Dr Gerard Lyons is a senior fellow at Policy Exchange. He was Chief Economic Adviser to Boris Johnson during his second term as Mayor of London.
How is Brexit impacting the City and how optimistic should we be? The House of Lords European Affairs Committee has launched a timely inquiry into the UK-EU relationship in financial services. I testified to it recently.
London looks set to remain one of the world’s leading financial centres, but the last six years have shown it faces intense global competition and political pressure from an aggressive EU, which hopes to grab some of the lucrative business that takes place in the Square Mile.
While some reforms and important reviews, such as Lord Hill’s Listings Review and the Kalifa Review of UK FinTech, have taken place, the Government has yet to unveil a clear longer-term vision to seize upon the opportunities afforded by leaving the EU.
Its failure to act has allowed an unnecessarily negative narrative about post-Brexit Britain to prevail and has also prolonged uncertainty, including towards the City.
One narrative is that London’s influence is experiencing a slow bleed; another is that Brexit is a dripping tap, with job losses to the EU being stymied only because of the pandemic. Both fail to appreciate fully London’s inherent competitive position, and that it is Europe’s only major global financial centre. They also fail to recognise that with the right vision, and enough ambition, Brexit can benefit the City.
The competitiveness of a global financial centre depends upon its inherent characteristics such as the rule of law, its regulatory environment and being a place where clients and firms want to conduct business because of deep and liquid markets.
Despite the importance of both financial services to the UK economy and of the City to Europe, the future relationship in financial services did not figure prominently in the Brexit Withdrawal Agreement.
One of the biggest issues since 2016 has been the issue of passporting, and that the UK and EU did not reach an equivalence deal on financial services, which would have allowed firms to continue to conduct their business much as before, cross-selling across the EU. This has changed.
In such an uncertain environment, and depending upon their business model, some firms, who previously might have serviced clients from London, now do so from within the EU.
Hence there has been a sharp fall in both exports and imports of financial services to and from the EU. Between the second quarter of 2019 and 2021, such exports are down 31 per cent. Nonetheless, the UK still runs a healthy surplus in financial services, including to the US and has seen exports rise to non-EU countries.
Some jobs have moved from London to other European capitals. The survey most widely cited is from EY that around 7,500 jobs were lost; mind you, ahead of the Referendum EY thought thay 10,500 jobs would go on day one.
In spite of this – and despite the pandemic – it is generally accepted that London has seen a far bigger net increase in jobs since the referendum, reflecting the City’s vast ecosystem across financial services.
Another piece of positive news last year was that close to 1,500 firms had applied for permission under the UK’s temporary permissions regime to operate here. Many may seek to have a meaningful presence in London, thus investing and recruiting here.
This strength is evident in the half-yearly survey of global financial centres from Z/Yen. This simultaneously highlights London’s strong position while reflecting the importance of not being complacent, as other centres compete more aggressively – with Paris hoping to gain most at London’s expense.
London is second to New York, with Hong Kong and Singapore making up the top four. Outside the top places there can be frequent moves. Currently, Paris is 10th, Frankfurt 14th, Amsterdam 17th, Edinburgh 22nd and Luxembourg 23rd.
Two other regularly-quoted statistics to show London’s supposed decline include Amsterdam displacing London as the centre for share trading. It hasn’t, as I have explained previously, since the bulk of such trading never makes it onto exchanges and much of this still takes place in London. The other is that the interest rate swaps market has become more fragmented, with New York gaining at London’s expense.
At the same time, London dominates in electronic and automated trading, and indeed accounts for over two-fifths of global trading in foreign exchange and derivatives.
Indeed, London has a strong foundation on which to build, but it needs to remain at the forefront of change, particularly in new markets. In that regard, the last few years have been positive, with the UK establishing a strong position in green, sustainable finance and in financial technology (FinTech), both of which are seen as major global growth areas. Furthermore, London has a strong foothold in Islamic finance.
Events since 2016 are very much in line with those one should have expected, as firms adjust. The key is what happens from here. The UK needs to be more on the front foot, since the EU is unlikely to alter its aggressive stance.
A successful strategy needs to cover an effective role for financial services in helping the UK economy; and strengthening the City’s competitiveness.
The City has benefited in recent decades from London’s appeal as a place to live, work and visit. Let’s hope London’s vibe is evident again post-pandemic although, like other global financial centres it is now an expensive place to live, hence the importance of the UK ensuring its taxes are competitive.
During the 1960s, after the US introduced uncompetitive taxes, the international market in dollars moved to London. Perhaps likewise now. The UK should diverge from the EU on financial services regulation when it suits, helping London to become the attractive offshore venue for euro-denominated instruments.
Last summer, I produced a strategy paper for Policy Exchange highlighting ways of seizing the initiative, particularly with a regulatory approach where the UK would be at the forefront of modernising financial regulation – utilising RegTech and SupTech.
This need not be a race to the bottom, but it does mean easing the regulatory burden with smart regulation that makes sense where it applies. Outside the EU, the UK will also have the greater ability to be responsive and nimble in its actions.
Also, the City needs to return to being a home of top quality research, an area in which it lags New York, and in which it is not helped by MiFID 2. London also needs to invest heavily in its infrastructure, as other cities, including across the EU, are pumping money into their data and digital infrastructure.
The House of Lords committee was keen to understand why, despite having identical regulations with the EU when we left, only one EU equivalence decision concerning Central Counterparties remains in place for the UK, while in contrast the UK has granted equivalence to EEA member states in 28 out of 32 areas.
Central counterparties were granted for financial stability reasons – because the UK has the legal underpinning to make this work and the EU does not. While, in other areas, some might say that a politically motivated environment has ensured that the UK has not been afforded the same freedoms granted to other third countries such as the US or Singapore.
The devil in the legal detail is critical in such equivalence agreements, and while not having these may put some firms at a competitive disadvantage, it is important for the City’s future that the UK retains its regulatory independence. Equivalence is nice to have, but achieving it should not be a focus of future policy. Instead, this should be on ensuring London’s future competitiveness.