29 September 2016
Reports of the death of the City of London are exaggerated
Technology and global markets are bigger threats than Brexit
by Frank O’Nomics
Dear Frank, my children are hoping to pursue a career in finance. Do you recommend that they learn German or French?
Not an unreasonable question given the debate about the impact of Brexit on the prospect of the City of London maintaining its pre-eminent status as the financial trading capital of Europe. The major concern has been around the issue of so-called “passporting”, whereby EU-based firms can readily sell financial services to others in Europe. Without this facility, on Britain’s departure from the EU, the way is seemingly opened up for a significant part of this business to move to the continent, and it seems that a number of European cities are already looking to fill the void, with Paris, Frankfurt and even Warsaw making overtures to international banks and insurance companies. This matters because the City employees 414,000 people (with a further 145,000 in Canary Wharf) and generates 3% of UK GDP. The latter number may not sound much, but the ripple effect across London of a decline in this figure would be significant, and London as a whole generates 22% of UK GDP, paying almost one-third of the total tax take. The prize is a big one, with 35% of EU wholesale financial services activity occurring in London, and 58% of international insurance premiums. We should then be very concerned by the prospects of losing this business, but it is worth remembering that the City has withstood many serious storms in the past and has always found a way to sustain its ascendancy. If anything there are other concerns that need addressing just as urgently as Brexit, and there is an argument to suggest that Brexit itself could present at least as many opportunities as it does problems
There is no doubt that, even before the Brexit vote, the international banking community was looking at contingency plans in the event of a leave vote. However, these remain contingency plans after the event. Banks are more concerned with restructuring their businesses in the light of the continued decline in trading volumes, increased regulatory obligations and major technological changes. In adding to these problems, plans to move their business elsewhere would seem foolhardy, given the need to negotiate with a large range of new regulators and no guarantee that the staff that they need will be available. There are it seems, no first-leaver advantages. It is all very well to express concerns about the potential loss of access to the 11% of workers in the City that come from outside of the EU, but finding the other 89% in Frankfurt, Paris (where labour laws are particularly uncompetitive) or Zurich would be exceptionally difficult. It is not just the immediate workforce that is key, there would also be issues with finding the ecosystem of professional services firms, such as lawyers and accountants. On top of this there is the accommodative approach of the UK government, which could not be guaranteed elsewhere with potential regime changes looming in both France and Germany, as well as the obvious benefit of the language of business being English.
The passporting issue is clearly an important one, but there is hope that sense will prevail and some form of market access will be achieved by exploiting “equivalent” regulatory status. Quite why the EU would not want to agree to something similar to passporting seems strange when they have been considering giving passports to countries outside Europe, to the likes of Japan, Canada and Switzerland, so that they can market their investment funds. Further, a preoccupation with the passporting problem ignores the potentially bigger opportunity for London of being free to negotiate financial trade with other areas of the world which are not as growth constrained as the EU looks as if it will be for many years. Already London has become the second biggest clearing centre (after Hong Kong) for offshore Chinese renminbi trading and there is a valid argument that the UK should be focused more on competing with New York, Hong Kong, Singapore and Shanghai, rather than the EU. Indeed, while London remains the world’s foreign exchange hub, it has lost ground against Asia and the US, and has dropped behind New York in over-the-counter interest rate derivatives trading. A survey released this week by the Bank for International Settlements showed that continental Europe’s foreign exchange presence is virtually non-existent. Overall, when one takes a look at the major banks globally (when looking at Tier 1 capital ratios) the only European bank in the top 10 is HSBC, who have their base in London, with the rest being either Chinese or American.
Having covered the people and trading issues, the other big factor which determines where international businesses will site their financial trading is technology. Financial services are likely to be significantly transformed by a number of key developments. At a retail level, the move to develop robo-advice, whereby human financial planners are rendered obsolete, will automate a great deal of investment. Trading at a wholesale level has undergone a rapid transformation as more and more is executed electronically rather than via voice, and, in the back office, blockchain technology is revolutionising processes which will mean more job losses in time. The important point here is that London has become a “fintech” hub, with many of the companies at the forefront of the technology revolution based here. If financial services firms are to survive they need to be involved in, and on the top of, all of these developments and leaving London will only make this more difficult.
There is in all of this a great danger of arrogance and complacency, and much will still depend on the result and nature of Brexit negotiations. A CBI survey this week showed that, despite some signs that business volumes were picking up, a balance of 13% of firms were still less optimistic than they had been in the previous quarter, only a small improvement from the minus 16% number from the same survey conducted prior to the referendum in June. A hostile exit as opposed to a careful transition will clearly have very different implications, with estimates of the fall in investment banking revenues from a hard Brexit seen as high as 20% (£9 billion), but sanity and self-interest should leave us to expect the latter scenario. As we approach the thirtieth anniversary of Big Bang, an event that transformed the City into being able to compete as a leading global financial centre, we should remember how well it coped with the Asian crisis in the nineties, the dot-com issues of 2001 and then the post-Lehman environment since 2008, and realise that the ability to adapt has remained very strong. Overall then, it is less of a question of which foreign language one needs to learn to support a healthy career in financial services, but more a question of the role that you apply for, many of which could be made redundant by the pace of technological development, rather than by Brexit.
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