The City of London is a magnet for business and financial firms. It hosts 40% of the world’s top 250 companies with global or regional headquarters in Europe (Deloitte analysis, 2014). For non-European companies, the proportion even reaches up to 60%. With a referendum to determine the UK’s future in the EU looming over the City, its ability to maintain its leading position as the EU financial hub comes under pressure.
So what makes the City so attractive?
London & Partner, the official promotional company for the City, lists the key drivers for London’s attractiveness to include: advantageous corporate tax regime, convenient geographical and time zone location, easy access to a highly educated talent pool, the enviable lifestyle of the city and last but not least unconditional access to the world’s largest single market of over 500 million consumers.
Standard & Poor’s considers that UK membership to the EU was essential to attracting a disproportionate amount of foreign direct investment and, “solidifying [London’s] role as a global financial centre”. Over the last 30 years, banks and financial institutions have made London their springboard for conducting operations in the EU. The fact that the UK has not been part of the Eurozone hasn’t proven to be a stumbling block either. Even today, financial services represent almost 10% of the UK economy.
The City benefits from an important feature of EU membership: the passport system. This system enables UK businesses and UK based foreign companies to unconditionally conduct business and trade activities within the remaining 27 EU member States, without seeking individual authorisations from National Competent Authorities (NCAs) under the supervision of the UK financial authorities.
Will Brexit really change things for the financial sector?
Under any emerging EU-UK relationship, we can be sure of one thing: the regulatory sovereignty, which is supposedly expected to increase after a Brexit, is actually largely illusory.  The UK will have to continue implementing EU financial legislation, but will not be able to shape it.
In many cases, the UK will have to demonstrate equivalence to the EU regulatory framework in order to continue to access the Single Market:

  • UK Asset managers would be allowed to market their funds in the EU on the condition that the UK regulatory framework is deemed equivalent to the provisions of the EU’s Alternative Investment Fund Managers (AIFM) Directive.
  • Activities on the EU derivative markets, governed by the European Market Infrastructure Regulation (EMIR), could also continue under the EU’s conditions of equivalence recognition and passport authorisations.

However, this access is not unconditional for “third countries” and some inescapable restrictions introduced in the aftermath of the 2008 financial crisis might severely affect UK business:

  • The most significant impact will be for the operators’ activities covered by the EU Markets in Financial Instruments Directive (MiFID), a regulation governing among others, investment services as well as stock exchange operations. UK regulations will not only have to be recognised as equivalent to the ones of the EU, but UK firms will be required to open a branch in an EU jurisdiction if they want to sell their products and services to EU retail investors.
  • The Undertakings for Collective Investment in the Transferable Securities (UCITS) Directive also requires these type of funds to be established in the EU, forcing managers based in the UK to relocate their activities which are aimed at the EU market.
  • At some point, the European Central Bank might also require clearing houses that settle euro-denominated trades to relocate to the Eurozone.

In general, London’s position as a location of choice to establish an EU regional headquarter is likely to be affected. Foreign non-EU institutions would have to comply with three different supervisory requirements: the one of their home country, the one of the UK (outside the EU), and the one of the host country of the EU branch.
The weakening of the City as the financial centre of the EU is unlikely to happen overnight. It is even highly likely that London will continue to be a major international financial hub in the future. However, the legal uncertainty surrounding a Brexit and a series of regulatory and prudential barriers is likely to force companies, especially non-European firms, headquartered in the City, to consider establishing European headquarters in other EU financial centres such as Paris, Frankfurt, Luxembourg, and Dublin. London’s ability to attract foreign companies looking to establish a European foothold could well be substantially affected in case of a Brexit.

Authored by: Marie Eichholtzer

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