Macaskill on markets: Brexit and the merchant bankers
Brexit will deal a mighty blow to the international and diverse City of London that has thrived for 30 years – but investment banks have bigger worries than the location of their EU offices.
Ukip leader Nigel Farage and the voters for Brexit have dealt a mighty blow
The phrase ‘merchant banker’ has not been in widespread use in the UK – except as rhyming slang for a British insult – since the Big Bang market reforms of 1986 ushered in an era of increased internationalization for the City of London.
Specialist merchant banks in the UK were displaced by larger-scale investment banks, most of them foreign owned.
So when Nigel Farage, the leader of Britain’s Ukip party, declared victory over “the big merchant banks” in speeches on Friday celebrating the vote in favour of Brexit, it was an indication of Farage’s distance from the modern City, where he once worked as a commodities broker and now serves chiefly as a customer of its longer-established pubs.
Farage’s repeated use of the phrase fits well with the ‘them’ and ‘us’ approach that was a key element in the success of the campaign for a British exit from the European Union.
It also has echoes of an unpleasant strain of hostility towards outsiders that was a feature of the campaign, given that many of the merchant banks in operation when Farage began his career were founded by immigrants to the UK and had foreign-sounding names.
Heads of the large banks that dominate modern capital markets must be wondering whether they should have behaved differently in the approach to the vote on Britain’s departure from the EU. They would not have served any purpose in attempting to directly gather votes, given the deep unpopularity of bankers in the UK and elsewhere since the financial crisis of 2008.
Jamie Dimon, CEO of JPMorgan, can at least be satisfied that he expressed his opposition to Brexit clearly and publicly with his warning that the bank was likely to be forced to move around 4,000 jobs from London to other financial centres in Europe in the event of a vote for departure.
Since the vote, JPMorgan has indicated it will move bankers to Paris. Morgan Stanley was reported to be in the process of moving 2,000 to Frankfurt, but it later denied the claim.
Farage probably does not care, of course. The clubby old City of London where he got his start as a broker through family connections is long gone and is unlikely to re-emerge
Jes Staley, CEO of Barclays and a former employee of Dimon’s, provided a stark contrast with his decision to remain largely silent on the implications of the vote – and afterwards released a statement on his commitment to a transatlantic UK/US model.
That didn’t help to inoculate Barclays from market turbulence after the decision to leave the EU was confirmed. Its shares fell by 30% at one point in early trading on Friday, before partially recovering when Mark Carney, governor of the Bank of England (BoE), publicly committed to provision of extra liquidity to support UK banks and stated they are adequately capitalized.
Staley – like his old boss Dimon – is American, while Carney is Canadian, which underscores how internationalized the modern City of London has become.
The key question for the investment banks that operate across Europe is how much disruption will be caused by the move towards Brexit, including potential reversal of the trend towards fungible international markets.
Conditions will clearly deteriorate in the near term, though increased volatility should boost trading revenues in some sectors.
The remarkably sanguine approach taken by investors to the risk of Brexit was reflected by low trading volumes in the months approaching the vote. Some sophisticated investors took out conditional trades that were designed to cheapen the cost of hedging in option markets. These often combine FX with equity exposure to lower the net cost of option purchases.
And no doubt some self-styled Chelsea Cassandras will brag in London restaurants they bought gold at the early stage of its recent rally to profit from Brexit related jitters.
Most investors took a wait-and-see approach, however, with a perplexing minority taking on additional risk in the final days before the vote. Many will now be forced to adjust positions, delivering a short-term boost to revenues for investment banks that can expect higher trading volumes and in some cases will be able to exploit wider bid-offer dealing spreads.
However, banks also face renewed upward pressure on their own credit spreads and funding costs, and further loss of investor confidence in their shares.
The policy reaction of central bankers could compound some existing problems for banks, such as the move towards negative interest rates for an ever-growing proportion of the debt markets in Europe and Asia.
The European Central Bank (ECB) followed the BoE in pledging to supply extra liquidity to markets on Friday. That should help to ensure that market channels remain functional. The ECB might feel forced to take additional easing measures in its seemingly never-ending quest to revive growth in the region, however.
And certain easing steps could exacerbate problems for banks. Rate cuts that take yields on more debt below zero present an obvious challenge to banks. An expanded programme for purchases of corporate bonds by the ECB could also pose a medium-term threat to revenues.
The shift towards disintermediation of capital markets in Europe – the replacement of bank loans with bond issues – was formerly viewed as a positive step for major banks in the region.
They would be able to benefit from higher bond underwriting fees and advisory work while simultaneously shrinking their balance sheets, or so the argument went.
However, if the ECB takes an even larger role as a buyer of both primary and secondary corporate debt, this model could be up-ended. Borrowers might exert downward pressure on fees to banks and explore alternative ways to sell debt if they know that much of their paper is going to the central bank, while secondary credit liquidity could decline even further, undermining trading revenues.
Banks also face higher costs related to the mechanics of financial services as the move towards Brexit reverberates in the coming months and years. Product sales into the European Union from London are threatened, as is London’s position as a clearing base for euro-denominated deals.
That will leave major banks with difficult choices to make on location of staff. London currently has no peer in Europe for financial services employers. Paris is the only other city with significant investment banking activity, but has restrictive regulations and employment laws, while Frankfurt, Dublin and Madrid are limited in scale.
Big banks – such as JPMorgan, HSBC, Citigroup and Morgan Stanley – that do move staff from London to other European cities are likely to take the opportunity to cut costs and net staff numbers further.
Weaker firms that are already struggling to maintain scale – such as Deutsche Bank and Credit Suisse – might simply abandon business lines or withdraw from competition with more successful banks.
The victory celebrated by Farage over the ‘big merchant banks’ is therefore likely to be pyrrhic in terms of net employment and tax revenue.
Farage probably does not care, of course. The clubby old City of London where he got his start as a broker through family connections is long gone and is unlikely to re-emerge.
However, Farage and the voters for Brexit have dealt a mighty blow to the international and more diverse City that replaced it.