The financial industry in the City contributes some £100bn of UK tax take, but following Brexit it is getting smaller as workers are being moved to Paris or Frankfurt. This is one of the major harms of Brexit, as we will see it in the reduction of public services nationwide.
Graham Bishop was the speaker at a recent webinar organised by London for Europe. He has been working in financial services in the City of London for 50 years. He provided evidence to the House of Lords in 2022 on the future of cross-border financial trades and has written a number of reports on Brexit and financial services. So it was very interesting to get an insider view of what is happening to the City of London’s main industry.
In his opening remarks, he contrasted how a British Prime Minister with a majority in Parliament can just make a grand decision and whip it through Parliament with how it works in the EU where each proposal is consulted upon, member states consulted, and then it goes to the European Parliament. There is no whipping system and what comes out is settled legislation with broad consensus behind it. Thus it is interesting to see how the growing mercantile power of the EU is based on this consensual law-making.
What the City is for
Graham then showed us a list of the main types of financial services the City does:
- trading of equities, shares and bonds
- trading of derivatives
- asset management
Once the biggest equity market in Europe
Throughout his career, London has been the biggest equity market in Europe. But when the UK left the EU, share trades had to be reported to the EU systems. So on Brexit day, a lot of share-trading moved to the EU, making the Paris Stock Exchange bigger than London, with a market capitalization 10% bigger. London also had a big capital market where companies would raise new money for their operations. This has also grown much smaller. Recently, when the leading electronic chip maker needed to raise capital, it was listed in New York and got a 40% higher valuation than it could have got from London.
Concerned about this, the FCA has produced various plans to stem the outflow from the City of London, but nearly all of them mean lowering regulation and reporting standards. Graham remarked that in his experience this may let more companies list, but it also lets in more crooks and ends in tears. 10 of the largest pension funds have already written to the government saying they do not like the reduction of the Investor protection role.
It’s a problem for the EU as well as they do not have such a big investment culture. In the UK 50% of the shares are owned by foreigners and used to be owned by UK pension funds and life insurance.
Bond trading is 50-50 still in London, but when it’s the bonds of EU governments the trading is done in Europe and only 40% in London. London is hanging on to about 50% of bond trading altogether.
Along came derivatives
Derivatives came along about the year 2000, and they have exploded in size. Derivatives were nine times the size of global GDP before the crash of 2008, and they are now down to seven times the size because they now have to be centrally cleared. The UK still has about 99% of €-denominated derivatives trade, but the problem is that they are 66 times the size of the UK GDP. The total amounts to about 140 trillion. If anything goes wrong there is a monstrous crisis. [Remember the 2008 crash?]
Since 2008, more rules have been brought in to make sure it won’t happen. But you can argue that the huge run-up in natural gas prices after the Russian invasion of Ukraine was a gigantic margin squeeze causing social problems. The Europeans can look at this, and notice that derivatives are run from a third country. Can Britain be trusted with derivative exchanges? Does Britain have 20 billion of liquidity to pay up when margin calls come in? Could they trust Boris? Send along a gendarme? That is why the EU wants to shift this trading to the mainland. The EU is making this happen, but the companies are complaining it will cost them money. But note: greater regulation always has financial costs, 2% after the 1980s crisis, and it is now up to about 15% because of regulations the G20 have made following the 2008 crash.
Asset trading to be moved to the mainland
Now with asset trading in the EU and UK, there are about 32 trillion trillion, of which only five trillion concern assets managed on behalf of UK firms. EU assets are five or six times bigger. The EU does not want asset management from EU postboxes on behalf of firms really staffed in London. They now want real staff in EU offices and have now legislated for this. There is fraught debate on that directive. It is a major problem for UK asset managers if half their business is obliged to move to the mainland.
Looking at the big numbers and rankings, Graham noted that London used to be significantly ahead of New York in the rankings of financial centres. Now New York’s ranking is 763, while London is 744 (Singapore 742, Hong Kong 741). The City of London Corporation is talking about convening a group to plan how to restore the London ranking.
From rule-maker to rule-taker
When the UK was in the EU we played a leading role in formulating financial services regulation. Now no longer a rule maker, we are only a rule-taker. There was hope of an MOU for equivalence in financial services so that an action taking place in London would be regarded as valid throughout the EU. Clarification about this was veiled while there was the quarrel about the Northern Ireland trade. Now the Trade and Cooperation Agreement (TCA) has been ruled upon and clarified, and it says that regulatory cooperation should not restrict either jurisdiction from implementing whatever regulation it finds appropriate: in other words, the EU intends to go ahead with what suits it, regardless of London.
The banks handling risks on the mainland hoped they would be able to continue to do so from London. But it has now been clarified that the ECB (European Central Bank) is to be the supervisor of the top banks and thus of 80% of banking assets in the EU. Covid put some physical moves on hold, but now the pandemic is over the ECB is going around to every trading desk to see whether its EU operations require it to be physically relocated to the mainland. Some personnel are not moving, but there are hires going on in Paris and Frankfurt.
With regard to sovereign bonds, the top six banks handle 50% of these, with Barclays the only British bank (the rest are JP Morgan, Deutsche Bank, Crédit Agricole etc.). Again, the ECB will put pressure on them to move their trading desks. And once they move bond trading, they will move derivatives and that’s where the big profits are. The move hasn’t happened yet, but it will do.
With regard to sustainability criteria of the finance industry, the UK has produced a taxonomy which the Treasury will launch a consultation on. The EU is further ahead, to the third stage, on their Statutory instruments. For international accountancy standards, the EU has just produced some and the Global Reporting Institute (GRI) is matching their rules to those of the EU. So that’s an example of the UK still in the consultation phase, while the EU is racing ahead. It’s the same with AI: the UK is still consulting and the EU is enacting.
How all this affects the ‘tax take’
Finally, there is the effect of all this on the UK tax take. The chancellor has said that the City produces £100bn of tax revenue. As the City industry gets smaller, there is less money to spend on public services, such as the police with its spread of employment across many cities, not just London. Prime Minister Johnson, a former Mayor of London, was well aware that the City produces 10% of UK taxes, yet he went ahead with a TCA that we are now seeing the consequences of. Less money earned in the city means less money for vital public services.
The value of goods UK exports is only 60% of the value of imports. Some of that deficit used to be made up in services (including, of course, financial services) which made up for 5% of that deficit. Now our financial services are in decline because of Brexit. The current account deficit then increases. But you still need capital flowing in. Up to now, many foreign investors have kept the money flowing in. Mark Carney, former Governor of the Bank of England commented on the dangers of relying on the kindness of strangers.
There followed a Q&A
In question time, there was further discussion about the exodus of financial workers (who are big spenders too) from the London economy, with a knock-on effect on other industries.
It is unlikely there would be any reversal, even if the UK sought to rejoin the EU. By that time, cities like Frankfurt and Paris would be contributing to the tax take, and national governments would be counting on that money for their budgets. The actual workforce in the financial sector of the City of London is mostly non-British, who are just as happy to move to another city.
Discussion whirled into pessimism. “It’s all too late. And people like me can stand up and say, I told you so. I will have my portfolio of articles to point to,” said Graham.
“Did people in the city not see this coming? If they’ve got some financial background, why do they not see it coming?” said Andy Pye. I can recall the news coverage on the day of the referendum vote. Caught on camera was a city worker in a frenzy of shock crying something like “We will not leave… we cannot leave… I cannot leave”.
Thanks to London for Europe for organising this webinar and making the recording available.