Brexit will be anything but negligible for the organisation of European finance.
It is estimated that up to 20 % (i.e. circa £ 30 bn) of the revenues of the City of London are related to services sold into the EU single market and will therefore be impacted.
For the European economy, the question is whether it will be able to access the financial services it needs given that a large proportion of those services are acquired today from London-based firms.
This short brief looks at three questions related to the ability of the European financial system to finance its economy without London after Brexit:
1 – Is the loss of the so-called European financial passport inevitable for the City of London or could a special deal be put in place that would benefit both the City of London and the European economy?
Should we speak about the loss of the European financial passport for London-based firms as a possibility or as a certainty? Can a special deal for the City of London to access the EU single market be negotiated?
A European passport is an authorisation granted by the financial regulator of a Member State that is valid throughout the Union. By definition, an authorisation granted by a UK financial authority after Brexit will not be an authorisation granted by a regulator of a Member State. Suggesting that such an authorisation could be deemed a European passport is an oxymoron.
In theory, a so-called “third country equivalence regime” could also give UK regulated firms access to the EU market. But for a City firm in the business of selling services into the EU, betting the possibility to conduct its business on the equivalence regime would, given its lack of predictability, be highly risky.
It must also be noted that the EU equivalence regime will be revised to ensure the possibility to reflect the evolutions of regulations and to fill a number of weaknesses of the current “outcome based” equivalence regime. In order for the UK to benefit from the EU equivalence regime, it would need to follow the future evolutions of European financial regulation and become a European regulation taker when it used to be a regulation maker. Given the current momentum of British political life, this does not seem to be a likely scenario.
Financial entities based in the UK and solely regulated by the British regulator will lose access to the EU single market from the day of Brexit. There is no conditionality in this matter: EU policy makers and regulators have no latitude to invent some form of bespoke agreement for the simple reason that it is their rule and that they have no choice but to abide by their rule unless they are ready to scuttle the EU ship (and they are not).
2 – Will the European economy, and in particular European banks, be able to access the hedging services they need in a context where up to 70% of those services are provided from London today? An inability to do so could trigger financial instability in EU 27 countries.
Hedging financial risks is about derivatives’ trading, and derivatives’ trading is about bringing together two main ingredients: the technical capability of the teams involved and the strength (or at least the size) of the balance sheet of the banks employing them. Derivatives’ trading is an oligopoly of a dozen among the largest banks of the world and, within that group, four EU banks are as important as American, Swiss and British banks.
For the large derivatives players emanating from EU 27 countries, moving part or the bulk of their derivatives operations to London was a purely operational choice made some years ago. That decision can be reverted overnight by sending their teams back to Paris or Frankfurt, and it will have no consequence on their ability to trade or to offer hedging services. As far as other non-EU derivatives players are concerned, it can be expected that they will choose to relocate to cities based in EU 27 Member States in order not to leave the cake to their French and German competitors.
All in all, the argument that hedging services to European corporations and banks can only be offered out of London does not seem to pass the real world test.
3 – Will the cost of funding of EU 27 firms and households increase after Brexit because they are not able to access what many voices call the “efficient London financial market”?
The reason usually given for a possible increase in the cost of capital of European households and corporates is the “loss of access to the efficient London financial market”.
But, the very notion of a “London financial market” can be challenged on two fronts: 1 - looking at the reality of the financial sphere, it can be said that there is no such thing as one financial market but rather a (relatively) large number of different financial markets for different asset classes or financial products (e.g. shares, corporate bonds, sovereign bonds, fixed income derivatives, equity derivatives, CDS, FX, etc…); 2 – even if a significant (and, in some cases, high) proportion of transactions on many of those financial markets is realised today out of London, this does not make a “London financial market” but rather “a financial market operated out of London”. This is not the same thing, and it makes a big difference: the fact that research or dealing teams of large investment banks relocate from London to an EU 27 Member State will not have any effect on the cost of capital of European issuers.
London will remain without doubt Europe's main financial centre post-Brexit, but the previous trend towards the concentration of the European financial industry in a single centre will be reverted. This new trend will have no impact on the cost of funding of European corporates and households nor on their ability to hedge their financial risks.
Thierry Philipponnat is the Director of the Institut Friedland.
This post is part of the ‘Brexit Negotiations Series’, a series of posts based on contributions at the ‘Negotiating Brexit’ conference that took place in Oxford on 17 March 2017.