Re-evaluating London’s place in global investment

December 2016  |  FEATURE  |  FINANCE & INVESTMENT

Financier Worldwide Magazine

London’s place in the hierarchy of great global cities has been guaranteed for decades, if not centuries. It has long been viewed as a cultural, legal and political powerhouse. London has also been a global financial hub, the epicentre of considerable financial and economic activity aided by the mechanics of the national and regional dominance that the city exerts over the rest of the UK – and arguably, Europe’s other financial centres.

In September 2015, London’s status as the world’s leading financial centre was cemented when it overtook New York in rankings compiled by Z/Yen Group, which determines the most competitive places to do business. On the strength of ringing endorsements from businesses in Eastern Europe, North America and the Middle East, London was recognised as the best financial centre in the world, beating off strong competition from traditional competitors and newer rivals in emerging markets.

Yet the fate of the city’s position at the top of the global finance table has been called into question by the UK’s referendum on EU membership in June. The notion of a Britain outside of the EU and without access to the single market is gaining ground. In October, prime minister Theresa May delivered a ‘hard Brexit’ speech to the Conservative Party conference in Birmingham, England in October. This would put the viability and popularity of London as a hub of global investment in doubt, particularly as global investment figures begin to fall. The vulnerability of the UK economy to its departure from the EU may be most clearly demonstrated in the financial services space, which contributes around 10 percent of national GDP. Many leading banks and financial institutions have questioned whether they will remain headquartered in London following the vote. It is entirely possible that Britain, and London in particular, will play a greatly diminished role in future European and global investment.

It is clear that the nature of the UK’s relationship with the European Union and the single market will have a considerable bearing on London’s footing in the global investment market. But Ms May is playing her cards close to her chest, noting that the government will not provide “running commentary” on the process. Early indications, however, suggest that the UK may opt for the most drastic, or ‘hard’, version of Brexit, which would have a colossal impact on the nature of London’s financial services sector.

Over the past 30 years the City has become increasingly international, with US and other global banks now prevalent. Crucial to their presence in London is the EU principle of ‘passporting’, which allows them to access the European single market without restrictions. Removing the UK from the single market would challenge their logic for using London as the base for their European operations, when relocating to Frankfurt or Paris, for example, would allow them to remain inside the single market. Russia’s VTB Bank became the first big lender to publicly announce plans to move its investment banking headquarters out of the UK as a result of the expected disruption arising from Brexit. It may be the vanguard for other financial institutions moving out of the city, which would cause serious issues for London’s financial services industry.

The mood on the ground

In mid October, a number of senior executives from the European divisions of some of the world’s biggest financial institutions told the UK Financial Services Brexit Summit in London they felt the government’s tougher rhetoric on immigration risked harming the economy and threatening the continued presence of banks in the City. Robert Rooney, chief executive of Morgan Stanley International, also highlighted the concerns over passporting. He suggested that his bank would be forced to move parts of its operations from London if Britain were locked out of the single market. “It really isn’t terribly complicated. If we are outside the EU and we don’t have what would be a stable and long-term commitment to access the single market then a lot of the things we do today in London, we’d have to do inside the EU 27,” he said.

This concern has been echoed by the chief executive of the British Bankers’ Association, Anthony Browne, who, in an October article in The Observer, warned that “the public and political debate at the moment is taking us in the wrong direction” over Brexit. According to Mr Browne, Britain’s biggest banks are preparing leave the UK in the first quarter of 2017 amid growing fears over the impending Brexit negotiations, and it is possible that some smaller banks operating in the UK may leave before the end of 2016.

The fact that EU banks based in the UK are currently lending £1.1 trillion, and are in effect “keeping the continent afloat financially” is of further concern, particularly given that this arrangement appears increasingly uncertain. Whether Mr Browne’s stance on the future of the City truly reflects the potential impact of Brexit, or whether he and the BBA are attempting to influence the government’s stance is pure conjecture, but it is clear that the process of leaving the single market and the four EU freedoms that are tied up with access to that market will have a transformative effect on the City’s financial services space. Jobs and firms will leave; the question is, how many?

According to the Z/Yen Group, a number of financial institutions are considering Luxembourg and Dublin as potential locations if they leave the UK. But it is difficult to predict where banks may decamp to. Frankfurt, Paris, Lisbon and others may benefit, although there is no overarching favourite which could conceivably accommodate a mass influx of companies and people. Goldman Sachs suggested as many as 2000 jobs would leave the City if passporting rights were not guaranteed. Financial services body TheCityUk has claimed that up to 70,000 financial jobs could be lost if Britain leaves the EU without a new relationship agreed for the City of London.

An inflow of thousands of new staff could overwhelm existing financial and legal services infrastructure in other cities. Solidifying operations in the US may be an option for some banks, alongside strengthening offices in the Far East.

The fact that more than 5500 UK registered companies rely on ‘passports’ to do business in other European countries demonstrates the scale of disruption that Brexit may cause. The number of job losses could be enormous. A potential exodus of banks was also emphasised by the Open Europe think-tank in mid October, which claimed that banks could start deciding to move assets out of the UK as early as the end of 2017 if there is no deal in place to maintain their rights to sell services freely across the EU.

In further troubling news for London, there have been suggestions that the European Central Bank may follow through on its attempts to bar clearing houses outside the eurozone from handling the euro. The ECB had attempted to push this through in 2015, but a ruling from the EU’s highest court stopped the plan. Now that the UK is to leave the bloc, it is possible – or even likely – that the ECB will try again, with a much greater chance of success.

Proposed plans to force companies operating in the UK to list their foreign workers in an attempt to ‘name and shame’ those that do not hire British workers have set alarm bells ringing. Though dismissed as merely a proposal, such plans are indicative of the confounding approach to Brexit currently being pursued by the UK government. The proposal caused an outcry from business groups, which labelled it divisive and discriminatory. Parallels were even drawn in some quarters to measures employed in Nazi Germany – proof that Godwin’s Law truly can be applied to anything, even the financial services sector. Regardless, suggestions such as this do not portray London and the wider UK as being open to foreign business and foreign workers.

The financial services industry harbours grave concerns about London’s future role on the world stage. In the short term, however, there is hope that London may still retain its status as the centrepiece of the global financial services industry. In spite of the country’s Brexit vote, London voted overwhelmingly to remain in the EU. A poll by City UK, a lobby group comprising most of the City of London’s big employers in banking, insurance and asset management, found that 84 percent of its members were in favour of remaining in the EU. The city is still a popular place for businesses to operate, thanks to a number of favourable conditions including the country’s time zone, the ubiquity of the English language, the rule of law and the ecosystem of professional services all operating within a reasonable distance of one another.

London retains its title… for now

While the UK draws up its plans in relation to exiting the EU, London remains at the top of financial centre rankings, according to the latest The Global Financial Centres Index released by the Z/Yen Group and the China Development Institute in Shenzhen. It is important to note, however, that the Z/Yen Group’s rankings were calculated using data collected up to the end of June. In the months following the report, London’s average score has dropped 10 percent, which is likely to affect its position in the 2017 index. The annual index is compiled using an online survey of 3200 financial professionals and 105 data sets, including the cost of living and office space, quality of internet and transport infrastructure, and measures of corruption and political stability. Other factors include quality of life, murder rates, inflation, foreign investment, value of bond and share trading, and tax rates.

Though there is understandable consternation, there is no immediate successor set to replace London as Europe’s investment capital. Though Dublin, Luxembourg and others may gain considerably in Europe, New York would probably reclaim its position as outright global leader in investment. Looking further afield, Hong Kong, Singapore and Tokyo make up the rest of the five leading global financial centres. London is just one point ahead of New York (on a scale of 1000 points). Singapore is 42 points behind New York in third place. Tokyo, in fifth place, is 60 points behind New York. How far could London slide down the scale?

Negotiations

For the UK, divorcing itself from the EU was always going to be a taxing and painful proposition. The ‘leave’ campaign was fought under the banner of taking control back from Brussels, but the notion of control is rather nebulous, and the European bloc will have a strong say in determining the nature of its future relationship with Britain. If Ms May and her negotiators are to secure the best possible deal for the country, some concessions will have to be made, particularly as banks and other financial institutions begin to leave the country. Given the UK’s reliance on the financial services industry, it is unlikely that the national economy – which is only expected to grow by 1 percent in 2017 according to S&P – would be able to withstand the substantial hit that the decimation of the City of London would cause.

In the interests of the UK economy and the future of London, passporting and access to the single market need to remain on the table.

© Financier Worldwide

BY

Richard Summerfield