London’s financial sector is likely to lose business—but to whom, and how much?

Author: Jonathan Gregson

As the outcome of the Brexit referendum started becoming clear around 2:30 AM on June 24, London’s black cabs prowled the streets, ferrying City bankers and traders to their desks ahead of what promised to be a stormy day in the markets. Few doubted then that Britain’s vote to leave the European Union (EU) would have a dramatic impact—not only on immediate markets, but on the City of London’s long-term future.

The vote to leave is likely to affect not only 1.2 million-plus people working in the UK’s finance sector and related services, such as lawyers and accountants, but every Briton who benefits indirectly from the £63 billion ($79.8 billion) trade surplus that financial services generated last year. It will also impact banks, fund managers, insurers and industrial companies from all over the world that for decades have benefited from London’s expertise and price competitiveness in financial services.

Nobody knows yet how Brexit will affect the City or which lines of business may have to relocate.  Barbara Casu, professor of banking and finance at City University of London’s Cass Business School, is downbeat. “That London’s position will survive unscathed post-Brexit,” she says, “is wishful thinking.”

Amid this uncertainty, other financial centers across Europe have lost no time in courting London’s bankers. Paris began its campaign with a “Welcome to Europe” slogan long before the referendum result was known, later switching to “It’s Time to Move On.” Frankfurt, Dublin, Luxembourg and Amsterdam also are looking to win business from the UK capital.

Precisely how much business London will lose depends very much on future negotiations between Britain and the EU—especially what agreement is reached over the British government’s desire to regain sovereignty and control of immigration on the one hand, and its wish to retain access to European markets on the other. And it depends, even more crucially, on how much Brussels insists on “punishing” the UK’s interests in order to discourage other EU members from leaving.

For the City of London, the key issue is whether UK-based banks and financial services providers will retain “passporting rights” that enable them to sell their services across the EU. Some major players, including Barclays’s chief executive, James “Jes” Staley, express confidence that London will remain a major hub for capital markets despite Brexit. Others, particularly senior European bankers, are hedging their bets.

When UBS announced in December that it would establish a hub for wealth management in Frankfurt, Axel Weber, the Swiss bank’s chairman, commented: “Our broad base in continental Europe gives us optionality in case we need to move employees from London to onshore locations.”

Weber, UBS: A broad base across Europe gives UBS options in case we need to move.

WHAT’S THE ALTERNATIVE?

Each London alternative has its particular attractions. Paris scores high on quality of life, is home to four of Europe’s largest banks and, after London, has the largest number of people working in finance and insurance, according to 2015 estimates by Oxford Economics. But France’s high taxes and employment costs could act as a deterrent.

Citigroup, according to British press reports, is already talking with German regulators about the logistics of setting up shop in Frankfurt, which is home to the European Central Bank and the headquarters of Germany’s two largest financial players. But tax rates are comparatively high, and many global bankers have said they would not want to move there—they cite lifestyle and the availability of suitable housing and schools as factors.

Dublin has the advantage of an English-speaking environment and a low-tax regime. Likewise, Luxembourg’s rise as an international financial center is built around its favorable tax treatment of foreign corporates and wealthy individuals, as reflected in its strengths in private banking, fund management and custodial services. These tax advantages, however, may come under further pressure from the Organization for Economic Cooperation and Development (OECD) and EU authorities. And none of these European rivals has the combination of air links, infrastructure and availability of housing and education that bankers can find in London.

Nor are they widely accepted as global financial centers. Most research surveys—whether based on numbers of employees, business volumes or diversity of offering—put London in pole position or a close second to New York. In the 20th semiannual Global Financial Centres Index (see table), published by research house Z/Yen, which carries out extensive online interviews, London barely leads New York, which is followed by Singapore, Hong Kong and Tokyo, according to the firm’s proprietary scoring system.

The only other European city in the top 10 is Zurich, which, although not an EU member, could well win some EU-sourced business—especially wealth management—from London, provided the Swiss electorate makes no further decisions that run counter to Brussels’ priorities. Luxembourg ranks 12th, Frankfurt comes in at 19th between Dubai and Vancouver, while Paris (29th), Dublin (31st) and Amsterdam (33rd) are in the same echelon as Casablanca, Abu Dhabi and Calgary.

Unless the final outcome of Brexit is extremely severe, the likely outcome for London is that it will lose out in some business lines. Discrete segments, such as fund management and insurance, would suffer from losing their passporting rights to serve clients in other EU countries. Casu sees asset and fund managers as being particularly vulnerable. “While they might not leave London,” she says, “their ability to continue with their current business models is under threat.”

Global Financial Centres Index 20

Top Six Globally

City

Index

Rank

London

795

1

New York

794

2

Singapore

752

3

Hong Kong

748

4

Tokyo

734

5

San Francisco

720

6

Other European

City

Index

Rank

Zurich

716

9

Luxembourg

711

12

Frankfurt

695

19

Geneva

689

23

Paris

672

29

Dublin

663

31

Amsterdam

659

33

Milan

624

53

Source: Global Financial Centres Index 20 Z/Yen Group

Based on data collected up to end June 2016

Possibly the most vulnerable operation, for political reasons, is euro clearing, where euro-denominated swaps account for slightly more than half of the $1.2 trillion of deals processed in London each day. Any attempt by EU authorities to move euro clearing from London to continental Europe will meet resistance from large financial institutions, according to S&P Global Ratings, which notes that such “repatriation” would “likely result in additional costs and lower efficiencies for the affected global clearinghouses and could also vastly increase margin collateral requirements for their clearing members.”

At a time when collateral requirements are already rising, this would impose higher costs on European banks and thus make them less competitive globally. Coming at a time when, according to Thomson Reuters data, Europe’s share of global investment banking fees has fallen to an all-time low and is now only just ahead of fees generated in Asia, the dismemberment of London as Europe’s only truly global financial center, for political reasons, would seem self-defeating.

UK-based banks, insurers and fund managers are all lobbying hard to minimize potential damage, as is TheCityUK umbrella group. It is seeking to influence the government’s priorities by underlining the importance of financial services to the UK economy and to focus the self-interest of CEOs of banks and key financial players around the world in maintaining London’s leading role. 

Should they fail, however, many believe that the real winners from London’s demise will not be Frankfurt, Dublin or Paris, but New York, Singapore and Hong Kong.

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