Turn of the year, but not of the tide

The numbers on the calendar might have changed but conversations about the future are still based on uncertainties around COVID-19, Brexit, equivalence, meanwhile each region is facing its own challenges and opportunities as the pandemic differs by country.

How will 2021 pan out? At the turn of the year in the UK, there was hope that the destructive divide of Brexit and the arrival of new vaccines would improve matters. But that has hardly happened. The old protagonists on Brexit continue to snipe and the country remains divided. The vaccine is being rolled out but fears that it may not cope with all variants of COVID, a major rise in cases and a tightening of restrictions appear to be submerging any possible feel-good factor.

We can see similar trends in the banking industry. On 31 December at midnight CET, we did not witness a watershed moment other than from a legalistic standpoint. The changes in business and business practice are yet to come or have already taken place. The challenge of COVID is still at an early stage, for, when we return to a more normal existence, we will be faced with managing the financial cost of the epidemic.

In the securities services business, we have seen a migration of depositary activity to Luxembourg and Dublin but relatively little other movement. On the clearing front, there has been migration of activity from London but interim arrangements have limited its scale. On the banking and treasury side, there has been a minor bolstering of EU capabilities by major banks with an existing presence in the EU27 and we have seen some migration of Euro activity to that area. But the scale of people movement and business transfer has been much less than forecast in the immediate aftermath of the referendum.

COVID has a role in future location strategies as does the global world. And the City as well as the EU should be warned to allow for this factor. We could, and most likely are, at the early stages of a business revolution that will redefine the centres of gravity in the global financial market place.

On the securities services front, In the short-term there will be a clarification of equivalence. It is unlikely that the treatment of the UK by EU27 will be anything more than equal to that in place currently with countries such as the USA. The EU27 will also, almost certainly, place capital barriers to any meaningful off shore domination of euro designated instruments. There is also likely to be a tightening of the rules on delegation with the use of remote investment managers for EU27 funds being permitted, but not without material caveats and constraints. Thus, it is likely there will be preference given to EU27-based depositaries and investment managers over remote ones and the key issue is how stringent these rules will be and how unique any UK specific rules will be? In theory, there is an argument for specificity for the UK by the EU27 in both funds and clearing from a systemic risk perspective, although likely continued strong regulation in the UK will mean that such an argument is political and protectionist rather than primarily risk driven.

On the banking front, there will be migration to EU27 if only to allow for efficient use of capital. But there is a risk that the low returns available on EU27 banking will limit the appetite for business and the net result may well be a reduction in overall activity and a much smaller growth than expected in EU27 based activities. On the treasury front, it appears that any migration from the UK will be accompanied by two fundamental trends. First a reassessment by global and non-EU resident banks of their centres of excellence for such activity. And second, a much more global approach, rather than a multiregional one, to the management and execution of such activities.

COVID will play its role. At one level there is definitely change in flow as a result of the experience of working from home. At another, there is a realisation that time zones may be more important than geography. Basically, irrespective of whether one is located five miles or five thousand miles away, we have learnt that many roles can be equally well managed from either distance. In addition, the business case for much process automation has metamorphosed from a primarily cost base with additional risk considerations to a primarily risk base with additional cost considerations. This means that many of the tasks that necessitated on the ground in office presence in pre-COVID days can now be executed remotely. Firms have been forced to adopt such processes since lockdowns began and it would be surprising if they do not formalise them into their business model as the current crisis unwinds. We will all be hoping for no repeat of COVID-19 but, at the same time, we will need to plan and be aware of the potential for a new outbreak to occur.

A further factor in making business location decisions will be the quality of the response to the current crisis by the different countries. It would be fair to say that Asia has responded best, although it is hard to say if this is due to lessons learned from SARS or other reasons. Although the US has had a horrific experience in terms of cases and deaths, the flexibility of the US business environment is apparent as we see the solutions that are being proposed by different firms for the future. Europe has had a mixed experience with substantial lockdowns, and, although there have been no material losses or systemic risks in the process, there is a malaise in the major cities and a lack of clarity over term solutions. This augurs badly for the region, and especially the UK, in any quest to be a location of choice for the longer term.

In conclusion, Brexit, COVID, regulatory protectionism and automation will impact the UK’s standing in financial markets. The US scale will allow it to maintain a critical role and, indeed, reappraisal of global coverage is likely to result in added flows moving in its direction. Asia will develop its own momentum and it may well be that a London-Asia axis develops that enables London to maintain its dominant role. But a London-Asia axis is dependent on geopolitical choice for the key component of such an axis would be the UK-China relationship. The future is unclear but the aspiration of London, or EU 27, to be a pivotal centre for finance in the coming decades is challenging to the extreme.

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