Although the British political system appears to have staved off a no-deal Brexit for now, London still faces an existential threat. Unless the UK suddenly changes its mind about leaving the EU, banks, insurers and other financial services businesses still face the prospect of a hard Brexit in all the likely scenarios — including a no-deal departure or membership of the customs union.
It is understandable that politicians have made little effort to shield financial services from the coming hit. A sector that has become associated with bonuses and privilege cannot really expect more. But make no mistake, the approach being taken by the EU and UK risks not only near-term market disruption to Europe’s capital markets, but also long-term outcomes that neither side has anticipated.
The EU’s approach has focused squarely on creating an onshore financial centre within the bloc. It has therefore insisted that UK-based firms set up EU subsidiaries to service their EU clients.
The UK, for the most part, has dismissed concerns about the demise of London as a financial centre, citing the City’s peerless infrastructure and policy framework. Less sanguine politicians have also dangled the prospect of looser financial regulations once the country is freed of Europe’s embrace.
What is lost in this London-versus-the-continent dogfight is a larger truth: finance is global, not regional. The result of EU-UK manoeuvrings may not be to move the market from one side of the English Channel to the other but rather to send it packing to New York or Hong Kong. After Brexit, the comparison between Europe and other continents will only become less flattering.
Europe’s basic problem is that continental capital markets are too small and fragmented to justify the extensive ecosystem of asset managers, lawyers and accountants that a financial centre requires. Pushing global firms to relocate certain operations to the continent cannot deliver the market dynamism Europe needs. That is a pity, as the potential for capital market growth is huge: European firms receive only a quarter of their funding needs from capital markets (versus three quarters in the US).
If the EU is to succeed in developing its capital markets within the next five to 10 years, it will need to focus on scale, expanding the ambit of its Capital Markets Union project and giving it a more global vision. What, in concrete terms, would that entail?
First, the current dominance of state-run pay-as-you-go pensions means that the pool of private savings to invest in capital markets is small. Several EU countries have sought to encourage “third-pillar” privately-funded pensions, sometimes with tax incentives. Such efforts will need to be ramped up if the pool of investible resources is to expand.
Second, EU27 capital markets are subject to national rules and national supervisors, making for a patchwork of inconsistent regimes. For example, Ireland and Luxembourg, following other global centres, allow large sophisticated financial institutions from third countries to trade with firms in their home jurisdictions. But France and others do not, insisting instead that non-EU firms set up local subsidiaries — at considerable expense. If capital markets are to develop to their potential, idiosyncratic national systems must give way to a single rule book and further supervisory convergence. In other words, Capital Markets Union should follow the tack set in recent years by Europe’s own banking union.
Third, and related, insisting that EU entities trade only with other EU entities and subsidiaries limits the participation of global firms and thus capital market liquidity. By contrast, all major global financial centres allow sophisticated foreign financial institutions to participate in their markets.
Although Europeans are understandably wary of ceding oversight of foreign firms to non-EU supervisors, global financial centres have found ways to limit their own firms’ offshore exposures and collaborate with foreign supervisors. Europe should draw on this experience, adopting similar approaches that balance openness and financial stability.
As for London, politicians should not think that any shift in financial operations to the continent can be offset by easier regulations. That is an illusion from the 20th century. What global firms want is regulatory consistency, not ad hoc leniency. Thus, the UK should align with global and EU regulations rather than set off on its own path.
Because of the paramount importance of scale, liquidity and risk diversification, capital markets are intrinsically global. Instead of a regional tussle for financial sector dominance — a battle that risks killing the golden goose — both the UK and the EU should aim for maximum openness and regulatory consistency around the world.
Just as Asia has both Singapore and Hong Kong, there is no reason why Europe cannot be home to more than one international financial centre.
The writer is president of Morgan Stanley