Since the UK voted to leave the EU, financial services has been largely absent from Brexit discussions. This is despite the fact that financial services are an important piece of the UK economy. They account for around around 10% of total tax receipts in the UK and 40% of the financial services sector's exports go to the EU.
Furthermore, as soon as the then UK prime minister Theresa May announced that Brexit would mean the end of free movement between the UK and the EU, it was clear that UK financial services would face significant changes to their EU operations as a result of Brexit.
Most notably, financial services firms knew that from January 1 they would lose their passporting rights, which allowed them to sell their services into the EU from their UK base without the need for additional regulatory clearance.
Goodbye passporting, hello equivalence
The EU-UK Trade and Cooerpation Agreement (TCA) does not, and was not designed to, provide a substitute for the EU market access available to UK firms through passporting. In a document stretching to over 1,200 pages, only four and a half focus on financial services.
In order to access the single market, UK based financial services firms now have to either comply with the regulatory requirements for market access set at the level of individual member states or rely on equivalence decisions. Equivalence is an EU system that gives single market access to financial firms in third countries such as the UK if their home rules are considered by Brussels to be "equivalent" to, or as robust as, regulation in the bloc.
Neither is a like-for-like replacement for the common EU-wide market access the UK had through passporting. Seeking permissions on a state-by-state basis will add complexity and hence costs for financial services firms.
Relying on equivalence brings changes in UK-EU financial services trade because it does not cover the same range of financial activities as passporting.
Retail banking services, including lending, payments and deposit taking are not included, for example. Neither does equivalence provide the same degree of certainty as passporting because the EU can remove equivalence determinations with 30 days' notice.
One of the most significant causes of uncertainty currently for UK financial services is when and if equivalence determinations might be taken by the EU. In the 2019 political declaration that set out the framework for the future relationship between the EU and UK, both sides agreed to try to finalise their respective equivalence decisions by mid-2020, but the deadline was not met.
The EU has adopted a cautious approach to equivalence since then. It has only made two time-limited equivalence decisions in areas of strategic importance for the EU (derivatives clearing and the settling of Irish securities).
The way ahead
Equivalence decisions were not formally part of UK-EU trade negotiations. However, during the negotiations it was expected that a deal would have made equivalence more likely than under a no-deal scenario.
There is evidence in the deal that this is true. The European Commission has identified future equivalence decisions as one of a number of unilateral EU measures available to the EU within a wider set of "pillars of cooperation" between the UK and the EU.
Under the terms of the TCA, the UK and the EU have committed to agreeing a Memorandum of Understanding relating to financial services regulation by March. This is likely to cover issues related to financial market stability alongside the outstanding equivalence issues. As such, whilst the UK's financial services sector is now trading outside the single market, negotiations are continuing on how it will trade with the EU in the future.
However, there is little evidence that equivalence decisions are forthcoming. The EU has reiterated that it will not rush equivalence determinations. Indeed, as time passes, in many ways the prospects for EU equivalence determinations diminish.
Equivalence can be thought of as a perishable good. As firms begin to operate without it by, for example, moving assets, activities or employees out of London to other European financial centres, so the potential for these corporate decisions to be reversed diminishes if an equivalence determination is made.
For example, there has been a large shift in Euro-denominated share trading from London to European financial centres such as Paris and Amsterdam since January 1 2021. This has been an area of financial services activity that London has historically dominated within Europe. Financial services jobs have also been moved from London to the EU, although the rate has been lower than many anticipated. Firms are currently awaiting the outcome of current EU-UK negotiations on the future of financial services before making a final decision about where to base their operations.
Additionally, part of the EU's caution in granting equivalence reflects its desire to learn more about the UK's plans for any possible divergence from EU regulation after Brexit. This is a key domestic policy question for the UK currently.
Brexit centred, in many ways, around a desire to "take back control". But little is currently known about how this new found control will be exercised in financial services. The outcome of negotiations surrounding regulatory cooperation and EU decisions on equivalence due in 2021 should be watched closely as these will be central in determining what Brexit means in practice for financial services.
Author: Sarah Hall - Professor of Economic Geography, University of Nottingham