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Market bets on Boris breaking Brexit promise

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By Jasper Cox, Toby Fildes
13 Dec 2019

With a Conservative majority in Parliament meaning the UK will almost certainly leave the EU in January, attention turns to the transition period —market participants expect prime minister Boris Johnson to break his pledge not to extend it. Meanwhile, the UK’s financial sector now knows it will become less aligned to the EU, and bankers on contingent contracts could be about to move across the Channel.

Johnson’s large majority means the chances of the EU Withdrawal Agreement failing to pass before the January 31 deadline is very slim. It also gives the prime minister greater freedom over how he negotiates a trade agreement with the EU. He will have to rely less on MPs in the hardline Eurosceptic European Research Group.

“For market watchers, we will probably not have to stay up late and watch as many parliamentary votes, hopefully for the next five years,” said an FX strategist. “It’s more about his statements as a government and how those talks with the EU go, rather than what the latest ERG member said or the latest court case that’s going to happen. A lot of that will calm down.”

The Conservative Party has ruled out staying in the European single market or the customs union and is going instead for a trade agreement. 

But the party has promised not to extend the transition period beyond December 2020. Reaching a comprehensive agreement before then is considered unlikely, while the EU's deadline for the UK to request an extension is the end of June.

“Johnson has left himself just 12 months to strike a new trade agreement with the EU, which has taken others around four years,” said Paul Dales, chief UK economist at Capital Economics, in a note to clients. “We suspect that if Johnson falls short he would extend the transition period at the last minute.”

The view that the prime minister would break his promise and extend appeared to be widely shared on Friday morning.

“The question between February and the end of June is how Boris is going to be able to extend this, given the manifesto said he wouldn’t,” said the FX strategist. “From what I can tell, and there isn't a consensus, a lot of people are thinking that this majority means he has the flexibility to renege on that manifesto pledge.”

This may come from a sense that Johnson at heart supports financiers.

As a senior debt capital markets official at a US investment bank said: “It’s time for the real Boris Johnson to stand up. We need his liberal Conservative values to come to the fore. Will this big majority allow him to soften Brexit, to stand up to the ERG wing of his party and no longer have to do what they say?”

However, not everyone in the market is convinced that the prime minister is about to change his spots.

“I personally worry that the expectation that Boris Johnson will return to his liberal and inclusive values is wishful thinking on behalf of a market that fears Brexit,” said a Gilts market participant. “It will become clearer over the next few weeks, but I would caution against thinking we will see a big change in him or a return to what he was like when he was London mayor — a consensual figure.”

Johnson’s political leeway “will remove parliamentary checks and balances, should the government decide to follow through on manifesto promises for a hard Brexit by the end of 2020,” warned Oliver Harvey, macro strategist at Deutsche Bank, in a research note.

Meanwhile, the finer points of exactly what the trade negotiation will involve are not being discussed yet. The FX strategist said his clients were not talking too much about the details. “It was: ‘get the election out the way first, and then we’ll discuss that later on’,” he said.

Future of financial services

But those details will be important for financial firms for their own operations, rather than just for the securities markets they make money from.

The simplest option for London’s finance sector would have been to retain passporting rights by staying in the single market, meaning it could continue to offer services in the EU.

That appears to be out of the window, since Johnson seems to have set his face against single market membership.

That leaves several options for how the UK’s financial sector could do business in the bloc. One is through an equivalence agreement, where the EU would recognise that the UK’s regulations were sufficiently equivalent to its own. This would give firms access to markets with a lowered compliance burden.

But it could be politically contentious in the UK because it would rely on a degree of convergence of regulation. It can also be an unstable regime that can end suddenly, such as earlier this year when the EU let the equivalence of Swiss exchanges expire.

Another option is housing an agreement on financial services within a free trade agreement. But this is generally difficult to do.

Putting services into a trade agreement means any potential deal is “likely to be a ‘mixed agreement’ in EU jargon and therefore require[s] the ratification by national and regional parliaments of the EU, a complex and lengthy process,” said Daniel Vernazza, chief international economist at UniCredit Bank.

A third option is using World Trade Organisation rules. That would lead to stricter regulation and supervision of the EU branches of UK banks, according to the Institute for Government, a thinktank.

Ready, set, relocate

Aware how difficult it could be to maintain the current level of single market access, banks are now likely to ramp up transfers of activity and jobs to the continent.

This would probably have happened even without a Conservative majority, as banks are moving ahead in the absence of certainty over Brexit. Many firms have already promised regulators in Europe that they will transfer more activity and people over time.

Frankfurt leads the way, in terms of which EU cities banks are moving to, according to recent analysis from thinktank New Financial, with 43% of Brexit-related EU hubs having been set up there. 

Dublin and Paris have 18% of the relocations each, followed by Luxembourg and Amsterdam.

However, one lawyer has expressed doubt over whether Frankfurt and Dublin are big enough to offer firms sufficient numbers of financial sector workers.

The transfer of activity and jobs may not all be visible as staff relocation: the next cycle of investment and hires may simply take place on the continent, with London operations stagnating or retrenching. But job moves are likely to take place as well.

“Generally, we’ve seen that banks have either moved their staff already to their EU hubs or at least they’ve planned which ones will go in the event of a hard Brexit, and have given them contingent contracts,” said Kumaran Surenthirathas, managing director at Rosehill Search, an executive search firm for investment banking. 

This means embedding in UK staff's contracts that they have to move to the continent if required.

“So if there’s a hard Brexit, many will be moving to EU hubs. A lot of these contingent contracts have been in place now for nine months to a year now,” he added — Brexit was of course originally scheduled for March.

By Jasper Cox, Toby Fildes
13 Dec 2019