The City could survive Brexit, but it would be badly damaged
May 21, 2016
Historically there have tended to be two potential models for a successful financial centre. The first, an onshore version, is based around the notion of a hub city servicing a sizeable domestic market – think New York and the US market. The alternative approach, offshore, depends upon attracting business primarily via competitive tax rates, regulatory arbitrage and other distinct selling points such as a respected system of law, privacy and a skilled workforce – the most obvious example here being the Swiss niche in secret bank accounts.
Until 2008’s financial crisis, the City of London had pragmatically been enjoying elements of both models and benefited handsomely. Prominent until the Great War as the epicentre of the British Empire, servicing the UK’s great global trading market, since the 1980s ‘Big Bang’ the City had once more taken on the role of offshore-onshore financial centre to the European continent. More recently still the City had derived the benefit of being a member of the European Union outside the Eurozone. As a pan-European capital market, the City flourished and alongside that role was able to take advantage of a light-touch regulatory approach advocated by Britain and applied across the EU that attracted huge volumes of foreign money. But the arrival of the financial crisis fundamentally changed the rules of this game.
Almost overnight since 2008 the EU demanded greater oversight of our financial infrastructure. Awkward questions have been raised about the ability of London and UK financial services regulators to prevent the system silting up; whether it is sustainable (or desirable) for Euro-denominated risk to be cleared offshore in the British capital. In turn, the City has expressed firm concerns about the way the new and numerous EU laws can fundamentally damage its global competitiveness.
It is deliciously ironic that the arguably single most important element of David Cameron’s pre-referendum renegotiation, namely the protection for non-eurozone nations from Eurozone dictation, seems so esoteric as to be largely ignored during the run-up to 23 June. Nevertheless at the February summit a package of important concessions was won by our Prime Minister. The express recognition that the EU has more than one currency is designed to assist the City in negotiating future economic reforms alongside Sweden, Denmark, Poland and the Czech Republic, whose electorates are even more averse to Eurozone entry than ours.
Critically Cameron has also been able to nail down a pledge that Eurozone nations will not inhibit the application of a single market across the EU: in return we have agreed not to obstruct any proposals for deeper Eurozone integration. Moreover, as a non-Eurozone nation we now enjoy a right of appeal at a full EU summit in the event of Eurozone decisions which we regard as prejudicial to UK interests.
UK negotiators also secured acceptance that the UK financial services industry will in future be able to apply the City’s own detailed regulatory rule book. The EU’s ‘passporting’ rights mean that the City of London would almost certainly struggle to remain the primary European centre for Euro-denominated trading if we were to leave the EU. It is widely accepted that Brexit would result in the loss of 70 000 jobs and up to 9.5 per cent of gross value added in financial services by 2020. It is surely wholly unrealistic to assume that the EU would not retaliate in the event of a Brexit and actively undermine the City’s pre-eminence as Europe’s main financial hub.
Apocalyptic visions of overseas banks simply shutting up shop in the UK can be readily dismissed. However, it is surely not fanciful to suggest that any fledgling Korean, Indian or Vietnamese financial services institution looking to set up operations in Europe would focus their attentions on an EU financial centre. Fine to have a representative office in London, but post-Brexit substantial future investment would arguably go to Paris or Frankfurt. Whilst this might enable a rebalancing away from London’s economic dominance in the UK, we need to question precisely towards which equivalent globally competitive sector we should then be rebalancing.
The UK’s overriding economic impetus now and in the future should be directed towards harnessing the growth of the world’s developing markets. In the financial and professional services field we already have such a competitive advantage in a sector that looks set only to grow as the twenty million or so international citizens being added annually to the ranks of the global middle class look to invest their savings. As several German friends have said to me over the years on listening to the persistent banker bashing amongst the UK’s political class, ‘I cannot understand why you Brits are so intent on throwing it away’.
Indeed the contrary argument, namely that if the UK were to leave the EU it would be free to rebrand itself as a global offshore centre attracting financial services from emerging economies around the globe, brings with it a new set of potential problems. The spirit of the age is of global regulators becoming ever more hostile to offshore financial centres (indeed David Cameron has led the way on this) so the idea that the City of London might become a Wild West show needing to attract some of the most nefarious funds from across the globe should rightly fill sensible observers with alarm. Predictions of Armageddon in the event of Brexit should rightly be taken with a pinch of salt, but the path outside the EU would undoubtedly be one of prolonged uncertainty for the City of London. It is a leap into the dark best not taken.