Twilight for the City?

Photographer: Matthew Lloyd/Bloomberg

London Could Lose Its Euro Trading If U.K. Leaves EU

Mark Gilbert is a Bloomberg View columnist and writes editorials on economics, finance and politics. He was London bureau chief for Bloomberg News and is the author of “Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable.”
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London's future status as the financial capital of Europe is a key factor in the debate about whether the U.K. should leave the European Union. It would be a mistake for either side of the argument to underestimate quite how aggressively London's competitors would attempt to wrest trading revenue away from the U.K. capital should the June 23 referendum vote in favor of what's known as Brexit.

Will Britain Leave the EU?

Tim Martin, the chairman of U.K. pub operator JD Wetherspoon, is a supporter of abandoning the EU. In a letter accompanying his company's earnings report last week, Martin suggested an amicable divorce was likely:

Clearly, if the U.K. decides to leave the EU, it would be in the economic and other interests of this country and our European neighbors to have friendly relations, strong business links, including free trade and, I believe, free movement of labor.

That view is very likely too optimistic. The aftermath of an anti-EU decision would be anything but friendly, not least because Germany and France in particular would seek to deter other countries from contemplating life outside of the Union. The world of finance would offer an irresistible opportunity for the euro core to make an example of Britain by attacking the crown jewel of the U.K. economy.

London has more than 40 percent of the global market for currency trading. Almost half of the world's interest-rate swaps business takes place in the City, as does a third of European equity trading. And although the U.K. has successfully challenged efforts to migrate euro-denominated trading and settlement to euro zone countries, that position might be hard to sustain after a Brexit -- a point former Bank of France Governor Christian Noyer made forcefully earlier this month:

It is already very difficult for euro members to accept that our currency is largely traded outside the currency area, beyond the control of the European Central Bank and of euro-area institutions such as market regulators. That can be acceptable only if, and as long as, the U.K. is a member of the EU, and accepts the involvement of, and co-operation with, the European regulatory agencies.

It's not the first time political and economic differences with the rest of Europe have threatened to diminish the City's standing.  Back in 1991, the talk was all about an artificial currency called the European currency unit, the forerunner of the euro, which was starting to gain traction in fixed-income and derivatives markets. So the Bank of England did a clever thing; It issued 2.75 billion Ecu of 10-year bonds at an interest rate of 9.125 percent (yes , back in the olden days government bonds had yields close to double digits rather than below zero).

It was the biggest security available in the currency, cementing London's role as the center for Ecu trading and paving the way for it to be the dominant market for the euro (even though Britain wasn't joining the common currency, much of the technical work about its introduction was done by the Bank of England prior to the ECB coming into existence). If Britain hadn't been in the EU, though, that trick might have been a lot harder to pull off.

If Europe's "coalition of the willing" is successful in introducing a Tobin Tax on securities trading, London may benefit, although the 10 countries still trying to introduce the levy have failed so far to reach an agreement. But if the EU succeeds in building a capital markets union, creating a seamless cross-border arena for small- and medium-sized enterprises to raise money by selling equities and bonds rather than relying on bank financing, then it’s hard to see how London could attract that market away from either Paris or Frankfurt.

Rather than remaining concentrated in London, Brexit may mean European trading splinters across several cities. Germany's Deutsche Boerse is in the midst of trying to merge with London Stock Exchange Group; the combined entity would be the biggest equities exchange in Europe, so it's not hard to envisage euro-denominated stock trading migrating to Frankfurt. It would also have the world's largest clearing house for swaps, which could also spur more of that business to move to Frankfurt.

The biggest manager of new corporate bonds in Europe, meantime, is HSBC, a bank that's already flirted with moving its headquarters out of London and which has said it might move 1,000 bankers to Paris if the EU splits. If you combine HSBC's 35 billion euros of corporate bond underwriting with third-placed BNP Paribas's 25 billion euros and fifth-placed Societe Generale's 21 billion euros, you can just about see how almost a fifth of company fundraising could end up in France. And if a post-crisis market for complicated derivatives ever comes into vogue, the mathematical/engineering bent of much of the top-tier talent at French investment banks may well steer that renaissance.

Bloomberg View contributor Jean-Michel Paul argued in October that Luxembourg would be a surprisingly strong competitor for some City-based financial services in the event of Brexit. Maybe, but I view Paris as the prime contender by far. Deutsche Bank's recent woes suggest Germany regulators don't have much appetite for hosting an expansion in investment banking in Frankfurt; and while I have a lot of banking contacts who've done a sojourn in Paris, I can't think of one who's worked in Frankfurt.

The future geography of European trading will depend mostly on the rules that are enacted after an EU divorce. A French government that's been at the forefront of the Europe project for decades and which saw euro trading slip through its fingers in the past quarter-century will seize this once-in-a-generation opportunity to drag euro trading away from London as aggressively as it can. By pushing for regulations that dictate euro securities have to be regulated in euro countries, France can emerge triumphant in the battle to be the dominant financial capital of a new-look Europe.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Mark Gilbert at magilbert@bloomberg.net

To contact the editor responsible for this story:
Therese Raphael at traphael4@bloomberg.net