Bankers are told to prepare for the worst and hope for the best when it comes to Brexit. But how bad is “worst”?
Talk to some City of London executives and one would think the UK was about to be plunged into the financial equivalent of a nuclear winter, with Brussels insisting on the most restrictive rules governing access to EU customers, and forcing the repatriation of euro clearing activities on to the continent.
These are the kinds of “punishment” scenarios sometimes painted by City lobbyists. They are the ones that led the consultants Oliver Wyman to predict up to 75,000 job losses, and EY, in a London Stock Exchange commissioned study, to estimate that as many as 232,000 posts might go were the clearing of euro-denominated securities to shift across the channel.
But while such talk is not uncommon, and obviously theoretically possible, these bleak outcomes are rather unlikely. That is not because the EU has given up on increasing its own share of Europe’s financial services business. Far from it: that remains one of the bloc’s clear strategic objectives. No, it is because to impose a harsh deal would hurt the EU’s financial sector more than the UK.
Consider the relative outcomes for British and EU banks of a deal that entailed both sides to put into full subsidiaries some of the larger and systemically important operations they have in each other’s territories. These at present enjoy the automatic right to operate through branches, which are highly efficient in consumption of capital. But “subsidiarisation” — creating legal walls between their UK and EU businesses — is a possible consequence of abolishing these so-called passport rights.
First, there is the question of what percentage of their revenues might be imperilled if the banks were forced to create such subsidiaries. For Lloyds and Royal Bank of Scotland, for instance, the numbers are trivial: a few percentage points at most. Even Barclays, while larger, is pretty manageable.
Then look at Deutsche Bank, whose monster London branch handles assets worth four times those of its nearest EU rival, BNP Paribas. According to experts familiar with its business, the bit that is affected is closer to the 60 per cent of group revenue made by its investment and transaction banking arm.
Then there is the question of how much capital would be required to support activities were they “ringfenced”, and so no longer subject to the netting and diversification benefits that eke out a bank’s precious capital.
Of course, it is a moving picture, as it is possible for banks to move businesses across borders. But those same experts estimate it could, for instance, require Deutsche to put in an extra €10bn or more in capital if it had to subsidiarise.
A study last year by the consultants BCG suggested European banks would have to find an additional €30bn-€40bn in aggregate. That is quite something for a sector that is hardly awash with capital and earnings. Meanwhile for the British? It is a few billion at most.
What about moving businesses back to the continent as an alternative to stumping up capital? EU banks could, in theory, shunt books back to home territories. But apart from the regulatory and business hassle, this could damage their access to the all-important dollar markets in London, which are settled through the US Federal Reserve-regulated but London-based CLS International Bank.
Because about three-quarters of the $5tn worth of trades passing daily through global foreign exchange markets have a dollar “leg”, trillions are processed through this gigantic machine, shielding counterparties from each other’s failure. And while it is true that US banks would also be inconvenienced by a hard Brexit, there is no sign of CLS or the dollar moving anywhere soon.
Having to access these indirectly might not matter so much for a small EU bank. But it could cramp institutions such as Deutsche and BNP, which have global aspirations. Add to that the loss of yet more netting benefits were EU banks forced to abandon the UK as a source of euro clearing services, and switch to smaller, less capital-efficient EU-based providers. Then, assuming London stayed an important hub for global business as seems likely, EU banks would have done little more than raise their own relative costs.
Of course, none of this means Europe will cut the UK any favours. Brussels is keen to build up its own financial infrastructure in future. But that means fostering a stronger banking sector, deeper capital markets and the liquidity to support them. None of these goals will be advanced by erecting some financial wall down the Channel.
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