By Stéphane Monier, Chief Investment Officer, Lombard Odier Private Bank
Talks over how to consolidate a patchwork of bilateral accords into a single agreement between Switzerland and the European Union have faltered with both sides trying to use financial markets as leverage. The disagreement is required watching for anyone interested in what may lie ahead for the UK and the continent’s biggest trading market post Brexit.
Negotiations began in 2014 to replace the existing 120 or so bilateral agreements between Switzerland and the EU that have developed piecemeal since 1972. Published in November, a 34-page draft covers the free movement of people, mutual industrial standards recognition, farming products, air and land transport. The agreement would see Switzerland adopt changes to EU legislation while guaranteeing access to the EU’s single market. The country depends on its surrounding EU neighbours for around 71% of imports, and relies on the bloc to buy some 53% of its exports.
Five years after talks began, the Swiss Parliament last month called for clarifications on labour protection for Swiss wages and workers, state subsidies and citizens’ rights, knowing that a referendum is almost certain to challenge any eventual agreement. Then the European Commission, the EU’s executive, decided not to renew the equivalence permit that lets European investment firms trade stocks on Swiss platforms. The decision had nothing to do with the technical qualities of Zurich’s exchange.
By its own admission, according to the Financial Times, the European Commission was unclear about the implications for letting ‘equivalence’ expire. Switzerland retaliated from 1 July with a ban on trading Swiss shares on European bourses.
The net effect has seen the share of trading in Swiss stocks on European platforms fall from around 30% to nearly zero while the SIX Swiss Exchange now accounts for almost all trading in Swiss equities. Concretely, brokers must place an order for a Swiss-listed stock in say Nestlé or Roche shares through the Swiss exchange while Swiss orders for shares of SAP , L’Oréal or BP must go through the German, French or for now, UK markets.
The Swiss stock market is Europe’s fourth largest, with a market capitalisation of around USD 1.5 trillion, trailing the UK, France and Germany.
For companies listed in both Switzerland and the EU, such as French-Swiss LafargeHolcim or Swiss-Swedish ABB, the option remains to buy on whichever exchange provides the more favourable price. In practice, the basic requirement for brokers to implement "best execution" means that they might still choose their exchange.
The stalemate over talks with the UK on agreeing the basic terms of Brexit have added to the European Commission’s impatience with Switzerland. Compounding the urgency is that the term of the current Commission ends on 31 October.
Brexit warning shot
Inevitably, the continuing impasse around the UK’s departure from the EU is linked to the dispute. The leading candidate to become the next UK Prime Minister, Boris Johnson, has said that he wants to renegotiate the terms of Brexit, which the EU has ruled out, or see the country leave the EU without an agreement.
"We simply cannot accept further attempts of foot-dragging and watering down internal market rules, especially in what is probably the decisive phase regarding Brexit," Johannes Hahn, the EU commissioner responsible for the EU-Swiss talks, wrote in a note dated 17 June according to Bloomberg.
Commentators wonder whether the European Commission may also want to withdraw equivalence from the UK as a negotiating tool. At this stage, we believe that the European Commission is unlikely to want to repeat the experience of dropping equivalence for the UK’s markets, in the light of the Swiss experience. Not only is the UK stock market twice the size of Switzerland’s, its clearing houses, which guarantee contracts even if one side proves insolvent, are a core part of Europe’s trading infrastructure. London has three clearing houses (LCH, LME Clear and ICE Clear Europe), which account for large amounts of trade in financial instruments ranging from interest rate swaps, precious metals and oil futures.
That does not make the UK’s financial exchanges, nor London’s clearing houses, untouchable. Last year, François Villeroy de Galhau, governor of the Banque de France, said that the UK’s clearing houses should only be granted a "temporary solution, for a period of no more than a year or so" after Brexit. The UK’s departure, said the governor, "can also represent an opportunity to restructure the European financial system."
We began anticipating the potential fall-out from the EU-Swiss dispute in 2018 and prepared our trading infrastructure for all eventual scenarios to ensure that we continue to provide best execution for clients. For now, the Swiss Federal Council’s retaliatory measure appears to have successfully defended the Swiss stock market and had little discernible impact on trading operations, in terms of both price execution and liquidity.
"There are only losers, no winners," Jörg Gasser, CEO of the Swiss Bankers Association told Le Temps newspaper last week. The bilateral negotiations, he added, are a "five to ten year" project that is being complicated by Brexit, according to an interview with Finanz und Wirtschaft published 9 July.
At this stage, we are closely monitoring developments and awaiting signs that the Swiss and EU are working to resolve this situation as Switzerland’s domestic political consultations continue.
Clearly, the future shape of European markets post Brexit, and the continent’s financial infrastructure, are being tested.