02 July 2016

The Economist: From folly to fragmentation

[...]The main worry is that financial firms will no longer be able to serve the whole EU from London when Britain leaves, perhaps two years after the formal start of exit talks. Companies from one EU country have “passports” to do business in the other 27, with no need for local branches or subsidiaries. Thus equipped, banks from both outside and inside the EU have made London their second home. Goldman Sachs, for example, has 6,000 of its 6,500 European staff there, against just 200 in Frankfurt. Insurance is more localised, but passporting still matters to some, such as America’s MetLife, which saw its share price fall by 17% in the two days after the vote. London’s asset managers sell mutual funds (UCITS, in Eurojargon) across the whole union; they managed more than €1 trillion ($1.1 trillion) last year.

A deal that preserves passporting is imaginable, even though no non-member of the EU enjoys full rights at present. In theory, Norway (to some, the most promising model for Britain) has unfettered access to the EU’s single market, although most of the EU’s post-crisis regulation has yet to be incorporated into its deal. But access to the single market requires freedom of movement, which Brexiteers reject. And Norway has no say in setting the EU’s rules.

Without a Norway-like deal, some wonder whether MIFID 2, a directive that comes into force in 2018 and that allows non-EU members to enjoy some access to the single market, might open a back door to Europe. But the surest way to serve the EU would be to do so from other places. Asset managers would no longer be able to sell UCITS from London. One, M&G, has been planning to replicate funds in Dublin, and will move some staff; another, Columbia Threadneedle, is applying to expand in Luxembourg. Some banks may have to acquire new licences elsewhere, which takes months. It would mean shifting some people. And European regulators would surely want entities on their patch to have their own capital. No bank has yet said it will move anyone, but these are early days. Before the vote HSBC said it could transfer 1,000 of its London staff to Paris and JPMorgan Chase warned that up to 4,000 of its 16,000 jobs in Britain could go. Morgan Stanley has denied a report that it is already working on moving 2,000 investment bankers to Dublin and Frankfurt.

A second concern is that London could lose its status as the main centre for clearing trades in euro-denominated securities. Around 70% of trading in euro interest-rate swaps takes place in London, four times the share of France and Germany, even though London is outside the euro zone. LCH, part of the London Stock Exchange, clears the lion’s share. The European Central Bank has long wanted clearing in its currency to take place on its turf, in case it ever needs to provide liquidity to a clearing-house in a hurry. Last year the British government won a case at the European Court, thwarting a four-year attempt by the ECB to bring euro-clearing home.

The ECB has a currency-swap agreement with the Bank of England, to provide liquidity if needed. But it would surely prefer direct oversight. If it tried again, a post-Brexit Britain would no longer have recourse to the European Court. A promise of non-discrimination against EU countries outside the euro zone, negotiated by David Cameron, Britain’s prime minister, before he called the referendum, will be null. It is “unlikely”, writes Angus Armstrong of the National Institute of Economic and Social Research, a think-tank, “that a major central bank would permit a swap line to support such a volume of transactions to take place offshore”.

Another worry is whether London can hang on to its lead in new areas of activity, such as fintech. No one knows what will happen, says Marta Krupinska of Azimo, an online money-transfer service used mainly by migrant workers. But she points to three possible problems: restricted access to the EU market; an inability to look abroad for talent (three-quarters of Azimo’s London staff are non-Britons); and the feeling that Brexit will make Britain a less attractive place to work. “A place perceived as not welcoming and insular will not attract the right talent.”

Britain’s efforts to make itself a hub for trading in Chinese assets are also in question. London has been the European focal point for China’s plans to internationalise its currency. But reports from China say it may now shift more toward other European cities. The link between the Shanghai and London stock exchanges, announced when China’s president visited London last year, is also likely to be delayed, though officials say it will still go ahead.

Undaunted Brexiteers promise an energising cull of regulation. Some hedge funds hope to see the end of the Alternative Investment Fund Managers Directive, which they regard as costly and bureaucratic. Freed from red tape, some fund managers hope to tap fast-growing sources of wealth in Asia, or recall the growth in European issuance of dollar bonds in the 1970s, which bypassed American regulation. But most of London, if it wants EU clients, will have to play by the EU’s rules. And lifting the cap on bankers’ bonuses—another European imposition—may be popular in the City, but much less so among British voters. [...]

Full article on The Economist

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