By Barry Eichengreen /Berkeley
Only now, as we approach the third anniversary of the United Kingdom’s referendum on membership in the European Union, are the implications of leaving the bloc finally sinking in. One indication, amusing to those with a taste for black humor, is the marketing success of Brexit survival kits containing a water filter, fire-starting equipment, and enough freeze-dried food for 30 days.
Another indication is the launch, at the end of January, of a parliamentary inquiry into London’s prospects as a financial centre. This investigation is a response to prominent financial firms voting with their feet. Goldman Sachs, JPMorgan, Morgan Stanley, and Citigroup have moved nearly $300bn of balance-sheet assets from London to Frankfurt, and Barclays has won approval to move another $215bn to Dublin. BNP Paribas, Crédit Agricole, and Société Général have transferred 500 staff from London to Paris. HSBC has shifted ownership of many of its European subsidiaries from the UK to France.
Anxiety is heightened by uncertainty about the post-Brexit regime. Prime Minister Theresa May’s government entered negotiations confident of obtaining passporting rights – authorisation to provide services throughout the EU without the further approval of host-country regulators – for UK banks. But had it looked more closely, her government would have seen that the EU has granted a non-member passporting rights only when the country – Norway, for example – belonged to the European Economic Area.
EEA membership confers not only rights but also obligations. Members commit to accepting EU financial regulation. In the event of a dispute, EEA members accept the decision of the European Court of Justice (ECJ). Technically, they have their own EFTA Court (called that because it has jurisdiction over not just Norway, Liechtenstein, and Iceland – the three EEA members – but also Switzerland). In practice, however, the EFTA Court follows the ECJ more or less in lockstep. Such is the predictable outcome when there is a disagreement over market access between two economic blocs, one much larger than the other. Such an arrangement does not exactly warm the cockles of a dedicated Brexiteer’s heart.
That leaves the more piecemeal arrangement known as equivalence: individual regulations in the EU and a non-member state are deemed to be, for lack of a better word, “equivalent” to one another. The non-member’s banks can then provide the products covered by those regulations to customers in the EU.
Equivalence is requested regulation by regulation, and applies only to the products or services governed by that regulation. The EU-US equivalence regime, for example, governs only over-the-counter derivatives and a limited number of other items. Where an item isn’t covered by equivalence, a US bank can provide it in Europe only by setting up a separately capitalized subsidiary. An expensive proposition, that.
The fact that equivalence arrangements are less than encompassing will have negative implications for the City. Economies of scope – the ability to provide a wide range of different financial services – are what make a financial centre. The fact that global financial institutions are already shifting business and staff out of London indicates that they see this as a problem.
To be sure, London’s strengths should not be underestimated. The City acquired its international financial preeminence sometime in the eighteenth century. Over time, a rich ecosystem of support services – accountants, barristers, consultants, and others – grew up around the banks. Building on this foundation, London became the centre of the Eurodollar market. With the advent of computerised trading, it became home to the matching servers of Thomson Reuters and Electronic Broking Services, and a hub for the fiber-optic cables through which electronic transactions flow. After 1999, it became the foremost centre for trading euro-denominated claims.
Edouard-François de Lencquesaing, the president of the European Institute of Financial Regulation, recently dismissed London’s prospects on the grounds that its rise as a global financial centre “was a mere accident of history.” This misses the point. Some accidents have enduring consequences, and the consequences of this one are not going away. Some big banks are indeed moving staff to Paris and Frankfurt, but it will be years before those centres develop an ecosystem of support services rivalling that of London.
The implication is that London will remain an important financial centre, though how important will depend on where equivalence negotiations go from here. If the UK crashes out of the EU, the negotiating environment will be poisonous, and agreements will be few. If Parliament approves May’s deal, EU negotiators will have more reason to believe that the UK is prepared to stick to its commitments. In that case, additional equivalence agreements are likely to follow.
There is, of course, another scenario with more favourable implications for the City, namely for Brexit to be called off. Given that London still has that rich ecosystem of support services, it is not inconceivable that the banks that today are decamping to the Continent could ultimately move those lost jobs and assets back. – Project Syndicate
* Barry Eichengreen is a professor at the University of California, Berkeley. His latest book is The Populist Temptation: Economic Grievance and Political Reaction in the Modern Era.
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