London’s attempt to maintain its financial muscle while boycotting Europe’s move toward a banking union risks isolating the city from its major trading partners and undermining its status as the world’s top money center.
The European Central Bank will become the main regulator for the biggest banks in the 17-nation euro region as early as Jan. 1, the first step toward a banking union, European Union leaders agreed last month. Britain has said it won’t take part and is negotiating to retain London’s influence within the single financial market. Last night, U.K. Prime Minister David Cameron lost a vote in the House of Commons on the nation’s contribution to the EU budget, highlighting the division within Britain over its European partnership.
The danger of a banking union that doesn’t include the U.K. is that Britain’s voice in setting the rule-making agenda will be weakened as the ECB gains new powers, bankers said. Trading in euros, now centered in London, could shift to Frankfurt or Paris in Europe’s core and be regulated by the ECB, said Thomas Huertas, a former U.K. representative on the European Banking Authority, which drafts financial rules for the 27-nation EU.
“If there is a European banking union and a notable missing member of that is the U.K., then that will likely hurt London as a major financial market,” said Jay Ralph, the management board member responsible for asset management at Munich-based Allianz SE, Europe’s largest insurer with 1.75 trillion euros ($2.27 trillion) under management. “A strong pan-European banking union ex the U.K. will have negative implications for Europe and the U.K.”
London, the world’s biggest center for foreign-exchange trading, cross-border bank lending and interest-rate derivatives, has 251 foreign banks and more international firms than any other financial center including New York or Frankfurt, according to TheCityUK, a bank lobbying group.
The City, as London’s financial district is known, is home to three-quarters of the EU’s foreign-exchange trading, including 42 percent of euro trades. Banks located there conduct about 62 percent of trading in euro-denominated, over-the-counter, interest-rate derivatives, the group said.
A European banking union that gives the ECB new supervisory powers will create an “inner core” of euro-region nations that sidelines the rest of Europe, including the U.K., said Huertas, who now works for Ernst & Young LLP in London. Two sets of regulations for so-called inner and outer Europe would mean U.K. banks wouldn’t have as easy access to European markets, he said.
“Most dollar capital-market business and most dollar business for the domestic U.S. market occurs inside the United States,” Huertas said. “It’s entirely possible that euro business moves from London to the Continent.”
The concern for U.K. banks is that “you end up with a policy-weighting toward the euro-zone banks because they’re in aggregate bigger -- that could damage the single market,” Douglas Flint, chairman of London-based HSBC Holdings Plc, Europe’s largest bank, said in an interview. A banking union “has to be done in a way that preserves the integrity of the single market in financial services so that banks within Europe but not within the banking union are not disadvantaged.”
David Walker, chairman of London-based Barclays Plc, Britain’s second-largest lender by assets, echoed Flint.
“Because we are not in the euro area, their shaping the union and equipping the European Banking Authority will be less sensitive to our concerns,” Walker said on Oct. 17 at a British Bankers’ Association conference in London. “We will see some undermining of the single market, some protectionism of the financial-services sector.”
Much of the structure and timing of a banking union remains to be negotiated, and that is adding to uncertainty in London, according to senior executives at U.S. and European banks in the City, who asked not to be identified because they aren’t authorized to discuss companies’ positions.
In addition to common supervision, a banking union could mean that governments share the costs of winding down failed lenders and guarantee deposits, or leave that to national regulators. In the meantime, a central supervisory authority could allow the region’s bailout fund, the 500 billion-euro European Stability Mechanism, to directly recapitalize firms, breaking the link between sovereigns and their lenders.
The U.K. doesn’t want to be part of a banking union because it doesn’t want to be responsible for paying for failed banks in Spain and elsewhere in the euro area, according to top government officials. Britain should stay outside because the plan is designed to address the “vicious circle” between sovereign debt and banks in those countries, Deputy Prime Minister Nick Clegg said in a speech last month.
“The worst outcome would be the creation of an over-powerful banking bloc,” said Clegg, whose coalition government is facing pressure from inside the Conservative Party to hold a referendum on the U.K.’s relationship with the EU. “The rest of Europe needs to be crystal clear: If they integrate in a way that hurts the City, they potentially hurt Europe as a whole.”
Charles Bean, deputy governor of the Bank of England, said the central bank shares the government’s view that a banking union will help bring stability to the euro area and that U.K. banks shouldn’t be a part of it. While the U.K. belongs to the EU, it opted out of the euro zone established in 1999.
“We don’t particularly want to be part of it, so what will be important going forward is that we establish a modus operandi that ensures that decisions that are taken in the European banking union don’t impinge adversely on the way the single market in financial services in Europe operates,” Bean told SkyNews on Oct. 28.
Last night, Euro-skeptic Tories teamed up with the opposition Labour Party as lawmakers in London voted 307 to 294 in favor of an amendment, which isn’t binding on Cameron, urging him to go into negotiations in Brussels at the Nov. 22-23 EU summit with the aim of securing a real-terms cut in the bloc’s spending. He’d already said he’d veto any proposal to increase the budget, and the vote reflects the same divisions that have played out in the debate over a banking union.
U.S. banks that have built securities-trading operations and European headquarters in Britain as a hub for the rest of the region share Ralph and Flint’s concerns, according to an executive with knowledge of lobbying by U.S. lenders who asked not to be identified because the effort is private. If a banking union were to leave London more isolated from the rest of Europe, foreign banks would consider shifting operations to within the euro zone, the executive said.
“A very large proportion of the City is made up of euro-area banks, and the question for them is whether being under one supervisory roof will deliver over time outcomes which affect their activities in the U.K.,” said David Green, who spent 30 years as a senior supervisor at the Bank of England and then headed international policy at the Financial Services Authority, the U.K.’s industry regulator.
Spokesmen for British banks including Barclays, Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc declined to comment, as did those for Citigroup Inc., JPMorgan Chase & Co. and Deutsche Bank AG.
“The U.K. is host to the EU’s main financial center, and it’s essential that it’s not sidelined in the making of regulations that affect it more than other countries,” Anthony Browne, chief executive officer of the BBA, an industry lobby group, said in an e-mailed statement.
London has withstood past challenges to its dominance. More than 10 years ago bankers in the City were dealing with the bursting of the dot-com bubble and concerned they would be left behind as the euro zone adopted a single currency. It went on to have its most profitable five years on record.
London No. 1
The City remains the world’s most important money center because of such advantages as its time zone, language, talent pool and legal infrastructure, according to Z/Yen Group Ltd., a London-based research firm. New York and Hong Kong are ranked Nos. 2 and 3 by Z/Yen.
“The effect will not be as much as people say,” George Mathewson, who retired as chairman of Edinburgh-based RBS in 2006, said in a phone interview. “My personal view is it won’t be dramatically bad for the U.K. The U.K. has got some in-built advantages that are difficult to dislodge.”
Ismail Erturk, a senior lecturer in banking at Manchester Business School, echoed that view.
“I doubt Frankfurt can replace London in the near future for euro-denominated businesses,” Erturk said. “The euro-zone banks are interconnected with the U.S. and the big emerging-economy banks in wholesale markets, and I doubt Frankfurt or anywhere else in the euro-zone will be able to accommodate interbank, interest-rate-swap and currency-trading markets.”
The EU has struggled to meet its year-end banking-union deadline as members negotiate provisions, including the scope of the ECB’s authority. The system is to be phased in for all 6,000 euro-area banks by 2014. Unlike Britain, Denmark and Sweden are considering whether to join the banking union and on what terms.
The U.K. has called for safeguards to prevent the ECB, or the euro area as a bloc, from dominating the London-based European Banking Authority once the transfer of supervisory powers takes place, according to documents obtained by Bloomberg News. It has also said that if observer status in the ECB’s bank-supervision arm is granted to any of the 10 EU nations that don’t use the euro, it should be granted to all of them, according to the documents.
Ash Saluja, financial-services partner in London at law firm CMS Cameron McKenna LLP, said global banks may opt for full ECB supervision either by moving their headquarters into the euro region or by pressing the U.K. to surrender national regulation in favor of the single supervisory mechanism.
It’s “very worrying for the City and the Bank of England,” he said. “The euro zone holds all the cards.”