London and Brussels Can and Should Be Constructive about Brexit
There is a reason they call it the City, capital "C." London accounts for 85 percent of hedge fund assets, 78 percent of foreign exchange turnover, 74 percent of over-the-counter interest rate derivatives, 64 percent of private equity assets, and 59 percent of the international insurance premiums in the European Union. Also, 87 percent of US investment banks’ employees who work on Europe reside in London.1 These are all reasons why London ranks first among global financial centers in 2016, ahead of New York and Singapore. The next highest ranked European city is Zurich at 9, Luxembourg at 12, Frankfurt at 19, Munich at 27, and Paris at 29.2
These figures suggest politicians on both sides of the Channel have reason to be constructive about Brexit, despite inclinations to the contrary. That’s because if financial services companies move out of London, it is unlikely most would relocate to another EU city. Financial centers outside of the European Union would be more likely to attract the business. In other words, if certain financial services do move out of London or are discontinued, European companies and consumers will have to look further afield for financing opportunities.
Much has been made of the possible loss of “passporting rights” after Brexit. Passporting covers a range of financial activities, including deposit taking, derivatives trading, loan and bond underwriting, portfolio management, payment services, and insurance and mortgage broking. Data from the United Kingdom’s Financial Conduct Authority show around 5,500 UK firms rely on passporting to do financial business in Europe. However, more than 8,000 European firms use passporting to do business in the United Kingdom. So the European Commission has as much of an incentive to reach a deal on the free flow of financial services as does the UK government.
So far neither side has behaved constructively. Using belligerent language, the UK government prioritizes control of immigration over access to the single European market. The responses from Europe are similarly rough. Earlier this month French President Francois Hollande sounded bellicose: “Madame May wants a hard Brexit. That means hard negotiations.”3 Anthony Browne, the head of the British Bankers’ Association, warned last week that “the public and political debate at the moment is taking us in the wrong direction.”
But despite these publicly stated positions, top UK and European politicians must be aware that the pull away from London in several financial services sectors is mostly towards the United States. For example, 112 companies from other EU member states were listed on the London Stock Exchange (with a market cap of £378 billion) in September 2016, out of 2,299 firms and a total market cap of £4 trillion.4 London attracts three-quarters of the European Union’s capital markets activity. The main competitor is New York: There are 155 European companies listed on the New York Stock Exchange, valued at £3.36 trillion. Frankfurt and Paris pale in comparison in terms of market size.
Another example is insurance, where about 28 percent of London-based insurance activity goes to the European Union. There is no single European market in insurance, and the three largest continental European markets are dominated by local insurers: AXA in France, Allianz in Germany, and Generali in Italy. Beyond these markets, US companies like MetLife and Prudential and Asian insurers like Nippon Life are the main candidates to increase their market share should Brexit disturb the status quo.
Several other financial service sectors may also look for home away from Europe, for example Sharia-compliant central bank liquidity facilities, emerging markets wealth management, “masala” bond issuance in Indian rupees, and green finance. In fintech, other European financial centers like Berlin and Amsterdam may benefit. For private equity, Vienna may attract some firms focused on Eastern Europe, while Berlin might lure firms investing in Central Europe. The remaining businesses will likely head to Asia, Dubai, or New York. Both the United Kingdom and the European Union will lose from such a development.
So what should each side do? Both the UK government and the European Commission can be more forthcoming in the coming negotiations than they have been to date. The United Kingdom would need to remain in the European Economic Area (EEA)—the trading club that includes the European Union, Norway, Iceland, and Liechtenstein—to keep the passporting rights that allow its financial companies to sell services across Europe.
The rhetoric of Prime Minister Theresa May suggests her government would rather leave the EEA than allow the free movement of people: “We are not leaving the European Union only to give up control of immigration again. And we are not leaving only to return to the jurisdiction of the European Court of Justice.”5 If the continuation of passporting is not possible because of restricted movement of EU citizens, the United Kingdom may ask for regulatory equivalence, which allows market access to companies based outside the European Union. It would require the European Commission to recognize that the United Kingdom’s rules and oversight of financial services are as stringent as its own. This should not be difficult: The United Kingdom starts by having the exact same regulation as the European Union. If UK regulation rapidly diverges, however, equivalence will create uncertainty, as it can be withdrawn by the European Union at a later stage.
In sum, there are available options to make the coming Brexit negotiations constructive. Such an approach will ultimately benefit UK-based financial institutions, European companies, and consumers seeking financial services. To achieve such benefits, less grandstanding and more attention to detail is needed.
5. Stephen Fidler, "Theresa May’s ‘Hard Brexit’ Signs Come With a Damper," Wall Street Journal, October 13, 2016.