In the immediate aftermath of last month’s Brexit referendum, we looked at the impact it would have on various sectors of the UK economy. One of the biggest potential victims is London’s financial sector, whose enormous growth in recent years (enabled in part by Britain’s EU membership) has secured the city’s position as a global capital of finance. The “passporting” rights that allowed British banks to access the entire single European market from London without dealing with regulatory authorities in each country helped the UK become a commercial hub for the entire continent and the location of 40 percent of global trading denominated in euros. While that meant London had to comply with EU financial regulations, its clout as a financial center gave it significant influence in the design of those rules (and as an EU member, the UK got to vote on them).
The free movement of labor, meanwhile, drew top finance talent from around the EU to banks in the City of London and Canary Wharf. Prior to the referendum, major banks had warned that exiting the EU could have a severe impact on their business, forcing them to move as many as tens of thousands of jobs out of the country. If Brexit means the loss of passporting privileges for UK-based banks, it may no longer make business sense for global financial institutions to headquarter their European operations in London, spurring speculation over whether they will move to Paris, Frankfurt, Dublin, or Amsterdam.
In a move to shore up confidence in the sector on Thursday, Chancellor of the Exchequer George Osborne issued a joint statement with representatives of six major financial firms (Standard Chartered, Goldman Sachs, Merrill Lynch, Morgan Stanley, JP Morgan, and Citigroup) affirming their commitment to “identify the new opportunities that may now become available so that Britain remains one of the most attractive places in the world to do business”:
One of Britain’s key economic strengths is that it is a world leading financial centre. It has one of the most stable legal systems in the world, a brilliant workforce and deep, liquid capital markets unmatched anywhere else in Europe, all of which are underpinned by world class regulators. In recent years it has established itself as a global hub for renminbi, rupee, Islamic finance and green finance, as well as leading in new markets such as FinTech.
Many leaders in British finance don’t believe that Whitehall will actually go through with Brexit, however. A survey of business and financial elites by Politico found that only 37 percent believed the country would fully pull out of the EU, though most believed that the vote would still have significant effects on the economy and labor market, particularly as long as the future remains uncertain. Even if the UK does leave, these business leaders also said they doubted that London would lose its standing as a global financial center, at least in the immediate term:
Despite dire predictions for the U.K. economy, 56 percent of those polled said that, two years from now, London will still be the world’s financial capital. “That isn’t to say its strength as a financial center won’t diminish,” said one participant. “It simply means that two years probably won’t be enough for London to lose top position.”
“In 10 years time, I expect the balance to have tipped toward Frankfurt or possibly Paris,” said one. Another predicted fragmentation: “Euro trading to Frankfurt, back and mid offices to Central and Eastern Europe, hedge funds to Dublin or Paris (or Madrid), etc. We will have less concentration in one city.”
The precise impact will depend on the outcome of negotiations between London and Brussels over the UK’s future relationship with the union as a non-member. Some hope that UK banks will be able to retain those passporting privileges, but as Anil Kashyap explains at FiveThirtyEight, that’s not likely to happen unless the UK accepts all of the “four freedoms” of the single market (i.e., free movement of goods, capital, and labor, and the freedom of EU citizens to establish businesses anywhere in the union):
In order for the U.K. to maintain the status quo regarding the City, it therefore will need to secure passporting rights. However, it would seem the only way that is achievable is if the U.K. accepts the four freedoms, which means no restrictions on the movement of people. …
And there are many in the EU who would like to take advantage of any decline in London’s status. EU officials would be happy to claw back as many of the high-paying financial services jobs and tax revenues from the U.K. as possible. The stakes here are large. To take just one example, swap contracts that are denominated in euros are a trillion-dollar market, and most of that business is now centered in London. French President Francois Hollande has said that this activity should be moved back into the EU.
The U.K. might conclude that the combination of its strong legal system, which makes dispute resolution relatively easy, along with its flexible labor market, which makes it possible to quickly downsize a business, will be sufficient to keep the City intact. However, this is far from assured. A decision to clamp down on the free movement of people could be the first step toward the financial fragmentation of Europe.