The UK financial services sector (including related professional services) accounted for over 10% of GDP and employed more than 2.3 million people at the end of 2019 (Source: CityUK). Moreover the financial services sector is the largest UK taxpayer (more than 10% of all tax revenues) and the biggest exporting industry generating a trade surplus of US$77bn in 2019 (including related professional services some US$102bn) - the largest in the world.
Yet in contrast to goods and manufacturing, and even the tiny fishing industry (accounting for 0.02% of GDP according to the ONS) there was barely a mention in the Trade and Co-operation Agreement (TCA) bar a Memorandum of Understanding which so far has largely been limited to derivatives so as to maintain EU market liquidity. This was no oversight. The EU has a large goods trade surplus amounting to £97bn in 2019 with the UK but a services deficit of some £18bn with us. In fact over a third of our financial services exports currently go to the EU.
The EU countries have longed to see EU financial market business move within its sphere with a belief that such activity should be in the core Eurozone. Its aim in the negotiations was if possible to avoid such agreement whether this would be in terms of mutual recognition or in some form of equivalence - other than dynamic alignment - so that it could chip away at London’s dominance of the European financial markets. (The City accounted for nearly 80% of its EU foreign exchange trading, three-quarters of derivatives trading, 85% of hedge fund activity, and 60% of capital market business). It has largely viewed this strategy as based on a zero sum game when in reality there are costs associated with such a policy of market fragmentation in terms of the loss of economies of scale, and of expertise and the knowledge that London has. The EU’s approach was greatly facilitated by a poor negotiating strategy by the Tory government under PM May and a “Remainer” Parliament (and other institutions) that
resulted in the UK giving into the sequencing of negotiations preferred by the EU that resulted in the Withdrawal Agreement and the loss of our negotiating strengths including payment of the £40bn divorce bill, the effective splitting of the UK between GB and NI, and the granting of freedom of EU residents to reside in the UK.
Anyway the damage to the City has been nothing like most commentators had predicted, just like with Brexit more generally. Many typically forecast the loss of up to 100K or even 200K jobs. A London Stock Exchange Survey in 2016 concluded that 232K financial services could leave the UK. By contrast I suggested that it would be more like 10K and that the City would continue to prosper in various reports and speeches that I have made (eg Brexit and Financial Services 2017). The reality is that some 7.5K jobs had left according to the EY Financial Services Brexit Tracker at the end of 2020. It also states though that some £1.6trn assets had been transferred – a figure that has increased since. Moreover the number of people working in the City has continued to rise since the referendum result. An FT Survey of 24 large international banks and asset managers in December found the majority had actually increased their London headcount over the past five years.
There will be further negotiations between the UK and the EU on access to financial markets in the coming months that may yield further agreements in areas such as reinsurance but they are likely to be modest. The EU will only agree to anything if it clearly benefits them. The EU’s preference is for the City of London to follow EU regulations very closely. But as Andrew Bailey the Bank of England governor recently said we should not become a rule taker, which would not only lead to us losing the opportunity for better and lower regulation but also as Michel Barnier, the EU’s Chief Brexit Negotiator said any access to EU financial services is a gift from Brussels than can be withdrawn freely – clearly one cannot operate under such a
threat. We should be focusing on how we can protect our position as a global financial
powerhouse. And anyway despite diverging from EU rules and the loss of passporting, international law protections will still allow financial institutions to provide certain cross border services to wholesale clients.
The City of London is one of only two leading global financial centres (see the rankings in the Global Financial Centres Index produced by Z/Yen consultancy) and its future lies in being a global centre, being innovative and not hampered by unnecessary regulation and high taxation. London is competing against the likes of New York, Tokyo, Singapore, Shanghai and even Dubai or Bahrain. Not so much against Frankfurt, Paris, Amsterdam or Dublin, none of which can be viewed even as serious rivals as a leading European financial centre. For example in the rapidly growing fintech sector, our rivals are really only Silicon Valley, Hong Kong and Singapore.
The best approach is what Barney Reynolds of Shearman and Sterling LLP has dubbed the World Financial Centre Model where we go alone and design a more attractive regulatory framework, freed of the EU’s restrictive policies and process-driven approach. In light of this, UK Chancellor Rishi Sunak is promising a “Big Bang 2.0”. While good governance remains paramount there is a desire to cut unnecessary red tape with changes to the EU rulebook such as on MIFID2, and Solvency 2 for insurance companies. Also recommended as by the Institute of International Affairs is that the UK form alliances with other major financial centres
through multilateral mutual recognition. Switzerland and Singapore would be two obvious financial centres.
Pivotal to the success of the City going forward will be the Fintech sector. It is worth £7bn employing over 60K people in the UK and includes brands such as Monzo, Revolut and Starling Bank. An independent review of the sector led by Ron Kalifa was launched in the Budget of March 2020 to support the City’s competitiveness through “ensuring it has the resources to grow and succeed, conditions that are right for the widespread adoption of financial technology, and that the UK’s global reputation for innovation is maintained and advanced. Also important is Green Finance where again it is one of the world leaders alongside specialist financial centres Amsterdam and Zurich. Over the last three years the amount raised in green bonds has almost tripled from £8bn in 2017 to £22.4bn in 2020 with 139 listed on the London Stock Exchange. There are also now 22 green funds listed on the LSE. Furthermore the UK is leading the world in committing to reaching net zero carbon emissions by 2050. It has committed £12bn investment in green finance over the next 5 years among other things.
The City has a long history of resilience, adaptability and reinventing itself. It survived the 1930s and two world wars. It saw the rise of the Eurobond market in the 1960s as a result of US balance of payment controls. And it prospered after ‘Big Bang’ which was launched in October 1986 by the Thatcher government with its extensive market deregulation. Finally, it was unaffected by the UK’s decision to join the Euro. In any case despite the lack of agreement the City prepared well for Brexit and I have no doubt that the right steps will be taken to ensure its future prospects are rosy.
*Patrick Dennis is a British Economist currently working with Oxford Economics. He has spent nearly 40 years working as an economist in the City of London and its environs. He served as Chief Economist at the Industrial Bank of Japan and was also senior economist for both National Westminster Bank and Royal Bank of Scotland. He holds a postgraduate degree from Corpus Christi College, Oxford University.