Can the City Survive?
Ever since Britain voted to leave the European Union, analysts have debated the City’s fate. In 2016, the British financial services sector employed more than 1 million people (3.1 percent of all U.K. jobs) and contributed around 7.2 percent of the U.K.’s total gross value added, just over half of it from London. Any threat to the sector -- and to London’s place as arguably the leading global financial center -- would be a major blow.
Fortunately for the U.K., Brexit itself won’t erode the significant advantages London currently enjoys. Perhaps more importantly, neither will it help European rivals build up similar advantages.
It’s easy to see why cities such as Paris and Frankfurt (or Amsterdam, often mentioned as a compromise candidate) imagine they can steal business away from London. For one thing, all overlap with Asian and U.S. markets during the trading day.
London largely depends on transaction flow from European markets, British and European multinationals, international fund managers, insurers and global currency and derivatives trading. It also benefits from transactions completed elsewhere which flow through key exchanges or markets. LCH Clearnet Group Ltd., owned by the London Stock Exchange, clears over 50 percent of interest-rate swaps across all currencies. London clears 97 percent of dollar interest-rate swaps and 75 percent of those in euros. There’s no inherent reason that business couldn’t shift elsewhere.
But London also has some unique advantages over its competitors. English is the lingua franca of international finance. English law governs the bulk of international transactions and English courts are particularly well-regarded.
Institutions like the Bank of England command great confidence. Low taxes, reliable corporate laws and regulations that have historically been responsive to evolving industry needs all add to London’s financial power.
London benefits from network effects, where similar businesses and supporting services such as lawyers, accountants and consultants are located within close proximity to one another. Good infrastructure, technology and telecommunications as well as convenient transport links are key advantages. Even more important is access to a skilled labor force with the relevant expertise. London has historically treated foreign workers generously, especially in the financial services industry, although Brexit could make hiring European bankers more difficult.
It’s difficult to see Frankfurt, Paris or Amsterdam accommodating an English-speaking, English-law financial culture. Developing the infrastructure and networks needed to sustain a global financial center will take time, regardless of French President Emmanuel Macron’s invitation for foreigners to move to Paris. Neither Paris nor Frankfurt have a global trading culture, which in the cases of London and Amsterdam evolved over centuries of trading in goods and services.
An aggrieved European Union is obviously keen to use Brexit to diminish London’s much-resented financial dominance. The current debate about euro clearing is one example. Given that the U.K. was never part of the euro zone, there’s no reason it can’t continue to act as a clearing house. Nothing stops the relevant firms from agreeing to abide by EU laws and directives, supported by U.K. legislation. London-based financial firms can access European customers by complying with common-market rules under equivalent regulation provisions, or by establishing or using existing European entities.
Indeed, at a deeper level, the whole debate around London’s future as a financial center is perverse. Markets are global. Advances in technology and communications make location largely irrelevant. Most transactions are concluded electronically. People routinely work remotely and transactions are completed between firms and individuals who may never meet other than electronically.
The companies that dominate the U.K. financial services industry are mostly foreign and many of the transactions have little to do with Britain. Transactions are frequently not even recorded in London but booked elsewhere. Many functions are no longer performed in London but have migrated to other parts of the U.K. or further afield in order to save money.
The reality is that financial centers are creatures of tradition, habit and comfort. The concentration of financial firms in a small number of cities is driven by social connections and proximity of people in related fields, as well as factors important to highly paid financiers, such as reasonable personal income tax rates and an acceptance of large bonuses.
The perfect mix includes lifestyle issues which affect families, such as housing, education and health (not to mention reasonable divorce laws, given the prevalence of break-ups). Inevitably, a tolerance for masters of the universe (and those huge bonuses) is helpful.
These conditions aren’t easily replicated. London may or may not continue its historical role as a major financial center. But its competitive advantages are substantial -- and won’t be easily eroded even by a hard Brexit.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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