Much of the discussion around Brexit’s impact on the City has treated it as an inconvenience to be ‘managed’. This is understandable. Business rarely likes change, certainly not on this scale.
But as the Covid-19 pandemic has amply demonstrated, periods of major economic dislocation can offer an opportunity for first-movers and forward-thinking organisations to seize market share or reconfigure market dynamics in their favour. The same will be true of Brexit and the City.
Since February, the focus of Brexit discussions has been on the post-transition relationship between the UK and the EU. Initially, there were select advocates in the UK government for “permanent equivalence” between the two jurisdictions’ regulatory regimes for financial services. However, figures from Michel Barnier, the EU’s Chief Negotiator, to Jon Cunliffe, Deputy Governor of the Bank of England, warned that significant divergence was both likely and necessary.
The subsequent progress of trade negotiations has only heightened the prospect of an impending and dramatic reversal in the integration of the UK and EU’s financial services industries – with a few notable exceptions. The European Commission has offered EU-based banks an additional 18-month grace period on their access to critical clearing house infrastructure in London, which dominates the market even for euro-denominated transactions. But, by and large, UK-based financial institutions will be readying themselves more than ever before for either a no-deal scenario or a much looser trade relationship coming into force from 2021.
Divergence is typically framed negatively, with the focus being on the possibility of the City losing unfettered access to the EU’s single market. However, there are two potential ways in which London’s financial institutions might not just survive but thrive from the opportunity presented once the transition period ends.
The City should embrace divergence…. and give London’s financial services the technological edge over its international competitors.
Firstly, if the regulatory regime diverges even slightly from that of the EU by placing less onerous requirements on financial organisations, it can have a positive knock-on effect on UK banks’ performance and competitiveness. As we have seen in the USA, the more flexible approach to regulation has been a contributory factor to the stronger recovery and greater profitability of the American banking industry over the past decade.
City advocacy groups are already eyeing a new regulatory framework beyond MiFID II (the EU directive that instituted an extensive set of new obligations on banks, fund managers, brokers, exchanges, and underlying investors). Overseen solely by the UK government, such a framework would inevitably better reflect the priorities of UK firms, with a greater focus on maintaining financial stability and investor protections without inhibiting the City’s global competitiveness.
The second and much less talked about opportunity is something over which financial institutions have far more direct influence. Long-established firms are in a constant struggle to keep pace with technical requirements of regulatory change. Often, to meet tight deadlines, changes are shoe-horned into existing architectures at the expense of technical progress and evolution. This was the experience for many European banks around MIFID II adoption.
That represented a huge missed opportunity. The ultimate goals of new regulations are not necessarily detrimental to banks’ commercial interests; in fact, as with MiFID II, they are often directly aligned. For example, the requirement to comprehensively categorise and record all customer interactions, if done properly, can be an accelerator for better customer relationship management and risk control.
Technological advancement is already driving the reconfiguration of banks’ technology systems. The City should embrace divergence not simply as a new box-ticking requirement, but as the occasion for London’s financial services firms to implement new systems that simultaneously meet new requirements and give them the technological edge over their international competitors.
Whilst much may still change in the coming months, firms need to stop undervaluing the possibility and start considering the opportunities for the UK financial services industry.