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U decision on equivalence set to heighten UK post-Brexit fears Canada, Brazil, Singapore, Argentina and Australia to lose some market access rights Brussels has insisted the UK will have to rely on equivalence for market access after Brexit © Dreamstime Share on Twitter (opens new window) Share on Facebook (opens new window) Share on LinkedIn (opens new window) Share Save Jim Brunsden in Brussels JULY 28 2019Print this page278 Brussels will this week strip five countries of some market access rights, in a move set to heighten British fears that the system the City of London will rely on to serve EU customers after Brexit fails to offer a stable and permanent regime because it can be withdrawn. According to a document seen by the Financial Times, the European Commission will deem that Canada, Brazil, Singapore, Argentina and Australia no longer regulate credit rating agencies as rigorously as the EU does, removing a status that made it possible for European banks to rely on those ratings. The move marks the first time that such access rights, known as equivalence provisions, have been withdrawn, although some temporary permissions for Switzerland were allowed to lapse earlier this year. About 40 equivalence provisions are scattered throughout different EU financial regulations and are intended to make sure that trading platforms, brokers and other companies based in non-EU financial centres can serve European clients, so long as they are subject to strong regulation and supervision. The provisions are used by more than 30 countries. Valdis Dombrovskis, the EU commission vice-president in charge of financial regulation, told the FT that the decision on rating agencies set “some kind of a precedent for monitoring adherence”. “We had extensive dialogue with those countries, so they knew there was an issue and they knew there may be consequences,” he said. “If they, during several years, chose not to update their legislation, then we had to take the decision to withdraw equivalence.” Brussels has insisted the UK will have to rely on equivalence for market access after Brexit, when the financial sector will lose the right to seamlessly offer services across the single market. The EU rebuffed attempts by Theresa May, the former UK prime minister, to secure a more comprehensive and permanent access regime. Recommended Roula Khalaf London will be the first victim in Johnson’s Brexit plan Mr Dombrovskis signalled that UK fears were unfounded because the process showed how careful the bloc was about curtailing access, noting that the EU had waited six years to act. “We are doing so after a long process and actually a long negotiation which lasted several years,” he said. The move relates to EU legislation from 2013 that reflects the bloc’s frustration that agencies such as Standard & Poor’s and Moody’s deepened the sovereign debt crisis by downgrading countries such as Greece and Portugal at sensitive moments. The law restricts when such decisions can be published and sets ownership rules for rating agencies that are intended to prevent conflicts of interest. But few other countries have followed Europe’s lead. The equivalence provisions in the law mean that an agency’s ratings can be used for regulatory purposes in the EU, notably by banks when they measure the risk of losses on investments and so how much capital they need. EU officials stress that equivalence is not the only access regime that the EU offers for rating agencies. A separate scheme, known as endorsement, allows individual agencies to get access by setting up units in the EU that vouch for ratings produced elsewhere. Zulema Aragonés Monjas, head of European compliance at DBRS, a Canadian rating agency, told the FT: “The European Commission decision to repeal equivalence for Canada will have no impact on our business.” “We’ll continue to issue ratings from our US and Canadian credit rating agencies that can be endorsed by our EU registered CRAs and therefore used for regulatory purposes in the EU,” she said.

Switzerland’s loss of access rights to EU stock markets has concentrated trading in Zurich while raising costs for buying shares in smaller companies, according to research that sheds light on the potential consequences of Brexit. Banks and fund managers based in the EU were forced to change the way they bought and sold Swiss stocks in early July after a breakdown in political negotiations resulted in a ban on trading hundreds of such shares in the bloc. Virtu Financial, one of the world’s largest market-makers, analysed $36bn of trades in the eight months to August, covering about 120,000 orders for Swiss stocks and more than 100 institutions — across all types of shares and trading venues including bank-operated private electronic marketplaces. The loss of regulatory “equivalence” for Swiss stocks reduced investment choices and introduced friction into the market, Virtu said in a paper seen by the Financial Times. It increased costs for buying and selling companies with a small or medium-sized market capitalisation. “While the impact to end investors from ending equivalence of Swiss stocks is not fully understood yet, we do observe increases in trading costs . . . with small and mid-cap Swiss stocks becoming 20 per cent more expensive.” Virtu is one of the most active traders in European markets and also its subsidiary ITG, an agency broker. The data was gathered by Virtu’s analytics unit. Its findings are being circulated to fund managers this week. Brussels let the “equivalence” status granted to Switzerland and its stock exchange expire following stalled negotiations over a broader economic agreement. Switzerland retaliated with its own ban on trading Swiss equities on exchanges in the EU. Virtu found that institutional investors shifted business to the main Swiss exchange from dark pools and rivals such as UK exchanges CBOE Europe and Aquis Exchange. Average five-day spreads for Swiss stocks widened, particularly in small-cap stocks. It also said costs at “lit” venues, marketplaces where prices are transparent, had increased but said “the distribution of costs makes it hard to detect a clear link to the equivalence change”. Thomas Zeeb, chief executive of the Swiss Stock Exchange, said the volumes on its market had gone up since the equivalence permit expired, but said spreads on deals across the market had reduced by 19 per cent. “Investors have benefited from a single pool of liquidity more than a fragmented market.” Investors are keeping a close eye on the impact of the EU’s withdrawal of equivalence for Switzerland and the implications for UK markets, should Britain leave the bloc at the end of October without a political agreement. Watchdogs across Europe have warned that share trading markets would be split by a no-deal Brexit, but have differed over the best way to prepare. The EU’s main markets regulator, the European Securities and Markets Authority, has called on UK counterparts to lay out their plans in detail. Britain has urged the EU to issue more temporary equivalence permits to countries and institutions in order to smooth out market dislocations.


Financiers press for tax cuts and lighter City regulation Sajid Javid meets leading bank and insurance executives for first time Sajid Javid on his way to Downing Street on Monday © Neil Hall/EPA Share on Twitter (opens new window) Share on Facebook (opens new window) Share on LinkedIn (opens new window) Share Save Patrick Jenkins and Daniel Thomas in London SEPTEMBER 2 2019Print this page44 Tax cuts for banks and lighter regulation of the City of London are essential if the financial services sector is to thrive post-Brexit, top financiers told Sajid Javid in their debut meeting with the chancellor on Monday. At least two attendees at the hour-long meeting at Number 11 Downing Street told Mr Javid that lenders’ tax rates, which include a bank “supertax” and a balance sheet levy, must be cut for the City to prosper in a competitive global market after the UK leaves the EU. Insurance company bosses repeated calls that some of the more extreme provisions contained in the UK’s adoption of EU Solvency II legislation should be repealed. Among those present at the meeting with the chancellor were the chairmen and chief executives of Royal Bank of Scotland, Lloyds, HSBC and Barclays, as well as the bosses of Aviva, Prudential and Legal & General. Mr Javid, a former investment banker, sought to reassure those present of the government’s recognition of the City’s importance to the economy, and its role in helping British business, attendees said. He also stressed how keen he and prime minister Boris Johnson were to ensure that the City could continue to employ skilled staff from across the EU within a “light-touch” immigration regime, marking a “sea-change” from Theresa May’s government. One banker at the meeting said the contrast with the previous administration, both on immigration and on broader government attitudes to business, was stark. The Treasury was not immediately available to comment. “The debate centred on how to make the UK more competitive from a tax and regulatory point of view after Brexit,” said one person familiar with the discussion at the meeting. Despite broadly positive feedback about the meeting from attendees, several stressed their concern about the rising risks of a no-deal Brexit and the danger both to the City and the broader economy from disruption to trade, especially on smaller businesses. Mr Javid suggested that there would be forbearance from the UK authorities towards imports from the EU, attendees said, but would not be drawn on the likelihood of friction from the EU27 over export tariffs. Theresa May’s government had pledged to cut 87 per cent of tariffs on imports from the EU and from outside the bloc to ease the problems of a no-deal Brexit, although it had also planned to levy duties on cars as well as beef, chicken and pork. This had threatened to hike prices paid for food and cars imported from the EU, but cut the overall impact of price increases for consumers and businesses that rely on imports from Europe. Recommended UK government spending Five priorities for new UK chancellor Sajid Javid Mr Johnson has been repeatedly warned by business leaders that a no-deal Brexit would have a particularly damaging impact on smaller businesses, which often lack the resources to properly prepare themselves for the cost and difficulties in dealing with hard borders and tariffs. Michael Gove, the cabinet minister in charge of no-deal planning, hosted a similar meeting of business groups last month, asking business leaders for ideas about how to mitigate the impact of a no-deal Brexit. The lobby groups have been told to come up with “creative and practical proposals” to help businesses get ready for Brexit for relevant departments, while the government has unveiled a series of initiatives to help spread the message that businesses need to get operations ready for leaving the EU including a national advertising campaign. The government has also set aside a £10m fund for trade associations to advise on Brexit preparations. The chancellor “made clear his commitment to a close and ongoing dialogue between the government and the world’s largest and most influential firms in the sector”, according to a Downing Street official. “He also stressed that this sector is a top priority for him. He sees the financial services industry as a cornerstone of the UK’s economy, driving jobs, economic growth and innovation to the benefit of all.”

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Clearing reforms set to ‘disrupt’ asset management Costs are set to rise — but the question of how much and who pays is yet to be decided © Bloomberg Share on Twitter (opens new window) Share on Facebook (opens new window) Share on LinkedIn (opens new window) Share Save Eva Szalay in London YESTERDAYPrint this page1 Global regulators might have delayed completion of a major reform of derivatives trading rules by a year, but currency markets are already changing in anticipation. One aspect of the reform that investors and dealers can agree on is that trading costs will rise — the question is only how much, and who will pay. The last phase of the rules, which aim to promote the central clearing of derivatives to reduce systemic risk, will now kick in at the start of September 2021, after regulators delayed the deadline in July to facilitate preparations. But the changes, which will require investors who trade over €8bn of uncleared derivatives to post margin with their counterparties for the first time, are expected to have a much wider impact than just greater use of central counterparties. The largest foreign exchange prime broker, Citi, has already prepared the ground to share the increased costs that will come with the uncleared-margin rules, noting in a study published earlier this year that “all participants should share in these new costs”. It said prime brokers had “miscalibrated their business models”, which would become unsustainable when most investors are within the scope of the rules. “FX prime brokers and banks as a whole are becoming much more mindful of return on capital, not just profitability,” says Gil Mandelzis, chief executive of technology company Capitolis. The way investors interact with the market and trade is also on the cusp of a major change, says Kate Lowe, global head of State Street’s electronic trading unit TradeNeXus, who notes that the status quo was becoming “totally disrupted” and the model that asset managers rely on is “almost imploding” as a result of the new rules. “The question is: where do they go from here?” The new rules mean the model asset managers rely on is ‘almost imploding’ State Street’s Kate Lowe Investors have three options, the first one being to keep trading on a bilateral basis and build systems to manage and monitor margin calls. This means they would have to sustain the much higher costs entailed when they post margin with each exposure, without netting. OpenGamma, a derivatives analytics firm estimates that trading costs on a bilateral basis could rise by as much as 30 per cent, once the rules come into force and “billions of [dollars of] assets” are posted as margin for positions. Vikas Srivastava, chief revenue officer for technology company Integral, says the more trading counterparties an investor has, the more complex the process of managing the initial margin becomes. Reducing the number of trading partners in a bid to cut complexity is not an option, as that would go against best execution requirements under the second Markets in Financial Instruments Directive. A second option is to hire a prime broker and pay for their ability to consolidate and net exposures across counterparties, reducing margin requirements to the net amount. But prime brokers are not set up for the very different client requirements that asset managers are looking for because their traditional client base, hedge funds, were looking for credit. Asset managers are now looking for the ability to consolidate exposures and to monitor, manage and post margin on a net basis. Ms Lowe, who previously worked in prime brokerages, says shifting them to a world where they are able to set up and handle collateral optimisation and services they never had to provide before “is far from straightforward”. Clearing instruments affected by the rules is a third option, as once a contract is centrally cleared, it immediately becomes exempt from margin requirements. Just like prime brokers, clearing houses allow clients to consolidate their exposures and only post a net margin. But investors still need to pay for the service and for some instruments like currency options, the process remains cumbersome. Paddy Boyle, head of clearing house ForexClear, says that unless investors clear at least part of their portfolio, the prices they will need to pay for doing currency deals will go up, as banks that price deals for clients will have to post margin against trades that are executed on a bilateral basis. Ms Lowe says that once the rules kick in, post-trade costs, which have traditionally been bundled into currency prices by banks and were often underpriced, will have a much bigger impact in the future. “I believe that the connections between post-trade costs and the overall cost of execution will strengthen dramatically over the next year. This is a huge shift,” she says.