The City of London Will Survive Brexit

This morning the French Minister for the Economy, Emmanuel Macron, has announced that, post-Brexit, Paris will roll out the red carpet for the mass exodus of persecuted banker-refugees and traumatised hedge-fund-manager-asylum-seekers who will be thronging through the Channel Tunnel. One can imagine the pitiable scenes of these unfortunates, desperate to be reunited with their Swiss bank accounts, fleeing the odious tyranny of a nation that has had the temerity to question the beneficence of the European Banking Union.

No doubt makeshift camps will have to be erected on the White Cliffs of Dover as these desperate victims assemble to flee… And Ms Yvette Cooper MP will ask probing questions in the House of Commons in tones of deep moral disquiet about the welfare of the bankers’ progeny… Surely the Government will agree to alleviate the condition of children who have been abandoned at public school…?

But nice as it is to conjure with this idea, it’s just not going to happen, Monsieur. And by the way, even in your homeland, la belle France, everyone knows you’re a plonker!

The UK trade surplus in financial services is about £60 billion of which roughly one third is with the EU[i]. The City plus Canary Wharf employ some half a million people[ii]. No wonder the French would like to get a piece of the action.

My take on the much discussed issue of whether Brexit would toll the demise of the City of London, much to the advantage of Paris and Frankfurt, is simple. The French, and to a lesser extent, the Germans, have been doing all they could to attract financial services away from London for years and have failed thus far. If it was going to happen, it would have happened already.

A great time zone, a highly evolved legal establishment, English law (enforced by the courts of England), a flexible and diverse talent pool, the English language, openness to innovation, a favourable fiscal regime: these are all things which have propelled London’s success. It has proven extremely difficult to replicate this precise combination of factors elsewhere. In fact, one can argue that London’s unique position would actually be enhanced by Brexit.

Let me explain. You see, there never was a single market in financial services. And even post-Basel III (a cactus-dry topic on which I have written elsewhere somewhat gingerly for fear of sending my readers to sleep) bank prudential regulation is still ultimately the domain of the individual central banks of the various EU states. (In fact, stripped of any responsibility for monetary policy, that is about all they do do). The City has continued to prevail, not because of the EU, but rather in spite of it.

The banking community (an oxymoron I admit, since there is no group less collegiate than bankers), it is true, is divided. Like the prince paralysed with indecision as to whether to choose the silver or the golden casket[iii], bankers are uncertain where the greater gain may lie – forget sovereignty, control of our borders, fiscal creep and the rest. Mark Boleat, a big cheese in the City of London Corporation, has declared for IN. But respected City economists Gerard Lyons and Ruth Lee are firm OUTs. The admirable Ruth Lee has also said that if we remain IN then financial harmonisation (normalisation in French) will drag business from London to the Continent anyway.

If we leave, the City might even gain from new business escaping the tightening regulatory straitjacket of Brussels and the likely new taxes and penalties that it is itching to impose on the financial sector. In Europe, the idea of a Tobin Tax – a levy on all financial transactions – is widely considered to be inevitable, and not just by left-leaning economists like Monsieur Piketty. And regulation of bankers’ bonuses (enshrined in Capital Risk Directive IV (CRD4)) is just a foretaste of the dish they really wish to serve.

The City types who support IN are in large part the self-same people who told us fifteen years ago that if we didn’t sign up to the Euro we’d be toast. They were wrong then and they are wrong now. It is true that the French are peeved that London, outside the Eurozone, has become a major centre for Euro-denominated business, and that they might want to block British banks’ pass-porting rights – by which financial services firms are permitted to conduct cross-border business. But even that would not stop British banks from arranging syndicated loans denominated in Euros out of London, or underwriting the issuance of Euro-denominated securities.

London became the pre-eminent international financial centre in the 1980s (as opposed to the giant primarily domestic markets of New York and Tokyo, which remained bigger) with the explosion of the Eurobond market and the Eurodollar loan market. In fact, Eurobonds, had nothing to do with Europe – they were offshore debt instruments in which financial institutions could invest tax-efficiently. Banks could take deposits in Eurodollars without putting up reserve requirements. So London soared in status as an offshore market and with every successive development in banking practice it has retained that essentially offshore character.

Some years ago that great plutocrat, Sir Jimmy Goldsmith, said that the problem with modern banks was that they had become bureaucracies. Bureaucracies fear any kind of uncertainty and hate change. That is why HSBC has mooted that it might relocate 1,000 of its 5,000 global markets people from London to Paris in the event of Brexit. (Meaning that it might not – until last week they were going to up sticks to Hong Kong.)

Yet banks – which make money by trading in risk – of all institutions, should relish uncertainty. The British are only just waking up to the idea that, very crudely, if the Europeans play dirty after Brexit, we might want to imitate their game. That means protecting our interests.

It’s not as if the outlook for EU banks is rosy right now. I’ve written a piece for the March edition of the Master Investor magazine (out imminently) in which I explore what has gone wrong for them. UK banks are also facing challenges – just look at Barclay’s (LON:BARC) share price over the last weeks after it announced poor results and – what the markets now find unforgivable (vide Deutsche Bank) – its intention to cut its dividend. In fact, it has gone from 289 pence at the beginning of last August to 165 pence as I write (down about 43%).

The chances are, as I see it, that the pain of the Eurozone banks is set to continue and could get much worse. My esteemed colleague Jim Mellon foresees big trouble in Euroland and even has visions of France going broke. Even a reasonable expectation that this could happen is already putting huge strain on Eurozone bank share prices.

In contrast, conditions in the UK remain relatively favourable – despite the sound of creaking coming from the Treasury (more on that soon). And Brexit would actually impact bank shares on both sides of La Manche. A strategy of going long UK banks and short Eurozone banks is not as crazy as it might seem. (Watch this space.)

And remember that the City is much more than banks. It is home to the biggest assembly of fund managers on the planet, some of whom are doing well in these uncertain times. Henderson Group PLC (LON:HGG), an outfit I admire, is up around 10% over the last two weeks.

Brexit? Just keep calm, City of London, and carry on.

[i] The Banker, 22/02/2016: http://www.thebanker.com/video/v/4781034477001/brexit-and-london-s-financial-centre?utm_campaign=Newsletter+1st+March&utm_source=emailCampaign&utm_medium=email&utm_content=

[ii] https://www.cityoflondon.gov.uk/business/economic-research-and-information/statistics/Pages/research-faqs.aspx

[iii] The Merchant of Venice by William Shakespeare