If Brexit does go ahead (and probably even if it does not), the European Union is ready to chip away at Britain’s dominance in the financial sector. At least, that’s what a recent speech by François Villeroy de Galhau, the governor of the Bank of France, suggests.
First, the most urgent issue, that of a financial catastrophe caused by derivatives instruments left without legal support immediately after Brexit unless an agreement is reached. With London the biggest clearing centre for derivatives by far, a meltdown is a real possibility, unless authorities on both sides of the Channel come to an agreement on how to carry on the clearing of derivatives after Brexit.
The issue is one of the main worries for bankers in London. Immediately after the Brexit vote, some of them told me that if the City of London loses the right to clear derivatives for EU clients, business will slowly but surely shift over to the Continent. That’s because clients will probably prefer to do their other financial operations in the same jurisdiction as their derivatives clearing.
Regulators are nearing an agreement to avoid a derivatives meltdown that would equal or even exceed the magnitude of the Lehman Brothers collapse fallout, according to various media reports. They sound cautiously optimistic that it will be averted.
“We feel modestly comfortable that the right steps are being taken,” Adam Farkas, executive director of the European Banking Authority, told Bloomberg in a recent interview.
With that assurance in place, it’s time to look at the longer-term consequences of Brexit for both the UK’s and the EU’s financial industry.
The City of London is the powerhouse of the UK economy. It employs 483,000 people, making up 9% of Greater London’s employment and 1.6% of the country’s total employment. In the six years to 2016, employment increased by 36% in the City of London.
It is estimated that the City of London contributed 2.8% of the UK’s output in terms of gross value added in 2016, and 12.3% of London’s output. London itself made up 23.4% of total gross value added for the UK in the year of the Brexit vote.
The City is a dynamic place, too. More than 1,000 companies start doing business there every year.
But what if this flow were to be reversed? Already, anecdotal evidence suggests that removal companies are overwhelmed by demand from people moving over to the Continent ahead of the UK’s departure from the EU.
While it would not be an immediate exodus and loss of jobs, Brexit will definitely be a blow for the UK financial industry and a gain for the EU’s. François Villeroy de Galhau said that, while no single European continental centre can match London’s clout, finance would be shared by various centres of expertise – something that is already happening to some degree.
He likened this to the architecture of the US financial industry. “A polycentric system of this nature can function, as illustrated by the United States: New York’s financial centre is favoured by corporate and investment banks, Chicago’s financial centre handles futures, while Boston specialises in asset management,” he said.
This may sound optimistic, as the EU still has a lot of work to do to achieve its banking and capital markets union. A common deposit protection scheme, some sort of fiscal union and deepening of capital markets are the biggest sticking points.
Nonetheless, it looks like Brexit has given the EU impetus to accelerate its financial integration. The EU has “an exceptional savings capacity”, with annual flows of around €400 billion in financial savings, de Galhau pointed out. All that money needs to be invested somewhere – and, after Brexit, less and less of it will go to companies in the City of London.