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As Britain left the European Union last year, a few questions remained unarranged, perhaps the most significant ones of all are concerning the future of Europe’s financial sector. London has been the financial centre of Europe, employing a large number of domestic and international talent, and also lavishly contributing in tax revenues to the British national budget: £76 billion (€90.4 billion) in 2020, approximately one-tenth of its total revenues.
While Britain was part of the EU, the UK-based financial firms were able to export their services within the Bloc without needing any specific license or authorisation, a system referred to as passporting. Following Brexit, Britain, and with that the financial sector in London, has lost these passporting rights.
As a reaction, financial institutions moved some of their business to the continent. A research by New Financial, a UK-based think tank, claims that over 440 banking and finance institutions have left the UK and relocated to the EU. The City has lost approximately 7,400 financial services jobs and approximately 10 per cent of assets held in UK banks (totaling over £900 billion) to Europe. They have been distributed between the Bloc’s financial centres such as Paris, Amsterdam, Dublin, and Frankfurt.
Britain leaving the bloc has so far had a muted overall impact on the financial sector. Even though the Brexit negotiations had a number of unexpected twists and turns, the lengthy process did not lead to a market meltdown or a sudden shock. According to a paper issued by the Brussels-based think tank Bruegel, the pandemic contributed to Brexit having a mild impact on the financial industry because it led public authorities and market participants alike, to generally minimize their short-term risk-taking and to delay long-term decisions. Their expectation is that this effect will be in play until the pandemic is over.
A cornerstone of the process that remains unsettled is the clearing of Euro-denominated interest rate swaps. Swaps are financial instruments created to exchange a stream of regular future payments, for example when one party pays a floating, the other one a fixed interest rate that they would like to exchange with each other. These contracts are usually traded on large notional amounts, theoretical values being used for the calculation of the regular payments but rarely changing hands in their entirety. The euro-denominated swaps market has a staggering € 80 trillion annual volume in notional and the London Clearing House (LCH) still handles 90 per cent of the clearing of the global market in this product. Clearing a financial product means the correct and timely transfer of funds and securities from the seller to the buyer that is facilitated by specialised institutions called Clearing Houses.
London and some financial firms would prefer these services to stay in the UK because the nature of this business is that it works more efficiently when clearing houses oversee a larger pool of transactions due to the increased liquidity that a bigger market provides. Participants can more easily save money in deposited collateral costs by being able to net their transactions with each other.
On the other hand, the European Union sees it as a structural risk that the majority of euro-denominated clearing takes place outside of the Bloc and would like most of it to be moved inside its borders.
According to the current agreement in place, the UK can continue to host such deals without restrictions until the end of June 2022. Meanwhile, the European institutions are expected to get prepared for taking over these huge clearing volumes. However, the process seems to be behind schedule. Mairead McGuinness, the EU’s head of financial services hinted at a possible extension of the deadline. McGuinness said a few weeks ago that the EU wants to avoid a “cliff-edge” situation and avoid market instability.
The complex nature of the financial sector and its importance in today’s economies has predestined a difficult solution to how the EU can operate its financial system without having its former hub within its borders. So far, the split has created no earthquake-like effects. The transition should work in a way to reduce the EU’s dependence on London as an external financial centre but at the same time, the expectation is that it does not cause major disruptions for market participants.
Disclaimer: This article was issued by Tamas Jozsa, research analyst at Calamatta Cuschieri. For more information visit?www.cc.com.mt. The information, view, and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.
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