The long-awaited Brexit trade deal has created a stir among investors, but the agreement did little to cover financial services, which is a key sector for the UK economy and an area that brings in high levels of foreign direct investment (FDI).
“From a trade perspective, the UK is now able to negotiate trade deals that better align with its long-standing advantages, such as financial and related professional services,” says Miles Celic, chief executive officer at TheCityUK, an industry-led body representing UK-based financial and related professional. “Existing trade relationships with advanced markets must continue to be nurtured while further deepening ties with emerging economies, which, as they grow and expand, will have an increasing demand for the high-value, high-quality services in which the UK excels.”
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The Brexit trade deal, known as the ‘Trade and Cooperation Agreement’, was agreed in late December 2020, and will shape future economic relations between the UK and the 27 countries that form the EU alliance. The deal includes sections on free trade and the guarantee of zero-tariff arrangements on goods, but there is little covering financial services, with UK Prime Minister Boris Johnson admitting that the deal “perhaps does not go as far as we would like”.
The UK’s loss of access to the EU market is expected to make it a less attractive FDI destination, particularly when it comes to financial services. Filip Rambousek, Verisk Maplecroft
In a press release, Alan Farkas, a partner at international law firm Dorsey & Whitney, said: “The services industry, which represents more than 80% of the UK’s GDP, is not covered by the trade agreement. Instead, a memorandum of understanding on the cooperation on financial services is to be worked on in 2021 with the aim of reaching agreement by March 2021.”
Brexit setbacks for financial services in the UK
A document from law firm Shearman & Sterling outlines some of the areas that are not covered in the trade deal, including passporting rights that permit UK companies to access the EU and vice versa, the lack of a new mutual recognition regime, and obligations on the parties to evaluate their legal framework and collaborate on “non-conforming measures that do not apply to financial services”.
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Filip Rambousek, Europe analyst at research firm Verisk Maplecroft, explains that as the deal does not cover the UK’s financial services, it results in a loss of direct access to the EU financial market.
“This has already made itself felt with London losing nearly €6bn in share dealing to EU financial hubs on the first post-Brexit trading day,” he says. “Similarly, the UK’s services exports – which account for nearly 50% of all exports, and nearly 20% of which consists of financial services – are expected to suffer without appropriate market access. We are likely to continue to see the shift of euro-denominated share trading to the continent.”
On top of this shift, there has also been a move towards relocating businesses and jobs to Europe. In particular, data from EY reveals that in the third quarter of 2020, there were “more than 400 UK financial services job relocations to Europe announced, taking the total number of jobs leaving the country since the EU referendum to over 7,500.”
The future of UK financial services
Despite concerns over the Brexit deal, Rambousek adds that the deal is better than nothing when it comes to financial services. This, he says, is because the agreement can serve as the foundation for a future regulatory framework.
“To maintain access to the EU market, the UK government will need to win ‘equivalence rights’ from the EU, receiving preferable market rights on the basis that UK regulation will remain closely aligned to the EU’s,” says Rambousek. “While some parts of the UK’s financial sector have temporarily been granted these rights, their long-term viability will ultimately depend on the UK government’s decision to either maintain regulatory alignment, or build up its own regulatory framework. This will be driven by whether the government decides to keep its pre-Brexit alignment with the EU, or position itself as a competitor – and try to win business for its financial sector elsewhere.”
Data from EY shows that the UK was the leading country for receiving financial services FDI in Europe in 2019, attracting 99 projects. France and Germany attracted 38 and 43 projects, respectively. The data also reveals that this investment into the UK came from a wide range of countries, with the US accounting for the largest share.
Rambousek says: “Estimates state that nearly one-quarter of UK financial services’ revenues derive from business done in the EU. Moreover, FDI in the UK’s finance sector was the single largest item of the overall FDI inward flows in 2018. While much of this investment has come from the US – and is therefore not directly affected by the lack of a UK-EU services deal – the UK’s loss of access to the EU market is expected to make it a less attractive FDI destination, particularly when it comes to financial services.
“On the EU side, businesses may find it harder to access capital as UK banks provide a significant amount of lending to the EU. This is likely to be a strong incentive for the EU to agree to an equivalence deal in the coming months.”
Investors will have to wait for few more months to receive more clarity on any agreement between the UK and the EU about the trade regulations relating to the financial services sector. However, given the uncertainty over a potential equivalence deal, it remains to be seen if the financial services industry will remain one of the key sectors for the country’s economy and FDI attractiveness in the post-Brexit era.
