The scene is a pub in the City a few weeks before the British EU referendum on Brexit. I’m with a former colleague of mine; he looks a touch weary. “Anyone who works in finance in London who votes to leave the EU is a cretin”, he tells me, an edge of frustration in his voice, “it would be a disaster”. Not least a disaster for him personally, it seems. As a senior banker, he would need to be involved in the man-years of tedious meetings and planning sessions needed to cope with the fallout. “I can’t imagine a change that would cause me a bigger balls-ache – I’ll be swimming in sodding paperwork for a decade”, he sighs.

His view was (and is) a common one and it is easy to understand why. Banks like to see a bit of economic uncertainty: if funds, corporations and individuals disagree about the future and feel at risk, they are more likely to come to a bank to offset the risk or to take more of it. After all, one of banks’ key functions is to help the economy transform risk; from this transformation comes profit.   But bankers are far less keen when the uncertainty applies to them. Managerial energy that could be directed towards making money now needs to be focused on planning for, and coping with, a new world. Each individual is concerned with how will it affect them.  A Frenchman, say, living in London, wonders what exit will mean for where he and his family will live. It is probably not particularly surprising then, that several large banks helped fund the Remain campaign; Goldman Sachs and Morgan Stanley among them. But it was to no avail. On a date and by a margin that will rapidly become part of history (5248 may become as familiar a four digit number to future school children as 1066 or 1815) the UK voted to Leave. What does it mean for the City?

The honest answer is that, like Zhou Enlai’s quip about the effects of the French Revolution, “it is too early to say”. Not least, there is still some lingering doubt about whether the UK even will leave. Article 50 still needs to be invoked; any new deal needs to be voted on by a heavily pro EU parliament; party leadership is in flux. (As an aside, I think this explains the relatively muted impact of Brexit on stock markets: deep inside funds’ computer models of the future, one potential, albeit low likelihood, path is non-exit and a huge relief rally.) But even if the UK does leave – an outcome that I personally think is a racing certainty – the shape of a future relationship with the EU is completely unclear: could the UK be like an EFTA nation, one from the EEA, or just rely on WTO rules? This alphabet soup of possibilities masks a simple, but sharp policy choice – given that the EU’s demand that free trade is irrevocably linked to freedom of movement and given the nitroglycerine-like status of immigration in UK politics – how much freedom of trade will the UK give up to achieve limits on freedom of movement?

The future of the City will be one (high value) poker chip in this international game of “Exit Hold’em”. At stake, the so-called ‘passport’ that allows financial firms in the UK to sell into the EU. In one potential future state, where the balance between trade and immigration is settled with a bias towards trade, the UK does a deal in which the passport is retained. In this world, the impact on the City will most probably be fairly limited. Regulations will still be consistent across the EU and the UK (but with the UK playing no part in setting them) and the numbers of financial employees based in London and the mix of services they provide would look similar to the situation today. No doubt there would be some inconvenience and some attempt by EU nations to attract business to Frankfurt or Paris or Dublin, but I question how successful those efforts would be. Paris is wonderful but most financiers don’t speak French; Frankfurt is dull (and fewer still speak German); Dublin is great and the locals speak English but it hasn’t got London’s deep pool of expertise or legal infrastructure in place.

What’s more interesting is what happens if the negotiations result in a loss of the passport – an outcome that, even if it does happen, may only happen years into the future. In this world, a chunk of banks’ activities could no longer be carried out in London; the inevitable result would be a big geographical shift for banking business lines. This shift would not be an insurmountable practical problem (leaving aside my friend’s worry about managerial  ‘balls-ache’) since most big international banks that use London as their European base also have offices in other EU nations. My old employer Deutsche Bank has a substantial trading floor in Frankfurt and decent facilities in Paris and Milan, too. Large banks, then, would ultimately adjust. But how would the UK adjust? The key, I think, is regulation.

There is no doubt that, in part, the shape of  country’s banking regulation is not just about the safety of the financial system – it is also about attracting business and the tax receipts that go with it. As one expert commentator put it about the UK’s decision in the late 1990s to move towards a ‘light touch’, principles-based regulatory regime (‘PBR’):

‘Beyond the official rhetoric, there is also a clear subtext to much of the political debate. In the US–UK context, and to an extent in the EU–UK context, PBR is intimately embroiled in a competition between regulators (and their governments) for business. There is no doubt that, at least at the rhetorical level, PBR is a weapon in the fierce battle for business between London and New York.’ [i]

With tens of billions of sterling in tax revenues at stake for the UK (around 10% of all government income), my guess is that regulatory competition would come roaring back into fashion, especially if a ‘market friendly’ Conservative government was in power. Expect the current EU-created limitations on pay to be torn up; deals to be cut to attract hedge funds; EU rulebooks like MIFID to disappear. In this world, London would likely become a deregulated floating offshore challenge to the EU: a buccaneering centre of the more fringe aspects of modern finance.  It would stand as a sort of European ‘reverse Cuba’ separated from the mainland not by the Florida Straights but by the English Channel.  To put it mildly, this unintended consequence of the referendum may not be one that many who voted Leave would necessarily welcome.

 

[i] ‘Forms and paradoxes of principles-based regulation’, Julia Black, Professor of Law and Research Associate, Centre for the Analysis of Risk and Regulation, London School of Economics and Political Science, Capital Markets Law Journal, 3/4, 10 September 2008, http://www.lse.ac.uk/collections/law/staff%20publications%20full%20text/black/forms%20and%20paradoxes%20of%20pbr%202008.pdf