For post-Brexit London, the bad news keeps on coming. In February, the city lost its title as Europe’s top share-trading hub to Amsterdam, while the movement of up to €100bn in Irish securities from settlement house Euroclear’s London operations to its Belgian counterpart was announced in March, following a two-year effort. Seemingly, the city’s loss of blanket passporting rights with the EU has dented its status as a global financial centre. Yet, it is far from certain that the City of London is entering a phase of relative decline. Beyond the headlines, work is afoot to reposition the capital for a future that, in all likelihood, will broadly exist outside of the EU’s equivalency regime.
In the opening months of 2021, the mood music between the UK and EU was not encouraging. The Irish ambassador to the EU, Thomas Hanney, stated in March that he was not “overly-optimistic” about a strong equivalence regime in the future. In a similar vein, the governor of the Bank of England, Andrew Bailey, during a February speech at the annual Mansion House dinner, accused the EU of holding the UK financial services sector to equivalency standards that it applied to no other jurisdiction. Broader trade tensions between the two sides were also escalating. But what, if anything, can London’s present difficulties tell us about its future as a share trading and financial centre?
London is not falling
For one, recent events will probably have minimal bearing on the City over the long term. The news that Amsterdam usurped London as Europe’s leading share-trading centre, for instance, is less meaningful upon closer examination. The move by two multilateral trading facilities (MTFs) — trading platforms organised by investment firms or market operators — to Amsterdam accounts for most of the Dutch city’s gains. Under a revised share-trading obligation issued by the European Securities and Markets Authority (ESMA), EU investment firms must trade EU shares inside the bloc.
“We’re not talking about anything that affects UK share trading — it’s the ability to trade EU shares out of London on these alternative platforms. Those alternative platforms, because of Brexit and because of Markets in Financial Instruments Directive II (MiFID II) rules around share trading, were basically forced to move trading of EU stocks to the EU,” says Anish Puaar, European market structure analyst at Rosenblatt Securities.
Anish Puaar, Rosenblatt Securities
Cboe Europe and London Stock Exchange Group’s Turquoise are the two UK-based MTFs that set up Amsterdam hubs.
“[This move] means that trades are being executed in a data centre in Amsterdam under Dutch regulation instead of British regulation. But the firms that do the trading are the same. The underlying liquidity or flow is coming from the same firms,” says Per Lovén, strategic relationship manager at Itiviti.
Although London’s total share-trading volume has decreased as a result, it has delivered very little change in terms of lost revenue or the transfer of staff across the channel. “If you look at tax revenue and jobs, and the things that really matter, it’s not a big deal for the UK. In the context of what’s important to the UK, I think where share trading is executed is less important than some other issues. Things like listings and attracting fintech firms are probably more important rather than just the ability to trade French or German shares out of the UK,” says Mr Puaar.
Growing rift
The issue has cast a light on the clear split that is beginning to emerge between the EU and UK in terms of regulatory philosophy and overall approach to equity trading. The EU, for instance, is sticking with a more traditional stance that favours trading on lit, national stock exchanges. Under MiFID II, a double-volume cap (DVC) was introduced that limits the amount of trading that can take place in so-called “dark pools” — platforms that permit institutional investors to trade shares without disclosing a range of details on the trade before it is executed. The DVC effectively limits the degree of dark trading in a particular stock to a certain portion of total trading in the instrument.
Yet, this approach does not always produce the best results for the end investor. “The view on dark trading that some exchanges and regulators hold does not always make sense for end investors. It seems very hard to argue that the investor is better off with slightly more lit volume, when they might get a worse execution price by not being able to trade at mid-point. I think it’s a rather traditional view, almost viewing exchanges as neutral utilities rather than for-profit organisations,” says Mr Lovén.
In late September 2020, ESMA published further recommendations around the transparency regime for non-equity financial instruments, in particular the derivatives and bond markets. This includes several proposals designed to ameliorate pre-trade transparency, that, if enacted, would likely move the EU in a direction even further from that being taken by London. “Later this year, you could see further restrictions on dark pools and bank internalisation making its way through as part of the MiFID II review,” says Mr Puaar.
For its part, the UK has already adopted a relatively progressive posture in liberalising its own dark pool trading regime. In a statement issued in early March 2021, the Financial Conduct Authority (FCA) said: “In December, we announced that we would not automatically apply the DVC to UK equities, and we are now extending this to all equities.”
The move could attract significant volumes of equity trading on the part of large global investment firms that generally make use of dark pools to acquire and sell large blocks of shares in an anonymous way.
“The other thing that the UK is doing, which is absolutely right, is taking a look at the transparency regime. The whole concept of DVCs was never really something the UK was a big proponent of. It was largely a political/regulatory compromise between the FCA and ESMA, appeasing the strong exchange lobby in Europe. Now they are reviewing this, which I see as a positive,” says Mr Lovén.
We now have the opportunity to change the listing and prospectus regime... a lot faster than when we were in Europe
The difficulty here is that as the UK liberalises its transparency and trading rules, it could invite two related developments. First, London’s profile as an international share-trading hub could potentially grow as investment firms eye the more favourable operating conditions offered by the UK. In turn, this could heighten tensions with the EU and serve to accelerate the growing rift between the two sides, in terms of their respective financial services marketplaces.
“The UK has a chance to go its own path and create its own market structure, and that deviates from the EU in terms of share-trading rules. As a result, you could see the UK build liquidity back up in those EU names [lost to MiFID II requirements] because it’s easier to trade, but that would result in fragmentation, which may increase trading costs,” says Mr Puaar.
“The first question is how much tension does the UK want to cause with the EU when it comes to share trading? If the UK is going to make it easy [for global investment firms] to trade French shares in dark pools, that could inflame tensions with the EU and it could get messy. The second question is will banks and other trading firms decide to make use of any potentially easier or more liberal share-trading rules that the UK carves out for itself?” he says.
Reinvigorating the capital
It will be some time before the answers to these questions become clear. Meanwhile, however, the UK authorities are tackling another dimension of London’s attractiveness as a financial centre: the country’s listing and prospectus regime. In March 2021, the British government published the outcome of its Listing Review, a report detailing the steps required to reinvigorate rules around initial public offerings (IPOs). Chaired by Lord Jonathan Hill, a former European commissioner for financial stability, financial services and the Capital Markets Union, the review listed several key recommendations.
Among other proposals, it includes improvements to the listing environment, from permitting dual-class share structures to the easing of restrictions on special purpose acquisition vehicles, and a reduction of the free-float requirement from 25% to 15%. In addition, the review also highlighted the need to redesign the prospectus regime and to simplify the documentation and disclosure for existing and overseas issuers.
“The recommendations, once implemented, will have a transformative effect on the City of London, building on our existing issuer-friendly environment to make us far more competitive in comparison to other overseas markets,” says Kieran Stone, partner at Memery Crystal, one of just four law firms that provided recommendations to the review.
“As capital markets experts, Memery Crystal’s submission was based on our extensive experience acting for both UK and overseas issuers and banks. We believe that these changes to the listing regime, allied to London’s depth of capital, will turbo-charge the appeal of a London listing,” says Mr Stone.
In the context of London’s future, the UK’s departure from the EU presents new opportunities for the city to distinguish itself as a destination for IPOs. As such, the Listing Review highlights a number of areas that can be improved as a result of the FCA’s independence from ESMA.
The UK has a chance to go its own path and create its own market structure
“Regardless of your views on whether it was a good or bad thing to leave Europe, we now have the opportunity to change the listing and prospectus regime, to do it on our own terms and a lot faster than when we were in Europe. I know for a fact that there’s been pressure on the FCA to change various dimensions of the UK’s listing and prospectus rules. The response has always been: ‘We understand the point you are making, but it’s out of our hands’,” says Mr Stone.
This includes, for example, onerous disclosure and information requirements that are imposed on companies from markets with effectively identical rules and standards, such as Canada. As a result, there is a real chance that London’s IPO market could receive a boost if a large part of the Listing Review recommendations are acted upon.
“London holds a lot of appeal for foreign listings. Just in terms of my own practice, what I have seen over the past 12–18 months has been exclusively overseas companies coming to London because it offers them something that they can’t get in their home market. Whether that’s ASX, TSX or NYSE, [companies] come to London because they need additional liquidity or quality of coverage,” says Mr Stone.
In the opening months of 2021, London is already off to a strong start. By the middle of March, companies had raised £4.8bn ($6.6bn) in IPOs in the UK capital, with further deals, including the listing of Danish consumer review giant Trustpilot, in the pipeline.
Liberalised structure
Looking ahead, the trajectory of London as a financial centre remains far from clear. The UK has cut itself off from the world’s largest single market area at a time when the dynamics of global politics and finance are in a state of upheaval. Long-term scarring across a range of financial services sector activity is inevitable. But there also gains to be made. Assuming that broad-based equivalence proves elusive — which appears an increasingly likely prospect — the UK has an opportunity to revert to an open and liberalised financial market structure.
“I think there is a cultural issue here. And the European approach, if you like, is very technical, and very rules-focused and preoccupied with the protection of the European market. That has led to a lot of positions, I think, for the UK that didn’t make sense,” says Mr Stone.
As other global financial centres feel the heat of great power competition, London may yet find a new role for itself in a rapidly changing world.
