The RSMR Weekly Broadcast - London: the uncertain future of the world's financial hub

There's no shortage of knowledge and expertise at RSMR! Each week we get our heads together and talk about events in the world and how investments are affected by them. Our broadcast tackles a wide range of topical issues facing investors from liquidity to the future of alternatives to politics and the pound. We like to think of it as cracking content for the financial adviser. Have a read & get clued up...

London has been a leading international financial centre since the 19th century, acting as a centre of lending and investment around the world. Britain’s future access to European Union financial markets is looking increasingly uncertain, as Brussels tries to limit the activities which can be carried out from London, prompting more business and jobs to cross the channel.

London manages over $2 trillion of investments and assets on behalf of European clients. The Markets in Financial Instruments Directive (MiFID) is a European regulation that increases the transparency across the European Union's financial markets and standardises the regulatory disclosures required for firms operating in the European Union. Passporting, the regulation of financial services under MiFID, stipulates that money can be regulated and managed across the European Union, but with the UK leaving the EU, London may no longer be able to manage foreign investments. During the Brexit transition period, passporting rules do still apply, but if there is no free trade agreement, there could be serious ramifications.

What will happen to the fund management industry? The first implication is that UK Open Ended Investment Companies (OEICs) and trusts will no longer be recognised in Europe, meaning that they can’t be marketed or sold in the European Union and EU domiciled funds will no longer be able to delegate their investment management outside the EU. The withdrawal of passporting rules implies that European domiciled funds such as Dublin OEICs or Luxembourg SICAVs (a collective investment scheme) can no longer be managed in the UK.

London is the world centre for derivatives trading; every day there are nearly 1 trillion euros of European derivatives that are traded and cleared through London. ‘Equivalence’ refers to a decision by one state to recognise another state's legal requirements for regulating a service, even though they may not be the same. The EU has the power to unilaterally grant access to financial services firms based on whether UK regulations are similar to their own. Equivalence currently states that the UK has a very good regulator that is considered equivalent to European law. So, if you’re regulated and authorised in the UK, you can operate in France, Germany, Ireland etc. but Brexit could mean that equivalence no longer applies and since the EU wants derivatives trading to be covered by European legislation, repatriating this activity to Europe may be unavoidable.

Fund management companies are having to find ways of navigating the shifting environment. Investment houses that don’t already have offices in Europe are setting them up but with the EU potentially clamping down on ‘letterbox’ companies (businesses that establish a domicile in one place with merely a mailing address, while conducting activities in another), these new bases will need to be actual operating centres rather than just a postal address.  

Some investment houses such as M&G and Threadneedle have split their European clients out of UK OEICs and moved them to Europe, setting up new fund structures into SICAVs. They are essentially still managed in London but domiciled in Europe. As a result, the UK has seen significant outflows from UK funds.

London’s clearing houses are world leaders in facilitating derivatives trading. Clearing houses such as LCH and ICE Clear Europe are vital for the EU financial services firms, who would struggle to find suitable European alternatives. All trade is mutually beneficial, and the EU have recognised the huge risk that would come with repatriating derivatives. Equivalence in trading and clearing is still allowed for the time being, derivatives can still be settled and dealt with in London, but there needs to be an agreement in the medium-term providing clarity for London in Europe.      

The EU will allow its members to have access to the UK’s clearing houses, some of the largest in the world, on a ‘time limited’ basis but have warned that the EU’s financial services sectors should be prepared for this to change. The future of London as an international financial powerhouse is uncertain and we should prepare for all possible eventualities.

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