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Bluffing Over Banks Is a Dangerous Brexit Strategy

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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The British government is making a twofold gamble on finance and Brexit. First, ministers seem to believe that London's financial firms are crying wolf when they warn about the potential domestic cost of a so-called hard Brexit. Second, British officials seem convinced that the European Union is so reliant on the City that threats to raise the drawbridge are a bluff. Both could backfire badly.

QuickTake Why Britain is Leaving the EU

Bloomberg News's Gavin Finch reported Thursday that TheCityUK, a finance sector lobby group, has abandoned efforts to ensure its member firms preserve frictionless access to the EU once Brexit happens. Presumably the firm no longer believes the U.K. government will act to defend passporting, the system that allows firms in one EU member state to sell financial services across the bloc.

To be fair, the government's position has been absolutely consistent ever since Theresa May became prime minister; banks wouldn't get special treatment. May tends to view bankers as too close to the "elites" that riled Brexit voters. But her administration's hard line risks damaging an industry that contributes about 45 billion pounds ($55 billion) to U.K. national income and employs more than 400,000 workers.

The government seems to take the view that whatever hurts the U.K. hurts Europe more. Figures released in September by the U.K.'s Financial Conduct Authority showed almost 5,500 firms in the U.K. use EU licenses to sell services into the bloc; but more than 8,000 firms are trafficking the other way, based in other EU states but doing business in the U.K. under the passporting regime.

That imbalance seems to be informing British attitudes to how the EU will treat the finance industry once Brexit negotiations get properly underway, but it's only part of the story. Here's what Bank of England Governor Mark Carney told lawmakers on Wednesday:

"There are currently very deep and broad hedging markets, and they are principally run out of the U.K. Financial institutions and corporations rely on the continuous presence of those hedging markets. If you rely on a particular jurisdiction for three-quarters of your hedging activity, three-quarters of foreign exchange, half of lending, you should think very carefully about the transition from where you are today to the new equilibrium."

There's a lot of truth in what Carney says. Some 40 percent of Europe's financial assets are managed in London, while 60 percent of its capital markets business takes place in the City. U.K.-based banks provide more than $1.3 trillion of loans to other EU members.

In a draft analysis last month of what post-Brexit financial rules might look like, European Parliament officials said interdependence in finance does pose a risk to both parties in the negotiations. "A badly-designed final deal would damage both the U.K. and the other 27 EU member states," the draft report said.

Nevertheless, the argument about the City's importance seems circular. London furnishes Europe with most of its financial liquidity because trading and asset management are focused in the U.K. capital; but there's nothing that says Paris couldn't play the same role if banks moved more of their activity to France.

It's worth recalling that the Eurobond market sprang into life more than half a century ago by accident. A U.S. tax change drove money offshore, creating a pool of dollars in Europe seeking a home. It was pure happenstance that a U.K. tax anomaly dating from the 19th century that meant financial transactions originating in Britain between foreign counterparties paid no levy. By 1967, the market had grown to almost $5 billion; last year, $4 trillion of international bonds were sold. That is, circumstance not some divine right made London, rather than Paris, Luxembourg, Zurich or Frankfurt, the home of the corporate bond market.

London Stock Exchange Group Plc Chief Executive Officer Xavier Rolet told the Treasury Select Committee on Tuesday that as well as Brexit driving trade-clearing away from London, a disorderly transition could cost the U.K. 232,000 jobs and even threaten the nation's broader stability. He's in the middle of trying to merge his firm with its German rival, Deutsche Boerse; questions about where the combined firm would have its headquarters and be regulated may yet scupper that deal. 

It's not just Brexit that threatens London's role as a financial capital. Money flows to where it is welcomed, and stays were it is well treated. Any perception that the U.K. government has become hostile to the finance sector is bound to play a part in decisions on where banks put staff and resources going forward.

That's already starting to happen. London is resigned to losing the $570 billion market for clearing trades of euro-denominated derivatives, probably to Paris. Europlace, the French capital's lobbying group, said earlier this month it's hoping to lure as many as 20,000 finance jobs away from London, starting soon; "institutions are accelerating their process of thinking," managing director Arnaud de Bresson said.

"Don't it always seem to go, that you don't know what you've got 'till it's gone?" Joni Mitchell sang in Big Yellow Taxi. The City of London was viewed as a financial paradise until the credit crunch and the accompanying economic crisis. It would be a shame if a vengeful British government, in belatedly punishing the sins of the profligate financiers responsible for that mess, ends up weakening a vibrant contributor to the economy.

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