Napoleon Bonaparte played an important if unwitting role in spurring the City of London’s rise as the world’s first truly global financial centre. In its efforts to fund its seemingly interminable wars with the French, the British government turned to the City for financing, enabling the poorer country to spend up to five times the proportion of gross national product on military spending as France – and to win the battle of Waterloo.
That intense cross-channel rivalry indirectly fostered a culture of financial expertise in the City and fuelled a massive government debt market that funded the expansion of the British empire. By the late 19th century, London had emerged as the leading global centre for financing railways and mines as far away as Argentina, South Africa and Russia.
Today, some financiers believe that Britain is again facing an insidious threat from across the channel that is jeopardising the City’s future – but might yet turn out to be another opportunity in disguise. As they see it, a slew of regulations from the European Commission and parliament on issues ranging from bankers’ and fund managers’ bonuses to alternative investment funds to insurance companies’ solvency ratios is being targeted at the City. They fear the red tape from Brussels will tie the City in knots as it struggles to compete with other financial centres, such as New York and Hong Kong.
This hostile embrace from the continent is encouraging some City financiers to imagine life outside the EU just as the British political debate turns increasingly eurosceptic. If re-elected, the Conservative party is committed to holding an in-out referendum on Britain’s membership of the EU by the end of 2017, which might lead to the exit.
Could the City flourish in isolation as it did in the late 19th century as a rejuvenated global financial centre, channelling flows of funds to the faster-growing emerging countries of Asia, Africa, and Latin America?
If there is a majority view on the subject in the Square Mile, it is probably that – for the moment – it would be madness for the City to contemplate a future independent of the EU. For the past four decades, Britain’s economic interests have been entwined with the European single market.
Even though Britain has remained outside the eurozone, the City has emerged as the financial capital of Europe, attracting many of the biggest banks and the brightest financiers from France, Italy, Germany and elsewhere.
According to TheCityUK, an independent body, 164 financial services firms from the rest of the EU are based in the UK with 125 EU companies listed on the London Stock Exchange. EU banks hold £1.4tn of assets in the UK, about 17 per cent of the country’s total bank assets.
The City also accounts for a big share of trading in euro-denominated assets. The average daily turnover of euro-denominated foreign exchange trading in the UK is $868bn, 40 per cent of the global total.
Many non-European banks, private equity firms, insurance companies, hedge funds and sovereign wealth funds have also opened their European headquarters in London because they see the City as the launch pad to a bigger EU market of 500m people.
The head of one big US bank is blunt about Britain’s prospects as an independent, offshore financial centre. “If the UK leaves the EU, the City is dead,” he says.
But the apparent antipathy of many in Brussels towards the City, the seemingly intractable economic problems of the eurozone, the weakness of the British government in defending the country’s interests within the EU and the explosion of growth in the developing world are beginning to sway the debate.
Lord Lawson, the former chancellor of the exchequer, has argued that many British businesses feel too secure in the embrace of the European single market and are missing opportunities in the developing world.
Jim O’Neill, chairman of Goldman Sachs Asset Management, says: “I find myself having some sympathy with the ‘cutting loose’ school and that is not something I would have dreamt of saying three years ago. Not only has the euro failed to deliver what it was supposed to but the EU has failed to deliver what it should have done.
“I am not arguing that the UK should leave. I am arguing that the UK needs to make a strategic choice about where its interests lie. The alternative is to become much more deeply engaged in Europe.”
British eurosceptics argue that even outside the EU the City’s deep and liquid capital markets, its legal regime, timezone, language and historic trading ties would still give it a formidable competitive advantage.
Gerard Lyons, chief economic adviser to the mayor of London and former chief economist at Standard Chartered bank, says that rather than obsessing about the relationship with the EU, the City must reorient itself more decisively towards the faster-growing economies of the world.
“The most important thing is for the City to position itself for the changing global economy. And London is perfectly placed because it is a global city,” he says. “People in the west still do not understand the scale and pace of change in the emerging economies.”
Those opportunities are not wholly dependent on Britain’s continued membership of the EU. Britain is by far the world’s biggest net exporter of financial services. The City already serves as a conduit for financial flows between emerging economies.
Gao Jian, vice governor of the China Development Bank, which invests heavily in infrastructure projects around the world, says that China would continue doing business with the City even if Britain quit the EU.
“It may make a little difference but not much. The City’s position as a global financial centre with close connections to Hong Kong would not change. Because of its infrastructure, because of its legal environment, because of its participation in the world, China will definitely use London as a financial hub for many international transactions,” he says.
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Ideally, the City would like the best of both worlds: to remain as the financial capital of the EU while simultaneously expanding its business with the developing world. The question is whether the City can maintain this inelegant straddle if London and Brussels continue to diverge.
While Britain has been agonising over how, and how far, it should distance itself from the rest of the EU, some European officials appear keen to usher the City towards the exit. Some are incensed by what they see as City-based “attacks” on eurozone sovereign bond markets over the past three years and the British government’s obstructionism. They say that London cannot hope to cherry pick what it sees as the best parts of EU membership while spitting out the rest.
Christian Noyer, governor of the Bank of France, has predicted that an increasing share of euro-denominated trades will be conducted in the euro area under the supervision of the European Central Bank.
“We’re not against some business being done in London but the bulk of the business should be under our control. That’s the consequence of the choice by the UK to remain outside the euro area,” he said in December.
If the eurozone is to revive, its 17 national economies will have to integrate more deeply, developing a banking union, a fiscal union, and possibly even a political union. The ECB is rapidly acquiring increased regulatory responsibilities for the biggest banks across the region.
These developments have already caught the attention of US banks operating in the City, and may encourage a drift of new business and investment away from London.
The chief executive of one other big US bank says: “[Britain’s isolation] worries me long-term. Being an outlier may feel good right now. But how is it going to feel when Europe gets its act together and has one unified bank supervisor and Britain is not in it.
“If I moved all my people to Frankfurt I would have one supervisor. That is a three-, five-, seven-year problem. You have to be careful that the City is not isolated. There is a risk of growing isolation.”
In his long-awaited speech on Europe in January, David Cameron promised that if re-elected as prime minister he would campaign “heart and soul” for Britain to remain in the EU once it had negotiated revised membership terms.
But the prospect of years of rancorous wrangling with the EU over repatriation of powers followed by an unpredictable referendum is unsettling to many in the City.
“The most sensible and the most likely thing is for Britain to remain within the EU and remain outside the euro,” says Mr Lyons. “But the key issue is uncertainty. You can manage risk but uncertainty is the issue that people worry about.”
Few in the City show much confidence in the prime minister’s ability to negotiate a better deal. The head of one investment bank is withering in his assessment of how the government has dealt with Europe. If Mr Cameron’s stated purpose has been to defend the City then why does he walk away from the negotiating table where he can make the case, he asks. “Cameron has handled the whole dialogue with Europe incredibly badly because he has no allies,” he says.
“If we have learnt anything about how to deal with Europe since 1973 then it is that it is all about the game of consensus, coercion and self-interest. Nobody has ever succeeded by being isolated.”
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For some who follow the debate closely on both sides of the channel, it is a matter of regret that the City and Brussels are drifting apart, and a matter of urgency that they somehow effect a reconciliation.
Antonio Borges, a former central banker from Portugal and dean of Insead business school who later worked in the City for 10 years, says both sides will lose if Britain disengages from the EU. Other European economies, which are overly reliant on rigid banking sectors, need the City’s expertise in developing more flexible capital markets, he suggests.
“The City benefited hugely from the introduction of the euro. The eurozone became the domestic market of the City. But the eurozone also benefited from the support and contribution of the City in developing financial markets in Europe,” he says.
“What we have seen since then is that Britain has turned its back on Europe and Europe has turned its back on the City. The regulations coming out of continental Europe are definitely anti-British and anti-City.”
Mr Borges argues that Britain needs to re-engage with the EU, not just with Brussels but with those national governments that are its natural allies. British leaders must make the case that sophisticated financial services can stimulate innovation and longer-term economic growth. “It is a very sad process on both sides, at present,” he adds. “Nobody will gain from a divorce.”
Xavier Rolet: A Frenchman’s view of the City v Europe
As a Frenchman running the London Stock Exchange, Xavier Rolet has a valuable perspective on the City’s role in Europe – and beyond, writes John Thornhill.
He has no doubt that London retains a significant edge over other European financial centres because of its deep pools of capital and its long history of risk intermediation and underwriting. But he says that EU policy makers are divided as to whether they want to nurture or neuter the City as a European asset.
“If the EU wants to remain relevant on the world financial stage, I am quite certain that there is no other European alternative on a scale equivalent to the City of London, which today handles two-thirds of EU financial services,” says the LSE’s chief executive. “London remains home to more listed international companies than any other stock market in the world ... But the City must never become complacent.”
Mr Rolet predicts that Frankfurt will emerge as the most important financial centre within the eurozone as integration deepens. As home of the European Central Bank, it will assume increasingly important regulatory functions. But the German financial centre will also flourish, in Mr Rolet’s view, “thanks in part to the remarkable and prescient build-up over the past two decades of a major financial infrastructure company – Eurex.”
The Frankfurt-based clearing house, which boasts a collateral pool of €50bn, serves more than 160 members in 16 countries, clearing more than 2bn derivatives contracts in 2011.
“Eurex’s success in building the largest pool of collateral in the eurozone gives it a major advantage in luring financial flows away from European neighbours,” he says.
On that reckoning, Frankfurt’s emergence will intensify the pressure on other eurozone financial centres, such as Paris, Milan, Madrid and Amsterdam – as much as London.