EU and UK Financial Market Ties: Resilient to Brexit?

Srobona MITRA * Deputy Division Chief in the Monetary and Capital Markets Department, IMF. Contact: smitra@imf.org.

Mahmood PRADHAN ** Deputy Director in the European Department until July 2022, IMF. Contact: Mahmood.Pradhan@gmail.com. This article has benefitted from comments and suggestions from the editors of this journal and from many colleagues at the IMF. The views expressed are those of the authors' and do not necessarily represent the views of the IMF's management or its Board of Directors.

Brexit has not been resolved six years after the United Kingdom's vote. While much attention focuses on the disagreement on rules for trade through Northern Ireland, the resilience of cross border financial flows between the European Union (EU) and the United Kingdom (UK) does not suggest any significant dent in the longstanding financial market ties that bind the EU and the UK. Both sides have been pragmatic, to allow for a smoother transition, guarding against the well understood financial stability risks of cliff-edge disconnections. The Capital Market Union initiative, while well underway, is some time away from offering EU entities a common intra-EU capital market, and the market liquidity and network benefits that London currently provides. Building this capital market union will even out funding costs for corporates and households, but it will require eliminating barriers to cross border capital and banking flows in the EU. Preserving ties between the UK and the EU will, therefore, benefit both sides, bridging the long transition to more integrated capital markets within the EU.

Enduring financial market links between the EU and the UKSix years after the Brexit vote in 2016, income from financial flows between the UK and the EU has changed little. UK exports of financial services have actually increased (Chart 1a infra), although the share going to the EU has declined by some counts. Meanwhile, the larger EU countries' use of the UK financial sector has also not declined. In particular, the euro area's investment income from financial assets invested in the UK is marginally higher as a share of total investment income from all countries (Chart 1b infra).These ties run even deeper for derivatives clearing, going far beyond the evidence captured in balance of payments data. Almost two years after the UK's formal withdrawal from the single market, about 85% of the EU's interest rate swap are still cleared in the…