The interconnectedness of EU and UK financial markets

Five years after the UK left the EU, cross-border financial flows between the two markets still account for a significant share of overall financial activity in both the EU and the UK.  This experimental paper measures the interconnectedness of EU and UK financial markets before and after Brexit across 11 key metrics and makes five directional recommendations to encourage a closer relationship between the EU and the UK.

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Looking beyond the ‘reset’

Despite all the noise in recent years, the EU and the UK are relatively similar markets facing largely similar challenges of investment and growth. With Brexit, the EU has lost its biggest and one of its deepest capital markets. But despite a post-Brexit regulatory push by the EU to encourage the relocation of some capital markets activity, the EU is still connected with the UK in many areas of the capital markets. At the same time, the EU remains the UK’s largest economic neighbour and second-largest trade partner in financial services.

The interconnectedness of EU and UK financial markets remains a ‘fact of life’, and while there are many areas in which the EU and the UK need to develop and build their own capital markets to better support their economies, we think it is time for a more serious conversation about how both markets can work more closely together to address their common challenges.

This paper drills down behind the headline numbers and identifies i) the similar challenges facing the EU and the UK, and how capital markets can help address them; ii) the state of play in EU and UK financial markets; iii) the pre- and post-Brexit levels of interconnectedness of EU and UK capital markets; iv) the parallel reform agendas in the EU and the UK; and v) recommendations to foster a closer relationship - and ideas to help the financial services industry make the case for it.

The aim of this analysis is not so much to have all the answers but to inject some fresh perspectives and urgency into the debate on the relationship between EU and UK financial services. The dust has settled after many bruising years of negotiations following the UK’s Brexit referendum. Things between the EU and the UK seem to be fine. But are things really going well?

This short paper is a first attempt at measuring the interconnectedness of EU and UK financial markets across 11 key metrics. There are many more ways to analyse and illustrate financial flows, financial services trade, and investment from the EU into the UK and vice versa. Readers who would like to see and support a more comprehensive research report are very welcome to reach out with their thoughts and feedback. Any errors are entirely my own.

Here is a 10-point summary of our analysis of the interconnectedness of EU and UK financial markets:

1. The common challenges facing the EU and the UK: the EU and the UK face many common challenges - from defence and security to climate change and demographic shifts; from poor economic growth and low levels of investment to the rise of populism. They are tackling many of the same challenges for the same reasons in broadly the same way.

   
   

2. The aim of this paper: the interconnectedness of EU and UK financial markets remains a ‘fact of life’ and while there are many areas in which the EU and the UK need to develop their own capital markets to better support their economies, we think it is time for a more serious conversation about how both economies can work more closely together to reduce friction, better address common challenges, and help each other.

   
   

3. Moving beyond Brexit: this debate is not about re-litigating Brexit or seeking to reverse the relocation of substantial amounts of jobs and activity since Brexit. It is about the potential for pragmatic cooperation.

   
   

4. How we are measuring interconnectedness: across 11 key sectors of the financial markets we measure

   i) the total value of activity by EU and UK issuers, or booked in the EU and the UK; ii) the total value of cross-border activity in each sector; and iii) the relative and absolute value of financial activity in the EU and the UK that involves some form of interconnectedness of the EU and the UK. We take a look at where we are today, and at the change in the interconnectedness of EU and UK financial markets since 2015.

   
   

5. A ‘fact of life’: the UK overall is a much more international market than the EU, but activity between the two markets accounts for a significant share of overall activity in both the EU and the UK. In the three years to 2024, 25% of all venture capital investment in the EU involved a UK investor; and 28% of all VC investment into UK companies involved an EU investor. Two-thirds of all euro-denominated derivatives trading takes place in the UK, and roughly a fifth of all EU-domiciled investment funds are managed in the UK.

   
   

6. The change since before the Brexit referendum: the interconnectedness of EU and UK financial markets has increased in a surprising number of sectors since 2015. While the EU has seen an increase in EU-UK activity in around half of sectors that we look at, UK activity seems to be diversifying away from the EU.

   
   

7. A focus on cross-border banking: banking activity between the EU and the UK has increased from an EU perspective but decreased from a UK perspective since 2015. An upcoming change in EU regulation (article 21c of CRD IV) could make cross-border banking activity into the EU more difficult. For reference, 20% of all EU bank borrowing today is cross-border, and 12% of UK bank lending has an EU counterparty.

   
   

8. A focus on cross-border investment: at a time when the European economy is stagnating or shrinking, the EU and the UK overall are scaling down their investment into each other’s economies. Had things not changed since 2015, the UK overall could have seen an additional £580bn of potential investment from EU investors, and the EU economy a potential additional investment of around €260bn from UK investors.

   
   

9. What we can do about it: while accepting the realities of the post-Brexit EU-UK relationship, this paper makes five directional recommendations that could help encourage closer cooperation between the two markets - including coordination on incoming regulations, technical improvements, and non-financial measures; making a broader European or international case for cooperation; and making that case now.

   
   

10. A few caveats: the aim of this analysis is not to have all the answers, and there are likely many more ways to measure the interconnectedness of EU and UK financial markets. Readers who would like to see (and support) a more comprehensive research report on this important issue are welcome to get in touch.