Fund managers holding European equities are praying that a no-deal Brexit is avoided this week.
Europe operates the world’s most integrated cross-border share trading marketplace but the UK’s possible sudden departure from the EU would cleave this network into two: EU and non-EU markets.
Today, an asset manager in Paris can ask a London bank to buy a Spanish stock in Madrid. It may sell the same stock hours later in the UK or in Dublin. London’s investment banks and asset managers make the City the system’s nexus and it handles most of the €2.2tn-a-month market.
In the event of a no-deal Brexit, EU watchdogs produced a list of 6,200 “most liquid” securities that EU banks and investors must trade in the bloc, and included 14 of the UK’s biggest stocks, such as BP, Royal Dutch Shell and AstraZeneca. EU investors could not use the London Stock Exchange, for example. Senior City executives describe it as a “nakedly political” grab for London’s business.
UK regulators are likely to have to follow suit with their own list, which will contain more European names because of London’s dominance. If so, CBOE Europe, the region’s largest cross-border exchange, will relist EU shares in London later this year, it said on Friday.
Fund managers on both sides of the Channel are alarmed. Also on Friday, Efama, a trade lobby group, warned the European Commission a split would cost on average €165m per EU27 fund every year. Underlining the City’s heft, Efama also estimated the average fund manager would take at least 240 days to unload a holding of AstraZeneca shares in the EU, compared to a maximum 37 in London.
But these statistics do not even touch on the biggest problem — the daily closing auction. Portfolios worth billions of euros are benchmarked to the final prices set in auction on national exchanges. It accounts for nearly a fifth of daily business. Without cross-border access, asset managers would be shut out and the UK more affected.
None of the solutions to preventing a huge drop off in liquidity are clean or clear. Fund managers could set up a subsidiary in the right jurisdiction but it is legally complex and time-consuming. They could turn to banks and high-frequency traders to take on the risk for settling their trades against closing prices. Indeed, some are exploring the option, but the rules may not permit it. Brussels is trying to clamp down on off-market activity, not ramp it up.
A deal between the UK and EU this week would likely keep European share trading in London, so regulators will need to find a longer-term solution that will satisfy them.
To avoid chaos next week regulators could call a truce and temporarily agree not to implement the rules. Without it, investors may pay the price.