No sleep till Brexit: the city scrambles to deal with quitting the EU
As soon as Justin Urquhart Stewart arrived at his office on the morning of Oct 18, he huddled with his money managers and research chiefs. This was supposed to be a big day in the runup to Brexit.
UK Prime Minister Theresa May was supposed to make progress with European Union leaders on the last outstanding terms of Britain’s departure from the bloc on March 29. And financial institutions such as Seven Investment Management LLP, a London-based firm Urquhart Stewart co-founded 17 years ago, were supposed to finally get some clarity on a process that’s thrown their industry off balance for two years.
Yet everything that was supposed to happen didn’t happen— except for some talk about extending UK membership in the bloc in all but name for another year. Urquhart Stewart sighed. It was another kick-the- can moment. More political drama was bound to follow. The meeting over, Urquhart Stewart walked the floor of Seven Investment, which manages £14 billion ($18.3 billion) for middle-class British households. Phones were ringing, coffee was brewing, keyboards were clicking. Proudly old-fashioned, the firm’s male employees must still wear neckties. Urquhart Stewart, sporting red braces and cufflinks in the shape of his company’s logo, exuded the confidence of a 63year-old pro who’s weathered his share of market crises in the City of London.
But he’s really worried about Brexit. For the past few months, his team has diversified portfolios to lessen their exposure to the UK economy, prepared trades to hedge a potential steep drop in the pound, and even developed scripts to guide the firm’s relationship managers when they counsel anxious customers on this unprecedented process. Looming over everything is the increasing possibility that Britain will break away from the EU with no transition to lessen the turmoil. What’s to be done then?
“In normally moving markets I’ve got companies, I’ve got foreign exchange, I’ve got economic issues, and I’ve got political behavior within given norms,” Urquhart Stewart said. “Now I’ve got political behavior that is outside given norms, and that is having really dramatic effects that I can’t measure. So we huddle every day, and later we’re going to sit down and go through this in more detail and see what we can come up with to keep things safe.” Ever since UK and EU leaders deadlocked in Brexit talks this spring, there’s been a lot of huddling and brainstorming and war gaming in the City of London. The prospect of severing 45 years of regulatory integration in one fell swoop has jolted the world’s biggest international finance hub. Elements long taken for granted, such as market access and the integrity of contracts between buyers and sellers, are suddenly in flux. Everyone is trying to gauge what this means for their businesses. Money managers are worried about losing European clients. Bankers are scrambling to send more traders and sales staff to new outposts in the EU. Lawyers are confronting the Herculean task of transferring trillions of dollars of derivatives contracts to Paris and Frankfurt from London. And regulators are concerned that a hard Brexit may jeopardize financial stability.
“Many in the City didn’t believe that a no-deal scenario was possible—they thought it was just rhetoric,” said Alasdair Haynes, the chairman of Aquis Exchange, a London-based equities trading firm. “Now the reality is sinking in.” As the clock ticks down, financial firms are watching for any sign that a deal may be coming. On Oct. 31, the pound rallied after U.K. Brexit Secretary Dominic Raab predicted a deal with the EU will be finalized by Nov 21. He made the statement in a letter sent to a Parliamentary committee on Oct 24. Meanwhile, it appeared that U.K. financial services firms may obtain continuing access to EU markets post-Brexit after negotiators from both sides reached an agreement to align British regulations with those of the bloc, the Times of London reported, citing unidentified sources. Suddenly, the situation for the City has become very fluid.
Even if May bridges the warring factions in her party and reaches a deal with Brussels, the City is still going to feel the pain, say bankers, money managers, and finance experts interviewed for this article. For decades, London has profited from the forces making the world’s capital markets more open, liquid, and efficient. The financial-services industry employs more than 1 million people, generates almost £70 billion in annual taxes, and delivers a trade surplus of £58 billion.
Deal or no deal, Brexit throws sand into those gears—“frictional costs,” in the words of Matthew Chamberlain, the chief executive officer of the London Metal Exchange. Plus there’s the economic toll of a divorce. On Oct 26, Royal Bank of Scotland Group Plc set aside £100 million to cover the fallout from a recession or other adverse effects from Brexit. No matter what happens, it’s hard to see how the City comes out of this ahead. “Inevitably we are going to lose some business,” said Catherine McGuinness, the chairman of the policy and resources committee at the City of London Corporation, which governs the financial district.
With five months left to go, there are still many possible outcomes, including a snap election and the installation of Labour Party firebrand Jeremy Corbyn in 10 Downing Street, a scenario that frightens City denizens even more than Brexit. One thing does seem certain—if Britain drops out of the EU with no deal, the City of London will swerve from a trajectory set in the 1960s. That’s when its financial engineers created Eurodollar bonds, debt denominated in U.S. currency that could be issued by any company outside the US These handy instruments helped drive globalization and channeled a river of money through London. After Margaret Thatcher deregulated financial services in the so-called Big Bang of 1986, the City became the undisputed gateway to what would become the world’s biggest trading bloc, the European Union.
Now that the U.K. is opting for isolation, the City’s role as a portal to Europe will diminish for years to come, say economic historians. If there’s no deal, U.K.-based firms would face severe restrictions on EU-related business, and half the City’s revenue tied to the bloc, or £20 billion in annual revenue, would be at risk of slipping away, according to consulting firm Oliver Wyman. So, too, would 35,000 jobs and £5 billion in tax revenue. And perhaps most poignant, there would be a chilling effect on new investment in the industry.
“It would be a defining moment,” said
Emmanuel Mourlon-Druol, an economic historian and author at the University of Glasgow. “And the damage wouldn’t just be financial—it’s also a question of reputation. The UK government would be seen as unreliable, incompetent, and unaware of the consequences of its decisions.”
Taking in the Square Mile on a radiant autumn day it’s hard to believe a place this vibrant might lose its swagger. The cone-shaped Gherkin tower, once a lonely symbol of the City’s prosperity, is now surrounded by construction cranes erecting taller neighbors shaped like trapezoids and parallelograms. Across from the stone ramparts of the Bank of England, men and women socialize in the area’s hottest new club, The Ned, a palatial former lending house where guests sip cocktails inside a giant vault. And everywhere you can see the symbiosis of the City’s heritage and a digital future. On weekday afternoons, dealers wearing suits take their positions on the red sofas of the trading ring at the London Metal Exchange and buy and sell copper, aluminum, and tin the old-fashioned way— with their voices and hand signals. One floor below, table-tennis-playing entrepreneurs are hatching financial startups in a cushy WeWork-like space.
It’s possible, of course, that at the last minute British and EU leaders will strike a deal, and this crucible will come to an anticlimactic end. Remember the brinkmanship that preceded the resolution of the Greek debt crisis in July 2015 and dispelled fears of “Grexit.” Optimists say there’s too much at stake for both sides to let the UK crash out of the bloc. Stephen Jen, CEO of Eurizon Slj Capital, a London hedge fund, is betting both sides will come to terms in December. He’s told clients that his valuation model shows the pound’s fair value at $1.55, 22 percent higher than its price on Oct. 31. “I just can’t imagine that after so many months of negotiations we wind up with no deal,” Jen said. “Brexit cannot be seen as a success from the European side, so there has to be a struggle. And Brussels is playing this quite well.”