Turning Brexit to London’s Advantage

Brexit – Disaster or Boon for London?

It is widely assumed that London stands to lose a considerable portion of its capital markets to continental Europe due to Brexit. Now that UK Prime Minister Theresa May has triggered Article 50, the country’s future hangs in the balance while negotiations to leave the European Union get underway. Some investment banks are moving ahead with contingency plans, which will result in relocating staff and operations from London to other cities in the EU. Through this lens, the UK could at best obtain equivalence to EU countries and retain passporting rights, allowing London-based firms to continue to sell their services unhampered throughout the EU. At worst, a substantial migration of trading activity could take place. Simultaneously, deregulation is the order of the day in Trump’s America. This places further pressure on the City by luring away trading volumes in certain instruments. Some 40,000 jobs are at stake, with the City standing to either lose or gain that number, if appropriate regulatory changes are made.

Is passporting as good as it gets?

Passporting and equivalence are widely considered to be the most positive outcome for London. At the least favourable end of the spectrum, the UK would no longer have access to the common market, and tens of thousands of jobs would migrate to the continent, together with tens of billions of pounds in revenues. Paris and Frankfurt are already making overtures to firms based in London, touting their advantages.

Figure 1. Job Losses and Gains under Different Brexit Scenarios

However, such forecasts assume the UK government will broadly retain current regulations, regulations largely created by the EU. A different approach is possible, allowing London to attract financial firms away from the continent, rather than lose them. Instead of continuing to apply EU-concocted regulations, London could scrap them altogether. The alphabet soup of financial regulations that have emanated from Brussels — such as EMIR, the appropriately named MAD, CRD, AIFMD, MAR, and the truly awful MiFID II, which is currently being foisted onto financial firms across Europe — are creating rules that are costly and difficult, if not impossible, to comply with. Particularly in the case of MiFID II, it is difficult to see how the putative goals of greater transparency, investor protection, and lower structural risk will actually be achieved. Rather, these rules are creating an environment that stifles innovation, hurts profitability, and allows regulators to determine market structure in a political process, rather than a market-driven one.

Big Bang II

The UK could use Brexit as an opportunity to review all of these regulations, and replace them with an environment more conducive to business, rather than a framework that appears designed to punish financial institutions. With a more favourable regulatory environment, with more attractive labour laws and taxation, the UK would stand to draw asset managers, trading firms, banks, and corporate users of financial instruments into the UK.

London’s rise as Europe’s financial centre can be tied back to the Thatcher-era Big Bang of 1986—a set of reforms that encouraged competition and attracted financial institutions from across Europe, the US, and the world beyond. With the increasing standardisation of rules across the EU, this historical regulatory advantage has been eroded. Brexit gives the UK the opportunity to create a Big Bang II, and again draw in financial institutions from around the world. Rather than lose tens of thousands of jobs, the City could gain that number in trading, asset management, private banking, as well as associated services such as exchanges, clearing, and technology.

Deregulation in the US will force the UK to follow

The current UK government seems unlikely to engage in such a course of action voluntarily. However, Donald Trump has promised to take an axe to the US’s flagship post-crisis regulations, the Dodd-Frank Act. Once this occurs, trading in several instruments, such as swaps or commodities futures will be easier in the US than London, and will shift to the US at the click of a mouse. The UK will face the prospect of the US siphoning away trading volumes, in addition to losing business to continental Europe. This adds insult to injury.

Even if the UK negotiates equivalence and passporting rights with the EU, there will be a modest movement of jobs to the continent. If the UK fails to secure such rights, while largely retaining existing regulations, then as many as 37,000 jobs could be lost. On the other hand, an aggressive move to create a regulatory environment that encourages innovation and competition, is designed to attract financial firms, and protects investors without the excesses that are so evident in many EU directives, the City could attract as many, or even more jobs, than it currently risks losing.

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