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EU Economics

What will happen to the City if we quit the EU?

The City of London including the Gherkin, the Cheesegrater and Tower 42
Whatever the outcome of the referendum, the City of London should focus on global trade CREDIT:  MARK THOMAS/REX/SHUTTERSTOCK


The City of London is one of the UK’s greatest success stories. Hence if we were to leave the EU its fate is among the most important factors determining whether the UK would gain or lose from Brexit.

It is striking, therefore, that most of the City’s large institutions favour staying in the EU (as they were in favour of the UK joining the euro). It is also striking that many of City entrepreneurs are not.

For City advocates of staying in, the most serious issue arising from Brexit concerns so-called “passporting rights”. Under the existing regime, these enable a financial institution with operations in one EU country to sell into all other EU members without having separate operations there. A bank can sell from London throughout the EU, for instance, but by contrast, Swiss financial institutions cannot sell directly into the EU; they have to set up subsidiaries in an EU member country.

In practice, foreign banks overwhelmingly choose London for their EU base. But if the UK left the EU, under the existing rules they would have to set up subsidiaries in a member country – as would British banks wanting to do business in the EU.

At the very least, therefore, British banks as well as foreign ones operating here would face a substantial increase in costs, and would have to transfer a significant volume of business, together with the attendant jobs, from London to some other EU city, most likely Paris, Frankfurt, Luxembourg or Dublin.

In the extreme, they might think it wasn’t worth having two European centres, one in and the other out of the EU. Given the requirement to have one inside the EU, they might plausibly close their London operations, or maintain just a token presence.

How serious is this threat? The UK sells about £20bn of financial services to the EU per annum and enjoys a surplus with it of about £16bn. Without passporting rights, it is possible that UK financial services exports to the EU could conceivably fall by about half, or roughly £10bn, which is a large sum.

Admittedly, the resources used in producing that income – principally the skilled labour – would be released for employment elsewhere. But there would be serious knock-on effects for other sectors – including business services, in which the UK also excels.

Yet there are good reasons to believe that the loss of business would not be as great as this.

A spectrum of possible outcomes ranges from complete relocation from London at one end, to setting up a token brass-plate operation on the Continent at the other. Where things turn out along this spectrum will probably vary between different parts of the financial sector – and will also depend upon the outcome of negotiations between the UK and the EU.

It seems unlikely that the fund management industry would be greatly inconvenienced by the loss of passporting rights, since most big fund managers already have established legal entities in other parts of the EU.

For banking activities, however, if the UK left, the EU would probably insist that in order to do business within the Union, banks would need to have a significant subsidiary operation located within it, with dedicated capital and substantial workforces.

Nevertheless, that would still be compatible with a large amount of activity continuing to take place in London. Indeed, several factors would encourage banks to keep as much as possible of their business in London.

For a start, London has a huge network of support facilities, including legal and accountancy services that no other European city can match.  Moreover, outside the EU, although the UK would not be a regulatory soft touch, and indeed in some aspects of regulation would be tougher, it would be able to rescind unwelcome EU regulations and restrictions, including the bonus cap which limits bankers’ bonuses to two times salary.

When this was introduced, banks complained vociferously about it, warning that it would lead to a loss of business to New York, Zurich and Singapore.  Outside the EU, their London-based operations would be shot of it. And London would retain the features that have made it easy to lure European bankers and other professionals to work here, including the entertainment and lifestyle attractions of a great global city and a relatively favourable tax system.

More generally, it is widely recognised that financial services are not highly regarded in the EU. The proposed Financial Transactions Tax is currently stuck somewhere in the EU regulatory long grass. If it were to re-emerge, it could potentially deal a serious blow to financial services firms.

Given all this, would any self-interested investment bank transfer activities wholesale to Paris or Frankfurt? Their approach would surely be to transfer the bare minimum to comply with European regulations. It is not even as though remaining in the EU means that the EU authorities will welcome and support the City’s pre-eminence.

Indeed, some European officials would like to see the City cut down to size. In fact, the British government recently managed to stop an attempt by the ECB to deny euro liquidity to euro clearing operations outside the eurozone. The UK cannot be guaranteed to win the next time such a move is contemplated.

Looking to the longer term, despite its peculiarities and particular interests, outside the EU the City’s prospects would be determined by the same over-arching factor that affects all other industries. That is to say, over the long run the EU is going to fall in relative importance.

In an ideal world, the UK in general, and the City in particular, would not have to choose between doing business with the EU and the rest of the world. But if it comes to a choice, the most important market for the UK’s financial services industry is going to be the rest of the world – for which it can surely be the global financial hub. It is essential that nothing prevents London from seizing that prize.

Remaining in the EU, with growing regulatory burdens and dislike for financial services, might well prevent it. Outside the EU, even if the City initially loses some European business, it can still fulfil that role.

Referring to the impact of a Brexit on China’s use of London, Gao Jian, then vice-governor of the China Development Bank, said in April 2013: “It may make a little difference but not much.”

The City’s position as a global financial centre with close connections to Hong Kong would not change. Because of its infrastructure, because of its legal environment, because of its participation in the world, China will definitely use London as a financial hub for many international transactions.

And what goes for China will surely also apply to most of the world.

– This is an extract from Roger Bootle’s new book, The Trouble with Europe

http://www.telegraph.co.uk/business/2016/04/17/what-will-happen-to-the-city-if-we-quit-the-eu/

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