The financial services sector is a cornerstone of the UK economy, accounting for 6.9% of GDP, or £132 billion, and employing 1.1 million workers in 2019. However, financial services were largely excluded from the trade agreement signed by the UK and the EU in December.
As a member of the Single Market, London was able to operate as a trading hub for financial services across the EU thanks to passporting rights, which allowed UK firms to sell their services into the EU without the need for regulatory clearance. Since January 2021, British financial firms have been mostly unable to operate in the bloc, cutting them off from their biggest customer.
Having lost passporting rights, the key for British firms to access the EU market is now equivalence, a system used by the EU to unilaterally determine whether a third country’s financial services regulations are sufficiently similar, or equivalent, to its own.
Since leaving the EU, the UK has adopted its own equivalence framework and has granted extensive equivalence to EU firms operating in UK financial markets. In contrast, the UK has received temporary equivalence only in two areas – for derivatives clearing houses and for settling Irish securities transactions – leaving myriad sectors up in the air, from stock and derivative trading, to portfolio management and investment banking. This is despite the fact that the UK regulatory regime is currently broadly aligned with the EU’s, as the UK has only just left the Single Market.
At the end of March the EU and the UK signed a Memorandum of Understanding (MoU) on future cooperation for financial services, establishing a forum of informal discussions about financial rules, market supervision and the sharing of information. However, the MoU falls short of resolving the issue of equivalence and is much smaller in scope than a similar deal the EU agreed with the United States back in 2016.
Share trading
In the most tangible sign yet of the impact of Brexit on the City of London, the UK has lost its historic status as the capital for European equities.
From the opening bell on 4 January 2021, nearly all euro-denominated shares and derivatives previously traded on UK exchanges were transferred to European venues, an immediate loss of approximately €6.5 billion in daily transactions.
Although this has had little impact on jobs and revenue, as most of the money continues to be managed in London, losing its status as the European capital of share trading was a symbolic blow for the City. Amsterdam immediately took pole position, with approximately €9.2 billion worth of shares traded on Dutch exchanges each day in January, compared with €8.6 billion in London, according to Cboe.
The EU has indicated that it is in no rush to grant equivalence rights to UK-based financial firms for fear of future divergence. Indeed, the UK has made clear that it will not seek equivalence at any cost, signalling its intention to set its own regulations and deviate from EU rules. Initial evidence of this came in February, with London lifting prohibitions on the trading of Swiss stocks, which are currently banned from EU exchanges.
According to Cboe, in March the average daily value of stocks traded in London increased to €10.62 billion, almost closing the gap with Amsterdam, where €10.68 billion were traded daily in the same month.
Initial Public Offerings
The Treasury is currently investigating ways to make the UK more competitive post-Brexit, including by encouraging more companies to float in London. In recent years, the City has lagged behind other global centres in the IPO sphere, losing out to jurisdictions offering more flexible regimes, such as New York and Hong Kong.
The Treasury-backed Hill review, published on 3 March, proposed an overhaul of company listing rules, hoping to attract fast-growing domestic and international businesses. Among the most important proposals, the review recommends reducing the proportion of a company’s shares that must be publicly traded from 25% to 15%, allowing founders to sell fewer shares when listing.
The review also recommends that companies be allowed to sell unequal voting right structures, or dual-class shares, in the premium listing segment of the London Stock Exchange (LSE). Under the current regime, companies with dual share classes are only permitted on the standard listing of the LSE, excluding them from stock market indices such as the FTSE 100 and FTSE 250.
Perhaps indicating that desire for such reform exists, the day after the publication of the Hill review food delivery app Deliveroo announced that it would float on the LSE, something that was initially seen as a boost of confidence in the City. However, the hotly anticipated listing went down like a lead balloon, with its stock plunging by 31% in the opening minutes of trading and closing down 26% lower – the worst performance in a decade for a major UK listing and a disappointment to those seeking to attract tech firms post-Brexit.
Although Deliveroo’s slump can be attributed to a variety of factors, including investor concern about its employment practices, perceived overvaluation of the company and the timing of the IPO, its performance was also a result of corporate governance issues: investors shied away due to concern surrounding the founder’s decision to adopt a dual-class structure in order to retain control of the business for three years.
Indeed, British institutional investors have voiced concern that the listing reforms proposed by the Hill review could undermine existing minority shareholder protections and that loosening rules around dual-class shares could threaten London’s high standards of governance. The review addresses these points and recommends some safeguards, such as a five-year limit on dual-class structure.
Despite the flop of Deliveroo, the LSE has enjoyed the best start of year for IPOs since 2006, with 25 companies listing in the first quarter, raising almost £7.2 billion.
This included footwear brand Dr Martens, online consumer review group Trustpilot and online greeting card retailer Moonpig.
Strong increases in equity capital raising have provided a demand boost for investment bankers, an industry that grew by more than 27% in 2020-21. Most recently, financial technology company Wise, formerly TransferWise, has mulled an imminent IPO in London which could go ahead as early as May. If it proceeds, this would be a boost for London’s image as a tech hub.
SPACs
The Hill review’s recommendations also included liberalising listing rules for Special Purpose Acquisition Companies (SPACs). Also known as blank-cheque companies, SPACs are shell corporations listed on a stock exchange, but with no commercial operation and with the sole purpose of raising capital and acquiring a private company. The target company thus becomes public avoiding the lengthy and costly traditional IPO process.
SPAC activity has surged globally, making these vehicles one of the hottest areas of finance, though London has been snubbed by investors so far.
According to data by firm SPACInsider, 248 SPAC vehicles were listed in the United States in 2020, raising US$83.4 billion (£60.7 billion). In contrast, London saw just four SPACs list in the whole of 2020, raising barely £30 million.
This disparity has put pressure on the Treasury to relax SPAC regulations. The Financial Conduct Authority has now started a consultation and aims to implement new rules by early summer, an urgency justified by the large number of home-grown companies currently seeking valuations on foreign stock markets.
Under current rules, when a SPAC announces an acquisition target, trading in its shares is suspended until a deal prospectus is published, restricting investors’ ability to sell their shares. This is in contrast to the US, where investors enjoy greater flexibility and are able to sell even when a target company is found.
The fear investors have of finding themselves locked into an unwanted investment is considered one of the main reasons why SPACs have failed to take off in the UK. The Hill review recommends that acquisitions made by SPACs not be classified as reverse takeovers, as currently occurs.
Growth sectors
The government is currently exploring ways to shore up the UK’s global appeal in high-growth sectors such as financial technology, an industry that is estimated to be worth over £11.6 billion in 2021-22.
Former head of Worldpay, Ron Kalifa, the lead author of another landmark government-backed review published ahead of the Budget last month, has warned that the UK risks falling behind other global centres of fintech unless key reforms are implemented. He recommends:
- A relaxation of the regulatory environment overseeing fintech companies
- The creation of a new visa stream specifically for fintech professionals
- An expansion of tax incentives such as R&D tax credits.
At present, investment in fintech start-ups derives predominantly from private equity and venture capital firms. This reduces the potential for fintech investment, largely due to a lack of participation from institutional investors, who tend to favour lower-risk investments in traditional sectors such as financials and industrials. To tackle this, the Kalifa review endorses the creation of a £1 billion growth capital fund, financed by institutional investors.
Conclusion
While the City has recently lost some ground to European capitals, London remains Europe's biggest capital market and its deep wells of liquidity have so far shielded it from the worst damage. Although the road ahead may be bumpy, the direction taken so far by the government would suggest that London is likely to drift further away from Europe and aspire to take a leading role in global finance.
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