This is the first article in a series about the impact of Brexit on the City of London’s financial services industry.
Anyone in any doubt about the source of banks’ vociferous opposition to Brexit got their answer last week, as regulators published new figures showing how bound together the EU and UK’s financial services systems are.
The headline numbers of 5,500 financial services companies which “passport” their services out of the UK across the EU, and more than 8,000 passport in, hammer home how much is at stake for global finance as the UK and EU part ways.
New data collated by the Financial Times drills down further into quite how vital the bridge between the City and the rest of Europe is — for the banks themselves, but also for UK employment, the UK Exchequer and EU capital markets.
Banks that use the UK as a gateway to the EU employ more than 590,000 people, have more than £7.5tn of assets and make annual profits of more than £50bn, according to Companies House data analysed by the FT.
The 91 UK-incorporated banks that use passporting — which account for 60 per cent of all incorporated banks in the UK but more than 95 per cent of UK banks by assets and staff — do not disclose how much of their business is done across EU borders.
Nor do the five bank companies that have the “designated firm” status that the Bank of England grants to some parts of large investment banks, including Citi’s global markets business and Merrill Lynch International.
The proportion varies greatly among them. The big three UK retail banks Lloyds Banking Group, Royal Bank of Scotland and Barclays, whose UK-incorporated banks employ 363,000 people and have assets of almost £3.4tn, have passporting rights to almost all EU countries, but do most of their business domestically.
But the City’s investment banks use passporting for more than 20 per cent of total UK activities, according to banking insiders. “We reckon that around about a quarter is related to the EU in some way or another,” says John McFarlane, who chairs both The CityUK, a lobby group, and Barclays.
The top five US operators have almost £1.5tn of assets and about 21,000 staff in their UK-incorporated banks and designated firms. They also have tens of thousands of additional staff, and significant assets, in branches and other entities which do not file separate financial accounts. For example, the majority of JPMorgan’s 16,000 UK staff — many of whom would not be directly affected by Brexit — work for a London-based branch of its US parent company. The big two Swiss banks employ just over 6,000 in UK incorporated and designated firms, but have about 12,000 UK staff in total.
How much of that investment bank business is at risk is “impossible” to predict, says Dirk Schoenmaker, an economist with Bruegel, a Brussels-based think-tank, who has done extensive research on the consequences of Brexit for banking and made a submission to the House of Lords on the topic.
Still, the prospective loss of passported access into the EU single market should worry everyone, says Robert Rooney, chief executive of Morgan Stanley International.
“Anything that causes London to fragment, such as a loss of passporting, will result in higher costs, lower liquidity, more trapped capital and less-efficient capital markets. Ultimately that’s not just bad for the UK, it’s bad for Europe and the global financial system,” says Mr Rooney, who is also a member of the European Financial Services Chairmen’s Advisory Committee (EFSCAC), a newly formed lobby group, charged with steering the City through Brexit.
Mark Boleat, policy chairman of the City of London Corporation, says the financial consequences would extend beyond the banks to the Exchequer through the potential loss of a large amount of personal income tax from highly paid bankers and an “irrecoverable” amount of VAT. In corporation tax alone, banks that passport into the EU would pay a normalised bill of £14bn — assuming a 28 per cent rate not offset by the legacy deferred tax losses that many banks still benefit from.
How to preserve passporting, or replace it with a bespoke alternative, was a key topic of conversation when the EFSCAC, chaired by Santander UK boss Baroness Shriti Vadera, held a debut meeting with chancellor Philip Hammond earlier this month — a gathering described by one participant as “warm and friendly”.
Mr Hammond has made clear he understands the importance of passporting and has reassured financiers that they will not face curbs on employing EU nationals, another big concern for investment banks, some of which rely on non-British Europeans for 20-30 per cent of their UK workforce.
In the immediate term, however, bankers are pressing politicians to prioritise as protracted a timescale for change as possible. “It is in everyone’s interest that a measured and considered approach is taken,” says Michael Cole-Fontayn, Emea chairman of BNY Mellon and another EFSCAC member. Another senior figure at a US bank in the City says: “The priority is to negotiate a four-year transitional arrangement.”
In the meantime, bankers will set about preparing for their worst-case scenario — that Article 50, initiating Brexit, will be triggered in January 2017 and that they will need to be able to operate, with no single market access from the UK, by January 2019. That means establishing subsidiaries elsewhere in the EU and deciding between the pitches that Frankfurt, Paris, Dublin, Luxembourg and Madrid have been making to bank bosses across the City in recent weeks.
BNY Mellon’s Mr Cole-Fontayn, who has 5,000 staff in the UK, says that even though a change in the “geographic composition of European capital markets is inevitable” if passporting is lost, he does not believe there will be a “wholesale exodus of banks transferring business from London to another European location”.
“The high costs and operational disruption such a move would create are not attractive to anyone,” he says. “Such moves may occur, but would be a last resort.”
Scale may limit the options. “For the larger banks, shifting some people to a new office where you already have operations is costly, but not that difficult,” says Michael Mainelli, co-founder of City think-tank Z/Yen. “For smaller operations, do they really want to split operations from regulation-facing? Will a non-UK regulator accept a local regulatory vehicle while the bulk of the operations remain back in the UK? I doubt it.”
Jim Cowles, chief executive for Citi in Europe, the Middle East and Africa, says there was a “massive amount of work” that every bank had to undertake. “There’s no one-size-fits-all — we’re all going to come to different alternatives because we all have different [starting points],” he adds. What everyone agrees on, however, is that no size will fit as well as London.
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