The future of the City of London has been one of the key concerns since the Leave victory in the EU referendum last month.
London will remain an important financial centre under any plausible circumstances. It survived the 1930s and two world wars. It will survive Brexit. Yet, within the EU, it was emerging as the undisputed financial capital of Europe, as well as one of the world’s two most important financial centres. After Brexit, it is likely to become an offshore centre, relatively more vulnerable to policy decisions, especially regulatory decisions, made elsewhere, particularly by the eurozone.
It is inevitable that some part of euro-denominated business and asset management would then shift inside the EU. An important reason for this will be the desire of the European Central Bank to enjoy greater control over the provision of euro liquidity. Another will be the desire of EU countries to secure lucrative business opportunities for themselves: at London’s expense. An interesting question is what might happen to ancillary services — legal services, for example — in such circumstances.
Of course, it is quite possible that Europeans will over-regulate their domestic financial businesses, thereby pushing activity outside the EU. Indeed, the future of London might ultimately lie more in being a relatively less regulated offshore centre than in seeking to stay inside the EU single market, particularly once the UK has left the EU and so has little if any influence upon EU regulation.
If the City did indeed shrink, it might be a good thing for the UK, in the long run. But getting to that long run will be painful, particularly since the City helps London generate a great deal of tax revenue.
Thrive is a strong word. Among the few ardent Brexiters in the City there is a belief that exploiting new freedoms to operate globally rather than as a European hub will boost the City.
That is both fantastical and a misunderstanding of the City’s role in Europe.
Since the UK has been part of the EU, the City has steadily become more global, not more European. It is predominantly US and Asian banks that use London as a hub to operate across Europe, the Middle East, Africa and beyond.
Many asset managers and insurers use London in a similar way.
The sustainability of that hangs on whether access to the single market, via some approximation to current “passporting” arrangements, can be negotiated. The best outcome is negative compared with the status quo — some institutions will not wait for the outcome of political negotiations before they decide to relocate at least a portion of operations to Frankfurt, Dublin, Paris, Amsterdam or Luxembourg.
So any hope of actually thriving is predicated on developing new areas of business. Brexiters talk about maximising London’s role as a base for offshore renminbi trading or as a hub for incubating financial technology companies.
There may indeed be some opportunities but currently at least they look small and speculative. In the case of RMB trading, for example, a big question mark hangs over the commitment of Chinese banks, which recently picked London as their European financial base of choice, to remain here rather than follow the likely shift of euro clearing to Frankfurt or another eurozone centre.
The City has a long history of adapting to changed circumstances and will undoubtedly survive in reinvented form. But the idea of thriving — at least relative to what it might have been inside the EU — looks implausible in the foreseeable future.
London’s current pre-eminence as a global financial centre owes much to poorly thought-through American policy — a hated US tax on interest helped create the eurobond market in the 1960s, and the Sarbanes-Oxley corporate governance law prompted many international companies to list in London rather than New York. If the UK loses access to the EU single market, it will essentially be returning the favour.
However US financial markets did not die in the interim. Bankers and traders in New York created new products and pushed into new markets. Innovative Londoners will almost certainly do the same — renminbi-related products are an obvious place to start. Brexit could well provide the spur that banks, insurers and asset managers needs to rethink the way they do things and create a true 21st century financial system that taps big data, artificial intelligence and other new technology. It will probably be painful in the short term, with job losses and empty office buildings. But don’t count London out.
Yes, the City could thrive after Brexit but there is a serious risk that it will be diminished. It has largely had the best of both worlds in the EU, strengthening its global status while taking advantage of services passporting and freedom of movement to entrench itself as Europe’s financial hub.
The City is unlikely to wither away, no matter how hard Paris, Frankfurt and Dublin try to lure banks, professional services firms and employees abroad. It not only has strengths dating to the 19th century and earlier but, given the choice, most institutions and people would prefer to remain.
The question is now far it can retain access to the single market and sufficient freedom of movement. With both cut off, it would be at risk. With some fudge, it will make the best of it. It took the first world war to turn the City inward in the first half of the 20th century; Brexit is not as serious as that.
My bet is that the City will at first merely survive — the uncertainty is such that it is bound to affect hiring not only by core financial institutions but in all the ancillary services, from law to PR, that feed off the core. Only later will it thrive again.
There is a big difference between this and previous shocks to large financial centres — from the impact of the first world war (and the subsequent decades-long ban on non-UK citizens joining the stock exchange) to the US tax on interest that spawned eurobonds. Brexit will take place with a digital revolution well under way. Technology makes it possible for companies to source global expertise electronically, to work seamlessly with collaborators abroad, and this may change the calculation that companies and individuals make about the most agreeable and lucrative places to live and work.
Since the days of the coffee-houses, the City has operated as a sophisticated cluster, reliant on people being physically present. Language, timezone and legal advantages have underpinned the cluster. But changes in regulation and immigration policy wrought by Brexit will combine with the rapid evolution of digital technology and artificial intelligence in unpredictable ways.
The City is a many-splendoured place and its future will depend on which segment of the financial industry we’re talking about. Anything at the mercy of European market access or euro liquidity — the €2tr-worth of bank intermediation, euro-denominated clearing, and anything depending on settlement through Target 2 — is likely to migrate to eurozone financial centres, at least partially. Fund management can probably rely on “equivalency” provisions in EU rules, although this will constrain UK regulatory autonomy if the industry is to continue to market its products in the EU.
But offshore finance for global, non-EU markets can continue apace. That is to say, the UK financial industry can become the “Greater Guernsey” that featured heavily in German officials’ talking points a few years back. Such a City could, for the time being, thrive at a smaller scale. But two questions would continue hang over its future. First, would the smaller scale itself dry out some of the liquidity pool and cluster advantages that makes the City so competitive outside Europe as well? And second, for how long would non-European jurisdictions such as China blithely allow an island in the North Sea to skim the cream off the business of financing their economies? The best answers to both questions are pessimistic.
Brexit has aroused a great deal of concern over the City’s status as Europe’s dominant financial centre. No matter an exit from the EU, the City has plenty running in its favour. English law underpins global financial markets trading. The City has also prospered from a more benign view of regulation and oversight than what is favoured across the English Channel. We may well see the City ultimately gain in a post-Brexit world if the regulatory climate in Europe shackles investors and banks.
While Frankfurt will make a concerted effort to grab London’s clearing business of euro derivatives, some in the industry make the point that the euro’s status as a reserve currency means trades in that currency can be processed anywhere.
Finally, the City has long benefited from looking to the future and not the past. A new reserve currency beckons in the form of China’s renminbi along with bonds and derivatives. London will play a vital role in the global trading day between Shanghai and New York.