Governments and central banks have had other things on their minds, but they must address the next big shock

What a difference a crisis makes. The coronavirus economic downturn was not triggered by an unhinged financial system, as the 2008 great recession was. And the reason central banks and governments rushed to help banks keep lending to businesses and consumers was not to rescue the financial industry with taxpayers’ money, as happened more than 10 years ago. It was to limit the string of bankruptcies that the unprecedented current recession will bring upon economies worldwide.

However, that should only provide meagre consolation for the European financial sector, which is facing in the next few months the unenviable prospect of being hit by a second major shock called Brexit.

Much has been written in the four years since the UK’s referendum on the fate of the City of London and the end of its days as the true, undisputed financial capital of Europe. But on the political side, silence has prevailed since the UK government gave another direction to the talks after the election last year of Boris Johnson as prime minister.

This is understandable. The financial industry is mentioned only marginally in the documents that provide the legal basis for the talks — the withdrawal agreement and the political declaration framing the overall context of the talks.

Most of the time of the on/off talks between the EU’s chief negotiator Michel Barnier and his UK counterpart David Frost, has been spent on trade  issues — or fisheries, an insignificant portion of the UK economy. Bizarrely, the UK government has seemed to agree, even though the country has a major trade deficit with the EU on the exchange of goods, while it books a significant surplus on services, notably financial.

Most players in the financial industry, first and foremost the banking sector, consider Brexit a major historical mistake. But a significant minority of players see it as a chance for the UK to devise its own financial regulatory path, instead of being constrained by the unavoidable compromises that have to be struck when 28 countries (27 now) are involved.

Some segments of the hedge fund industry, some fund managers think the upside of lighter regulation will more than make up for the foreseeable difficulties of operating in Europe from outside the EU’s regulatory framework.

With the Treasury now headed by Rishi Sunak, a former hedge fund manager who was an early and enthusiastic advocate for Brexit, financial players, whatever their opinion on EU membership, might have expected more attention would be paid by the government to its immediate concerns. It just happens that since he took over as Chancellor in February, Sunak has had, to say the least, more pressing problems to address.

In the short term, the Brexit impact on the UK financial industry — and also, one tends to forget, on the EU’s as well — will not be limited to just a few bureaucratic hassles. From January 2021 onwards, the system will be based on the so-called “equivalences” granted unilaterally by Brussels to non-EU players.

That will create uncertainty because those authorisations can be revoked by EU authorities at short notice. Financial regulations in the UK and the EU are for now perfectly aligned. In theory, there would be little reasonable ground for Europe to ban UK financial operators on its territory at the outset. In practice, bad blood and the mutual mistrust accumulated over the last four years will bear on the EU’s response.

The real dispute begins when envisioning the UK and EU’s respective regulatory paths going forward. Forget about the UK aiming at becoming “Singapore-on-Thames” — which even if true, shouldn’t bother the EU too much: Contrary to what the cliché implies, Singapore has a detailed and strict system of financial regulation built after a few scandals revealed the downside of the regulation-light approach.

What really matters is that because of history, because of London’s current position as Europe’s financial hub, and because of the government’s mantra praising “global Britain” (whatever that may mean), UK regulators from the Bank of England on down will not always have the same idea of how regulation should evolve as Europeans do.

Liquidity and capital regulations will diverge. However, as can be expected, access to the EU single market will only be extended to the segments of industry that are broadly regulated along similar lines as Europe.

Regulators, shielded from the furore of politics, can be trusted to be able to work together better and in a more professional way than government ministers have shown so far.

Many problems will be of a technical nature and not require crucial political choices. But if one shares the hope that the UK financial industry and the City of London could well survive and even prosper outside the EU, the truth is that this will only happen in the medium to long term. In the short term, Brexit has a price. And finance could pay more than its share of it.

Source: Private Equity News

By Pierre Briancon

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