This week it was widely reported that New York had “surged ahead” of London as the world’s top financial centre, with uncertainty over Brexit undermining the UK’s global position. In reality, the picture is a little more complicated.
The story was based on a survey of senior financiers in which only 34% said they saw London as the world’s premier financial centre, compared to 56% for New York. This was actually only three points down from the same survey conducted last May: it was between 2018 and 2019 that the UK’s ratings plummeted by 17% and handed New York the top spot. Other surveys have been finding similar results for some time; as long ago as 2018 it was already being reported that London had “lost its crown”.
Of course, market sentiment is not the same as economic facts on the ground, and the stark changes in survey results have yet to translate into stark changes in the shape of the finance sector itself. It would appear that the UK’s net exports of financial services are still growing, and that it remains a globally dominant player in areas such as currency markets (where it accounts for 43% of global forex revenues) and derivatives trading (for which it remains the principal European hub). As of 2018, the UK’s cross-border lending still exceeded that of Germany and France combined. Firms are positioning themselves carefully for all possible Brexit scenarios, with many moving subsidiaries, staff and assets to Frankfurt, Paris or Dublin – but this does not yet appear to have resulted in big changes in London’s financial operations themselves.
Indeed, as Brexit Day sails by and the saga rumbles on, there’s a sense of groundhog day about these stories. What’s really striking this time is the continuity rather than the change: in spite of Johnson’s promise to “get Brexit done” and “unleash Britain’s potential”, the overriding mood is still one of uncertainty. Market confidence seems neither to have enjoyed a bounce from the resolution of parliament’s long period of stasis, nor to have suffered a knock from heightened fears of a hard Brexit. We still don’t really know what the UK’s post-Brexit relationship with the EU will look like when it comes to financial services – and, given the centrality of finance to the UK’s economic model, this means we still don’t really know what the UK’s post-Brexit economy will look like.
Britannia unchained? Two Brexit scenarios
The possible scenarios have changed little in the four years since the Brexit vote. The first possibility is essentially one of ‘business as usual’, where the UK agrees to continued regulatory alignment with the EU in exchange for market access, and the UK’s economic model remains substantively unchanged. The EU has already ruled out the continuation of ‘passporting’ arrangements which currently allow UK financial services firms to operate freely across the European Economic Area. The discussion now is over regulatory ‘equivalence’, in which market access for specific activities can be maintained if both sides agree that their regulatory approaches will deliver comparable outcomes. In other words, here as in other sectors, the UK will have to trade-off its degree of access to EU markets against its ability to diverge from EU rules.
Despite the hardening of the UK’s Brexit stance, it is still possible that it will ultimately opt to protect the status quo. Senior finance executives seem to be hoping so: one academic who interviewed a number of them during the election campaign said that she was “struck by their repeated sense that if a Conservative majority government was returned, the City could return to ‘business as usual’.”
Others in the City are hoping for something rather different: that Johnson will pivot to a model which a leaked DExEU paper fretfully referred to as ‘Singapore-on-Thames’, and £70m-a-year advertising executive Martin Sorrell has more enthusiastically termed ‘Singapore on steroids’.
This would involve doubling down on the UK’s status as a low-tax, low-regulation jurisdiction to make it the tax haven of Europe. The Tories have been making noises in this direction for a long time – from Phillip Hammond threatening that the UK could “change its economic model” if it lost single market access, to the recent enthusiasm for ‘free ports’. It is both the logical conclusion and, for key figures like Dominic Cummings, the ultimate point of the hard Brexit politics that now dominates the country. When it comes to finance, it would mean seeking to attract different types of firms and activities – perhaps more unsavoury and posing bigger risks to the wider economy.
Some see this as empty talk and doubt whether the UK will really go down this road. They point out that it has sometimes chosen to exceed EU financial regulations in the past, and therefore may be as likely to diverge upwards as downwards. But this seems like a misreading both of the UK’s historic approach and of its position now.
The voice of the UK banking lobby has consistently shaped EU regulation in its favour. It has contributed to the design of complex risk-weighted capital requirements, which offer the dual advantage of disproportionately hurting smaller banks and leaving big banks’ underlying business models essentially untouched – with the added bonus of allowing them to complain loudly about regulatory overload. More generally, the UK has been instrumental in pushing a deregulatory agenda in Brussels, including the exportation of the illogical and dangerous ‘one-in, one-out’ rule, and the revival of securitisation markets in the EU. To focus only on the fact that the UK has sometimes imposed additional requirements at the margins on domestic firms is to ignore the bigger picture.
Meanwhile, Brexit itself may change the UK’s calculation about its source of comparative advantage. As the global home of mainstream finance, it has been in the City’s interests to be seen as a ‘gold standard’, well-regulated jurisdiction (even if, as many commentators have pointed out, it is also the global home of money laundering and tax evasion). But as this status begins to appear under threat – and particularly in a scenario where the UK loses significant EU market access – it may calculate that its new niche lies in undercutting its neighbours. Indeed, the managing director of Duff & Phelps, the company that conducted this week’s survey, herself suggested that this could be the way forward: “If the government can position the UK as having a more favourable regulatory environment and separate it from the red tape of European regulation, then we may see the UK win back its crown and attract new talent to the sector.”
The City is not monolithic, and while many established players have opposed Brexit, others – such as some hedge funds – are more excited by the potential of this new model. With the City’s global reputation waning and its seat at the table in Brussels gone, the deregulatory path looks far from unlikely.
Johnson’s dilemma: delivering for the regions
Either way, both of these options present Johnson with a political problem: they do nothing to address the structural weaknesses of the UK economy, and therefore do nothing for the voters in northern towns who have just put him in power. UK financial services activity is overwhelmingly concentrated in London; indeed, the pursuit of a finance-led growth model has been largely responsible for hollowing out local and regional economies elsewhere in the UK.
Impressive headline figures on the sector’s contribution to GDP or exports conceal the fact that much of this is driven by investment banking activity that delivers few jobs or economic benefits for ordinary people. Some have even argued that it actively holds back the growth of other sectors by keeping the pound artificially high, thus making our exports more expensive. And as the global economy stutters and financial risks pile up, fears are growing that the UK’s debt-led, asset-based economic model could once again hit the buffers. Maintaining the status quo ante would leave all of these problems in place. The ‘Singapore-on-steroids’ model would put them, well, on steroids.
Professor Sarah Hall of the University of Nottingham has suggested that, faced with this dilemma, Johnson’s most likely path could in fact be a return to a version of Blairism – where tax receipts from financial services are used to fund infrastructure and social programmes in the rest of the country. Johnson has already signalled his willingness to abandon austerity and to talk the talk of regional rebalancing.
But there are reasons to think that this strategy will have limits in practice. It’s debatable whether his new northern voters will be satisfied with token gestures like promises to reopen a few closed railway lines or relocate the House of Lords to York. This may work for a while, but will it really carry him through five years of government?
Even if he does significantly boost spending, it is now widely accepted that the grievances that drove the Brexit vote in the first place were not just about money but about power. People want to see their communities regenerated, the return of good jobs and thriving high streets – and it’s very difficult to see how this can be achieved with an economic model that still relies on financial services.
Finally, under any version of the ‘Singapore model’, the pressure on tax receipts will only be down. Indeed, the sector is already exploiting concerns about London’s loss of global competitiveness to push for, as Stephen Jones of UK Finance delicately puts it, “a tax system that makes us attractive for international investment”.
There is an alternative
Of course, there is a third option. If change is coming one way or another, we could use this as an opportunity to reshape the UK’s broken economic model for the better. Given that much of the global investment banking activity threatened by Brexit comes at questionable value (and significant risks) to the wider economy, we could simply let it go and seek to shape a smaller sector, more focussed on supporting the domestic economy. Policy tools could include the promotion of new public and co-operative banks focussed on regional business lending, along with regulation to curb the power of big banks (for example, through full separation of retail and investment banking activities) and steer them towards more socially and environmentally sound business models (for example, by changing capital requirements and other aspects of prudential regulation).
Meanwhile, a green industrial strategy could focus on nurturing the industries of the future, spreading their benefits to people and communities across the country through local democratic ownership models. Such a strategy would no doubt come at some short term readjustment cost (as indeed does any realistic version of Brexit), but its long term benefits could be immense.
Sadly, the outcome of the UK general election has all but destroyed the prospects for this path. It seems inconceivable that Johnson will attempt to pursue such a fundamental restructuring of the UK economy, let alone that he will do so along democratic and sustainable lines.
Fishermen vs financiers: will Johnson have to choose?
Whatever Johnson’s preferred Brexit outcome, he does not have complete control over events: much will depend on the coming negotiations with the EU. In financial services as in many other things, the UK’s post-imperial delusions of grandeur may collide with reality. While the rest of the world takes steps to reduce its dependence on UK finance, the UK is still heavily over-dependent on selling financial services to the rest of the world. Moreover, 49% of UK bank assets are held by foreign banks, making the sector uniquely vulnerable to the loss of its global position. It has been suggested that London’s strength as a global player makes it one of the few cards in the UK’s negotiating hand, but early signs are precisely the opposite. EU leaders are already indicating that they will be using the UK’s need to maintain market access for financial services as leverage to secure concessions in other areas, notably access to fishing waters.
This offers a fascinating microcosm of the political choice Johnson is about to face. Fishing is dwarfed by finance in terms of its raw contribution to the UK economy – but it has become hugely politically significant to the Brexit debate. The ability for struggling coastal communities to thrive again by ‘taking back control of our waters’ has become a touchstone for so many of the issues surrounding Brexit, from xenophobic nationalism to democratic independence to the anger of communities who feel abandoned by politicians.
But if EU leaders are not bluffing, it may well be that the price the UK must pay for maintaining market access for the City is to leave existing fishing rights largely unchanged. Effectively, Johnson may be forced to choose between two very different parts of his electoral coalition: working class voters in the English regions, and the economic elites of high finance.
Of course, in true Johnson style, he may be able to fudge a solution that can be spun as ‘taking back control’ of fisheries policy whilst essentially giving the EU what they want. Or it may be that these dynamics push him towards the Singapore model, which is less reliant on EU market access and assumes greater regulatory divergence.
Either way – and whichever part of the financial services industry he chooses to hitch his wagon to – it is hard to imagine Johnson throwing the City under the bus. As Professor Sarah Hall puts it, while Johnson’s new base creates real political dilemmas for him, “it would be a mistake to assume that this will automatically result in the voice of the financial services sector not being heard in the Brexit trade negotiations.”
Certainly, their own comments suggest that when push comes to shove, senior executives trust him to look out for their interests. In all the ongoing uncertainty of Brexit, one thing can probably be relied on: the power of high finance to shape our politics and our economy is not going to disappear any time soon.