Failure to spell out transition plan could put global financial security at risk

The City is really three financial centres rolled into one: it is the UK’S financial centre, it is the EU’S financial centre and it is a global financial centre. Very roughly, about a third of the work it does (and the money it makes and the tax revenues it generates) can be ascribed to each role.

The City’s role as the UK’S financial centre will be broadly unaffected by Brexit. That’s also true of its role as a global financial centre (indeed that part could grow under a positive scenario in which the UK strikes new trade deals and financial relationships).

The bit at risk is the City’s role as a EU financial centre. Even here, not all of the business would evaporate overnight under a “hard” Brexit. Approximately half could still be done “offshore”. But the other half would require some form of “passporting”, which probably wouldn’t be available under a no-deal scenario.

This means that up to a sixth of the City’s business and jobs (not just bankers but also support functions and the firms whose work relies on the City – such as lawyers and accountants) could be affected. Several studies have estimated the figure at around 70,000 to 100,000 jobs.

This is clearly not the exodus that has been predicted by the doommongers who have conjured up empty trading floors in Canary Wharf and tumbleweed rolling down Threadneedle Street. No banks will quit London; the City will remain a large and important financial centre even after a hard Brexit.

But it is still a lot of highly taxed jobs. Mark Carney, the Governor of the Bank of England, pointed out in his Mansion House speech that the taxes generated by the UK financial industry covers two thirds of the NHS budget each year. Reduce this by a sixth and you have to make some pretty big cuts.

When will the banks start moving? Many City firms say that it will probably take them up to 18 months to set up EU operations. Regulators are pushing firms to prove they can handle a hard Brexit because they’re worried that there could be a systemic market failure if they can’t.

That’s why the next couple of months are crucial. If the UK Government and Brussels are not able to spell out the transition plan very soon, City firms will have to operate on the assumption there won’t be one and press the button on their contingency plans around the turn of the year. Some may already have. They could, of course, still have to move roles and functions after the transition period depending on what new rules the UK agrees with Brussels.

As well as being split in three by the parts of the world it serves, the City is also broadly split in three by the functions it performs. The first is the asset managers, who invest money on behalf of pension schemes and insurers. The second is the investment banks, which provide advice and finance to companies and broker trades for asset managers. The third is the market infrastructure – the stock

exchanges, the clearing houses and the other pieces of “plumbing” that connect the different parts.

Much of the debate about the impact of Brexit on the City has focused on this last part and especially clearing (a quite complicated, very boring and extremely lucrative function). That is because the huge majority of clearing in derivatives that are priced in euros is done in London. The eurozone countries disliked this state of affairs when the UK was merely outside the currency bloc and are even less happy about the prospect of it continuing when we leave the EU.

If you can’t clear euro-denominated derivatives in London it could become harder to trade them in London. This is where Brexit could hurt investment banks. And, if the EU’S financial centre of gravity moved, it could drag some asset managers with it too.

But this could be avoided. London is also an important centre for dollardenominated derivatives.

This is because the US and the EU have agreed to a system of joint supervision, whereby the watchdogs from both jurisdictions work together to police their markets. There is no reason that a similar arrangement couldn’t be reached between the UK and EU. Apart, that is, from politics. It would be unforgivable if Brexit is used as a pretext to fragment the global regulatory accord that has slowly and painstakingly been put in place since the financial crisis.

If that happens, it wouldn’t just be the City that suffered. It would become harder for European companies to raise money. And the safety of the whole global financial system would be undermined.