Who should be more humiliated: The City of London for losing €6 billion of daily trading volume in European shares on day one after the transition into a real and hard Brexit, or the EU for only being able to recapture that core financial market activity thanks to the UK unloading both barrels into its own feet?
The shift looked remarkable for being so complete and so sudden, and became the perfect story for the first week after the UK became a third country to the EU.
It surprised precisely no one in the City of London, where firms, exchanges and regulators had been preparing for it since the 2016 referendum.
No European city is ever likely to match the sheer scale of financial services – the close collection of global banks, fund managers, lawyers, accountants, market infrastructure providers – that slowly gathered in London during the past 50 years as international capital markets blossomed.
London’s decline as a global financial centre will play out slowly over many years, but there is no doubt that decline is already under way.
Even if the European Commission were to grant UK-based firms generous equivalence judgements in the 12 months ahead – which it almost certainly won’t – the money is already leaving.
The big story will be whether or not the EU can take advantage of Brexit by completing its capital markets union
As banks in London, most of the big ones being non-UK banks, discussed with European regulators their plans to set up operations in the EU, the European Central Bank (ECB) calculated a likely shift in the order of €1.2 trillion of assets into euro-area organizations.
Where the money goes, people follow.
One senior source at a US bank in London tells Euromoney: “We have decentralized our capital markets business, and while many of the one-off costs have now been taken, this is just the start.”
Moving the balance sheet that supports underwriting for EU issuers and the trading book for dealing with EU investors changes the economics of the business.
“The next step is to deploy more of the syndicate people, the risk managers, back office and senior management in the EU,” this banker says.
And that’s not necessarily moving people out of London.
“When you’ve shifted the capital, the marginal cost of hiring the next banker in Paris or Frankfurt or Amsterdam is lower than hiring in London. In fact, it’s a no brainer.”
EU challenge
The EU faces an even bigger challenge, though, to reduce its companies’ and in particular its SMEs’ reliance on bank financing and to boost capital markets.
One German banker complains: “The US is so far ahead in funding growth and innovation through deep and broad capital markets, which remain a dirty word here in many political circles. We still don’t get it in Europe.”
The crux is not share trading. That is a low-margin business, conducted in the cloud between the algos on the buy sides’ and the sell sides’ computers.
The EU is painfully aware that as much as 84% of the continent’s derivatives trading and 82% of FX trading takes place in London, and that 42% of funds investing there are managed from the UK.
So far, its only grant of equivalence recognition to UK firms has enabled EU organizations to continue clearing derivatives through UK central clearing counterparties (CCPs) to preserve financial stability. That runs out in 18 months.
On Tuesday, commissioner Mairead McGuinness laid out the European Commission’s determination to strengthen its own financial markets and reduce excessive reliance on foreign investment banks and on foreign financial market infrastructure providers.
“The message to the industry is clear,” she said. “Financial entities in the EU are expected to reduce their exposures to UK CCPs. And CCPs within the EU must build up capacity.”
This is a political decision, not one cooked up in easy calls between old pals at the ECB and the Bank of England.
Right now, a memorandum of understanding is being drawn up, due in March, between the European Commission and UK Treasury over financial services. It will concentrate on the exchange of information on the likely future path of regulation.
Euromoney can give the executive summary in three words: it will diverge.
The UK government’s Brexit zealots, unburdened by any in-depth understanding of the issues, harbour a fantasy that, freed from compliance with EU regulation, UK firms will enjoy a revival of entrepreneurial spirits and drive innovations that will appeal beyond Europe to global issuers and investors.
Rishi Sunak has called it Big Bang 2.0. He was six when the first version happened. I was reporting on it. Here’s the problem. In 1986, capital was flooding into London to take advantage of deregulation. In 2021, capital is flowing out.
Big Bang turned agency brokers that had once executed their customers’ orders for them on a best-efforts basis into principal traders that took positions against those customers.
Over time, the principal versus agency conflict led by way of high leverage – partners no longer risking their own money, but rather that of the shareholders of big banks that owned them – product complexity and regulatory capture to the great financial crisis.
When that broke, the UK government had to nationalize two of the country’s big four banks, the third was bailed out by Middle Eastern governments and the only one that stood on its own was a Hong Kong lender that had only moved its legal headquarters to London to rescue Midland Bank.
Money-laundering
Today, one of the biggest financial activities in London, as revealed by the FinCEN papers, is money-laundering, which the UK’s own National Economic Crime Centre suggests is a £100 billion-a-year business.
So, spare us the lectures on the benefits of returning to common-law principles where anything is allowed unless a specific Act of Parliament forbids it.
The big story will be whether or not the EU can take advantage of Brexit by completing its capital markets union, which has got nowhere since the first action plan was unveiled more than five years ago.
The EU recovery fund gives it a potential single joint sovereign Treasury bill. It’s a shame that European policymakers don’t grasp how important a building block that is.
The effort all seems to be on the minutiae of a consolidated tape and simplifying listing rules – as London is also looking to – when it should be on boosting the scale and flexibility of investors.
A third UK banker tells us London’s prospects are good. The sinking pound will bring plenty of M&A and UK issuers are big users of the capital markets. But the City was never really about the UK economy. It just happened to be there.
Serving just UK businesses would reduce it over time, not so much to Singapore-on-Thames, more a Milan-by-Mile-End.
