The Brexit deal leaves the future uncertain for financial services — here’s what is at stake

Key Points
  • One particular issue is the clearing of euro-denominated derivatives as the majority of European clearing activity takes place on London-based exchanges.
  • The loss of "passporting" also means that the days of financial advisors being able to fly in and out of Europe to operate have come to an end, prompting some to relocate.
  • NatWest Chairman Howard Davies said that while U.K.-focused banks were largely prepared for a "hard" Brexit, "what we can't prepare for is the uncertainty which persists."
A woman wearing a protective face mask crosses the road in front of the Bank of England in what would normally be the morning rush hour in the City of London on March 17th, 2020. The financial district of the UK is unusually quiet after the government requested people to refrain from all but essential travel and activities yesterday.
Jonathan Perugia

Britain formally left the European Union's trade bloc on Dec. 31, marking a new era for the U.K.-EU relationship.  

After months of wrangling, new rules for trade were finally agreed just days before the year-end deadline. But in a document spanning over 1,200 pages, there was very little mention of financial services: a sector which accounts for 7% of the U.K.'s economy and 10% of its tax receipts.  

One particular issue that arises is the clearing of euro-denominated derivatives. 

The size of the European derivatives market topped 680 trillion euros ($834 trillion) in 2019, and the majority of European clearing activity takes place on London-based exchanges such as LCH.

So far, the European Securities and Markets Authority has agreed to roll over current clearing arrangements for these derivatives until June 22, giving more time for EU-based institutions to decrease their reliance on the British-based clearers. It has previously said it wants euro-denominated derivative trading to only take place within the EU, or somewhere with "equivalent" regulations.

Equivalence rules  

The two sides have committed to releasing a memo of understanding within twelve weeks that will give further clarity on these equivalence rules. They are especially important for the financial industry as they enable U.K.-based companies to sell services into Europe, as long as the regulations don't diverge substantially from Brussels.   

Douglas Flint, chairman of Standard Life Aberdeen, told CNBC's Squawk Box that there does appear to be "a general recognition that financial stability is too important to risk by having a clumsy exit."

"There has been a discussion of mutual recognition or equivalence for the last four and a half years, so it would take a fresh approach between the U.K.and EU to agree what is important and how the infrastructure can continue to operate," he said on Monday. 

The current arrangement allows for the EU to withdraw equivalence rights for U.K. institutions with only 30 days' notice, a decision that the U.K. has no right to contest. 

"Europe has always been very defensive against external providers, so when the U.K. counts as an external provider it will have to take what it's given," Simon Gleeson, partner at Clifford Chance, told CNBC. "The regulatory response therefore needs to be a cooperative response between national regulators."  

The approach so far has been piecemeal and on a temporary bilateral basis. For instance, Italy on Sunday announced that it is allowing U.K. financial companies to keep operating as they are in the country for another six months.  

Leaving it up to each individual regulator to make arrangements has also complicated the setup on the ground. Many U.K-based banks have moved personnel covering the Dutch, French, Spanish and German markets to the continent, while those covering Italian and Scandinavian markets have been able to remain in the U.K.  

BoE has made 'decent compromise' on bank dividends, RBS Chair says

The loss of "passporting" — or the ability to trade freely — post-Brexit also means that the days of financial advisors being able to fly in and out of Europe to operate have come to an end. This has prompted many senior staff to relocate to other European hubs such Frankfurt and Paris, the latter being attractive because of the prospect of lower income taxes. 

In October, EY estimated that the total number of financial services jobs to have left the country since the Brexit referendum was just over 7,500, an estimate that falls short of the gloomy scenario of hundreds of thousands that was forecast by some think tanks in 2016.  

As for bank preparedness, NatWest Chairman Howard Davies told CNBC's Street Signs on Monday that while U.K.-focused banks were largely prepared for a "hard" Brexit by setting up subsidiaries on the continent, "what we can't prepare for is the uncertainty which persists." 

"At the moment we don't know what the future arrangement or the regulation of cross border entities in Europe will be. So there is a limit to what financial institutions can do when there are still very significant moving parts here," he added. 

Financial hub no more? 

Brexit trade deal 'will take time to settle down,' senior advisor says

Long term, industry players are still positive on London's fortunes as a global financial hub, with one hedge fund manager telling CNBC that he would still be willing to back the U.K. as "our business is largely immune to the changes and most aspects of the City are very reliant on talent, knowledge and relationships and for a lot of reasons this is embedded in the U.K." 

Natwest's Davies echoes this view, saying London will remain the largest financial center in Europe for the foreseeable future, but the extent that it can "retain intra-EU business will depend on the new arrangements on regulatory cooperation and equivalence." 

Former trade minister and Senior Advisor at Covington, Francis Maude, agreed. "London is not just a European financial center but a global center. I hope this will be dealt with in a pragmatic way with regulators operating in a non-political", he told CNBC last week, concluding that, "this is not the end of a story, it's the beginning of a different story."