Brexit gets worse for Wall Street with EU shaking up MiFID

Freed from British influence, European authorities are hatching an offensive to weaken the Brexit-addled City of London.

Officials in Berlin, Brussels and Paris are looking to amend the post-crisis financial rulebook known as MiFID II by walking away from concessions they made to the U.K. in the six years it took to complete the regulations.

Policies governing research spending, record keeping and trading in stocks, derivatives and commodities are likely to be revised and could make Brexit tougher to negotiate for international banks such as Goldman Sachs Group and J.P. Morgan Chase. Changes would also be aimed at bolstering Deutsche Boerse's dominance against the London Stock Exchange Group in futures and other listed derivatives.

"The fact that the biggest financial market in Europe is now outside the EU will change the equation for financial-service regulation in general," said Markus Ferber, a German member of the European Parliament who was the lead lawmaker on the rules, formally called the revised Markets in Financial Instruments Directive. It would be "naive" to think otherwise, he said in an email.

The EU is expected to seek initial feedback from banks and other firms within days, according to people with knowledge of the matter. A formal proposal is slated for the third quarter.

At stake is more than specific policies but the entire architecture enabling London's finance industry to maintain anything close to business-as-usual. After Brexit, London financial services firms' access to the EU will depend on a process known as equivalence — under which Britain would have to prove to Brussels that its rules are at least as stringent as the bloc's. The equivalence system that will govern finance gives the EU unilateral power to decide if British rules are tough enough to create a level playing field.

"Combining the MiFID review with equivalence allows them the possibility to move the goalposts for equivalence, which could very well give the EU more leverage," said Nathaniel Lalone, partner at Katten law firm in London who works on cross-border regulatory issues in the derivatives market. "There is a risk that the MiFID review could be misused for political ends, which could ultimately, and regrettably, serve to frustrate access to EU markets by City firms."

The U.K. left the 27-nation bloc on Jan. 31, with the deadline to complete a trade deal at the end of 2020. Initial sparring between British Prime Minister Boris Johnson and EU negotiator Michel Barnier points to a struggle to avoid a cliff-edge.

The pound reversed gains after this Bloomberg report fanned worries over the trade tensions. Sterling weakened 0.3% to $1.2997 at 4:40 p.m. in London.

Germany and France are already talking about reversing key parts of the finance law that were backed by the U.K. when it was a member of the EU.

Ferber has joined the German finance ministry and Deutsche Boerse in calling for a review of a MiFID provision known as open access. The rule is supported by the LSE; set to take effect in mid-2020, it's intended to make derivatives markets more competitive by allowing contracts to be traded on one exchange but cleared at another, loosening European firms' grip on listed products.

Another of Britain's top priorities in the law was a requirement that money managers pay for investment research separate from trading services. The U.K. Financial Conduct Authority says it'll save investors in U.K.-managed equity portfolios up to £1 billion ($1.3 billion) over five years.

Some Europeans say the rule permits predatory pricing by bigger firms, such as the London-based operations of U.S. giants. In France, the markets regulator is considering preventing big firms from providing research at a price so low that it stifles competition.

To be sure, the industry might welcome some of the MiFID revamp. Certain changes could cut costs, and bankers might be freed from having to record calls with clients due to German worries about privacy. Money managers might benefit from more transparency in fixed-income and equity trading and a proposal could even boost the ETF market in Europe.

If the EU goes forward and alters the law in big ways it'll complicate aligning regulations to ensure smooth cross-border market access, according to Kay Swinburne, vice chair of financial services at KPMG in London.

"If it's a moving target, how does anybody ever actually continue to stay in line?" said Ms. Swinburne, a former U.K. member of European Parliament in Brussels who had a leading role in financial legislation for a decade, in an interview. "What are we actually trying to match?"