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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Key Takeaways
- City of London’s Diminished Role: The EU’s CRD VI rules, specifically Article 21c, are poised to compel non-EU banks to significantly expand their operations within the bloc, potentially leading to a substantial shift of financial assets, staff, and critical cross-border banking services from the City of London to EU financial hubs.
- Impediment to EU Competitiveness & Rearmament: Despite the EU’s stated goals of boosting defence spending and fostering economic autonomy, the new regulations risk undermining these ambitions by restricting efficient access to diverse private finance from global institutions, making it harder for European firms, particularly in defence, to secure necessary funding and liquidity.
- Strain on UK-EU Relations: The looming regulatory clash adds significant friction to UK-EU relations, complicating Sir Keir Starmer’s efforts to forge closer post-Brexit economic and security cooperation and highlighting a pattern of EU protectionist measures that could further fragment European financial markets.
The intricate tapestry of cross-border finance is bracing for a significant rupture as new EU banking rules, enshrined in the Capital Requirements Directive VI (CRD VI), prepare to take effect next year. This regulatory overhaul, particularly its contentious Article 21c, is sending ripples of concern across global financial centres, with senior financial figures warning of profound implications for the City of London, European rearmament efforts, and the broader trajectory of UK-EU relations.
From a market perspective, CRD VI is not merely a technical adjustment but a strategic move that could fundamentally reshape the landscape of wholesale banking services across the continent. Approved in 2024, Article 21c explicitly restricts the ability of non-EU banks – including major US and UK institutions – to provide core banking services, such as lending, cash management, and critical foreign exchange facilities, to EU clients from outside the bloc. This marks a notable shift towards greater financial autonomy and regulatory ring-fencing within the EU, potentially at the expense of established international financial channels.
The Looming Shadow Over the City of London
For the City of London, a bastion of global finance, these rules represent a direct challenge to its post-Brexit ambition of maintaining a leading role in cross-border financial services. London has historically served as Europe’s gateway to global capital markets, a hub for international lending, and a critical centre for US dollar clearing. The new directive is expected to force a significant re-evaluation of operating models for US and UK banks that currently serve EU clients from their London or New York bases. Executives are already anticipating a migration of assets, staff, and operational functions from the UK to EU countries, increasing the cost of doing business and potentially eroding London’s competitive edge.
The UK Treasury, through Chancellor Rachel Reeves, is “monitoring” the potential impact, acknowledging the gravity of the situation. TheCityUK, a prominent lobby group for the UK financial services industry, has been vociferous in its warnings, highlighting the potential for significant market fragmentation. This shift isn isn’t just about jobs; it’s about the efficiency and cost of financial services. When banks are forced to duplicate operations or restructure their global flows, it inevitably leads to higher operational costs, which are ultimately passed on to corporate clients, impacting their competitiveness.
A Self-Inflicted Wound for European Rearmament?
Perhaps one of the most ironic and concerning aspects of CRD VI, from a market context, is its potential to hinder Europe’s own strategic objectives. In the wake of geopolitical tensions, the EU has articulated an urgent need to boost defence spending and enhance its military capabilities. This rearmament effort requires massive capital investment, much of which is expected to come from private finance. Scott Devine of TheCityUK articulates this paradox sharply: “The [European] Commission says defence firms need to have the best possible access to private finance. Article 21c will cripple that ambition. It’s a protectionist move that will undermine European rearmament.”
The argument is simple: global banks, particularly those from the US and UK, possess immense balance sheets, deep expertise in structured finance, and extensive networks for syndicated lending and capital raising. Restricting their seamless participation in financing European projects, especially those as critical and complex as defence procurement, means limiting the pool of available capital, increasing its cost, and reducing the efficiency of financial intermediation. Nikhil Rathi, head of the Financial Conduct Authority (FCA), raised this alarm last October, stating that “proposed EU cross-border branching restrictions… raise the cost of precisely the investment our EU colleagues say they want.” This situation highlights a fundamental tension between the EU’s desire for strategic autonomy and the practical realities of global capital markets.
An Unintended Consequence: Currency Markets and Liquidity
Beyond broad lending, specific market functions are also under threat. A major concern for US and UK banking executives is the lack of clarity regarding the provision of US dollar accounts and related services to EU clients. These accounts are vital for day-to-day liquidity management for EU companies with US operations or significant dollar-denominated trade. One British banking executive noted, “It’s not clear these accounts can be held any more under CRD VI and they may need to be closed. I think this is an unintended consequence.”
If EU clients are forced to rely solely on EU-domiciled entities for their dollar needs, it could fragment dollar liquidity, potentially increasing transaction costs and operational complexity. The example of Booking.com, a Dutch-based online travel giant reliant on diverse foreign banks for processing transactions in some 80 currencies, underscores the widespread impact this could have across various industries, not just finance. Such restrictions on essential currency services could negatively impact trade flows and the efficient functioning of the eurozone’s external economy.
A Test for UK-EU Relations and Starmer’s Agenda
The CRD VI dispute emerges at a critical juncture for UK-EU relations. Labour leader Sir Keir Starmer has pledged “ambitious” efforts to reverse the negative economic effects of Brexit and foster closer cooperation, particularly in economic and defence spheres. He intends to push this agenda at a UK-EU summit in late June or early July, advocating for “closer economic co-operation, closer security co-operation, a partnership that recognises our shared values, shared interests and shared future.”
However, the banking rules, coupled with other “Made in Europe” initiatives targeting sectors like car manufacturing, present formidable barriers to Starmer’s vision. They signal a continued EU strategy of regulatory divergence and protectionism, creating further friction points. Britain’s refusal to join the “Safe” EU defence initiative due to prohibitive entry fees last year serves as a stark precedent for the challenges in aligning UK and EU strategic interests when regulatory and financial hurdles are imposed.
Financial services trade associations, including UK Finance and the Bank Policy Institute in the US, have collectively warned that the Brussels directive threatens to “actively undermine EU competitiveness.” The absence of immediate comment from the European Commission further underscores the perceived unilateral nature of these regulatory changes and the potential for prolonged disputes.
Market Impact
The implementation of CRD VI, particularly Article 21c, is poised to trigger significant shifts in global financial markets. For the City of London, the immediate impact will be a likely outflow of financial activity, assets, and skilled personnel, potentially diminishing its standing as a premier global financial hub for cross-border services and US dollar clearing. This fragmentation could increase the cost of capital for EU businesses, as a reduced pool of global lenders and service providers leads to less competitive pricing and potentially reduced liquidity in specific markets. For US and UK banks, compliance will entail substantial operational restructuring and increased costs as they expand their EU footprints, impacting their profit margins and potentially their ability to service certain clients efficiently. Currency markets could experience increased volatility and reduced efficiency in dollar-euro transactions if the provision of dollar liquidity becomes more complex. Furthermore, the defence sector within the EU may face higher financing costs and greater difficulty in accessing diverse, large-scale private capital, potentially delaying or increasing the expense of crucial rearmament initiatives. On a macro level, these rules contribute to broader financial protectionism, risking a global trend of market fragmentation that could impede international trade and investment flows, undermining economic growth in both the UK and the EU. Investors should monitor the migration of financial talent and assets, the pricing of cross-border financial services, and the operational resilience of EU and non-EU banks as these regulatory changes take full effect.