Both the U.K. and the European Union have expressed optimism over reaching a post-Brexit deal but any final free trade agreement is likely to contain only limited provisions on banks and financial services, say sources.
The leading EU negotiator Michel Barnier has remained in London to continue talks instead of returning to Brussels as planned, which the British government has said is a "very good sign."
But industry figures say it is unlikely financial services will be extensively covered by any final agreement.
Lack of financial services details
"There is very, very little in the drafts that we've seen for financial services, so we don't expect much in a final deal," said a U.K.-based source with knowledge of the discussions who declined to be named while talks continued. An EU-based source, who also declined to be named, agreed.
The U.K. government proposed outlining a deal on regulatory and supervisory co-operation in an annex to the main chapter in a draft proposal, but the EU did not agree with this approach and the annex was subsequently withdrawn, said both sources.
Britain exports more than $30 billion of financial services to the EU each year, according to World Trade Organization data. Its next biggest export market is the U.S., to which it exports about $20 billion worth.
In addition to an agreement on financial services, there are other issues that still need to be addressed by the two sides including forging agreements over the use of data and for the mutual recognition of professional qualifications, for instance.
An EU spokesperson said that in previous free-trade deals agreed by the bloc, financial services had been covered in only a limited way.
"The standard approach in EU free trade agreements is to have limited market access commitments, notably on cross-border supply of financial services," said Daniel Ferrie, the EU spokesperson for banking and financial services and EU/U.K. negotiations.
"Like in all free trade agreements we will have a prudential carve-out that allows the EU to adopt any measure for prudential reasons."
Equivalence, investment banking
In addition to the free trade agreement, the EU is also carrying out an equivalence assessment on the U.K.'s financial regulatory system to decide if it is sufficiently similar to allow EU firms' access to U.K. markets, although the June deadline has already been missed.
But any deal on equivalence will not include investment banking, which the EU has already excluded from consideration. It decided to exclude Article 47 of the Markets in Financial Instruments Regulation, or Mifir, which covers investment banking, at the start of the assessment because, it said, it had never published a previous equivalence determination covering this article.
"It makes little sense to assess areas where, for instance, the EU framework is not yet in place. With regard to these areas the Commission will not adopt an equivalence decision in the short or medium term," said Ferrie.
However, Bank of England Governor Andrew Bailey, addressing MPs on the Treasury Select Committee, said the EU's decision was significant.
"If you look across the landscape of equivalence, at where the value of equivalence is in terms of activity in financial markets, it is interesting — I will use my words carefully here — that the largest amount of value is in article 47 equivalence," he said.
The EU's decision showed it was intent on using the departure of the U.K. from the bloc to build up its own investment banking capacity, said both U.K.-based and EU-based unnamed sources.
A banker at a major U.K.-based investment bank said British lenders would prefer an agreement covering investment banking activity "because it would bring more certainty — both about where we would be on Day 1 of Brexit, but also certainty of stability over the longer term."
"The biggest downside of no equivalence agreement is fragmentation of our business — having to split assets, pools of liquidity and people across multiple jurisdictions and locations, when it is much more efficient for a bank's bottom line to have operations centralized — in London, where the ecosystem is at its most concentrated," said the source, who declined to be named while talks continue.
UK Finance, which represents British banks, said the two sides should focus on reaching a deal on equivalence. But it also said parallel arrangements for future cross-border trade did not depend on a free trade deal, and that they could "build on the longstanding regulatory relationships and supervisory cooperation that already exist."
The Bank of England's Alex Brazier, executive director for financial stability strategy and risk, told MPs that less than a third of the trade in financial service between the EU and the U.K. would be affected by an equivalence deal.