – the largest by far amongst the world’s leading economies).


Background:

 At the end of this year, UK financial services firms will lose their “passporting rights” to deliver services into the EU. However, they may be allowed to continue to provide some services if the EU decides that UK regulations are “equivalent”. The draft Council negotiating directive makes it clear that this will be a unilateral decision by the EU – as it has always been for “third countries”. Presently, equivalence does not even apply to banking, but is of huge importance for trading in financial instruments – securities, derivatives etc.

However, the FT has reported – with the aid of a long distance camera shot of the UK’s negotiating documents – that “The British government is demanding the EU sign up to a “permanent equivalence” regime for financial services that will last for “decades to come” to ensure the City of London can maintain access to the European market after Brexit.”  The EU’s chief negotiator – Michel Barnier – responded immediately in striking language “I would like to take this opportunity to make it clear to certain people in the United Kingdom bearing authority that they should not kid themselves about this – there will not be general, open-ended, ongoing equivalence in financial services”.

The EU has not forgotten that the City was the epicentre of the Great Financial Crash (GFC) that wrought havoc with the EU’s economy (as well as with the UK’s!) A huge wave of post-Crash legislation ensured that the financial stability of the EU would never be imperilled again. Reviewing this legislation to cope with market changes poses a difficulty for the UK. Maintain “equivalence” with EU rules while they are in a continuous process of evolution: be a “vassal state” OR “take back control” and lose “equivalence” – and thus business.

Specific example: Regulation of trading in financial instruments (MiFID II).

The Investment Services Directive (ISD) of 1993 was a key plank of Mrs Thatcher’s drive to create a single market to rival that of the US. So it was enacted just after the single market came into force in 1992. Major changes in the structure of financial markets occurred in the succeeding decade – driven by technological developments – so MiFID I was enacted in 2004 to respond to this.  In the light of bad experiences in the GFC, the Directive was updated in 2014 as MiFID II. It came into in force in 2018 and, as usual with financial services legislation, is now up for review after two years. So a proposal is due later this year. As the UK is no longer in the EU, it will not be at the negotiating table.

At first glance, some of the initial proposals from the European Securities Market Authority (ESMA) to the European Commission are highly technical tweaks on data reporting. However, discussion is rising about repealing aspects of the “open access” rules of MiFID II for settling derivatives trades – where London has overwhelming dominance at the moment. The scale of these markets is mind-boggling: The notional value of euro-denominated derivatives is about 50 time EU GDP! They are at the heart of the provision of liquidity in securities markets – so correspondingly at the heart of concerns about financial stability in the EU.

The UK pushed hard for MiFID II rules to require exchanges to allow traders to have “open access” to settle their derivative trades at whatever EU-regulated clearing house they chose. As London will soon cease to be subject to EU rules, EU players are now arguing – unsurprisingly – against the continuation of that rule. In time, that could well push market liquidity in euros away from London and into the euro area. The handy factoids above may soon need to be re-written significantly.


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