It is becoming increasingly likely that the UK will have a referendum on whether to stay in the European Union. It’s not just that David Cameron, the prime minister, has promised to hold such a vote by 2017 assuming he is re-elected. The drumbeats from the opposition Labour Party that it too would hold a plebiscite are becoming louder. Opinion polls show that Britons would currently vote to quit.
Of the many industries that would be hurt by such a “Brexit”, the City of London is the most prominent. The damage would range from moderate to severe, depending on the extent of the amputation.
The City is not just the UK’s financial capital. It is also Europe’s financial capital and vies with New York to be the world’s financial capital. The UK accounts for 74 percent of the EU’s foreign-exchange trading and 40 percent of global trading in euros; 85 percent of the EU’s hedge-fund assets; 42 percent of its private-equity funds; and half of pension assets and international insurance premiums, according to a recent report by TheCityUK, which represents the UK’s financial services industry.
What’s more, 37 percent of the UK financial services industry’s trade surplus is with the rest of the EU; over 40 percent of foreign firms coming to the UK cite access to the EU’s single market as a core reason for doing so; and around 40 percent of the tax take from financial services is from international businesses operating in the UK.
It is fantasy to suggest that all this business would vanish if Britain quit the EU. But it is equally fantasy to suggest that the rules which constrain how the City operates would go in a puff of smoke in such a scenario.
The extent of the damage would depend on the type of Brexit. The least harmful would be a decision to quit the EU but stay in its single market. This could be achieved by Britain becoming a member of the European Economic Area like Norway.
The snag is that EEA members do not get to vote on the rules of the single market. Britain would, therefore, be left in a position where the rest of the EU would have a free hand in determining how the City was regulated. It might even deliberately damage the UK in order to shift business from London to Frankfurt or Paris. In such a situation, many firms based in the UK would relocate some of their activity across the Channel to be closer to where decisions were taken – dragging jobs and tax revenue with them.
This is a worse position than the status quo. Although the UK cannot currently veto EU financial services legislation, in practice it has only once lost out: when Brussels decided earlier this year to cap bankers’ bonuses.
But the damage would be far more severe if the UK quit the single market as well as the EU and relied merely on its membership of the World Trade Organisation to give it access to foreign markets, as some eurosceptics advocate.
The WTO is largely about protecting trading in goods, not services. It would not guarantee UK-based firms access to the single market in financial services by what is known as the “passport”. This entitles firms based anywhere in the EU to provide services anywhere else in the EU either remotely or by setting up branches so long as they are regulated by their home authority.
If Britain relied just on the WTO, firms wanting to do business in the EU would have to relocate there by setting up subsidiaries. There would be a loud sucking sound as both the UK and foreign firms transferred jobs, wealth and tax revenue across the Channel. British citizens wouldn’t necessarily even be able to follow these jobs abroad because, post-Brexit, they wouldn’t have the right to work in the EU.
Meanwhile, the City’s competitiveness would be undermined if Britain no longer allowed EU citizens to work in the UK. While post-Brexit it could still let them enter, it seems unlikely that Britain would adopt such an open policy. That’s because one of the main reasons that eurosceptics give for quitting the EU is to stop immigration in the first place.
It is also most unlikely that Britain would throw out its financial services regulation if it quit the EU. It needs rules to stop the system blowing up. And it makes sense to coordinate these rules internationally to make sure things don’t fall through the cracks as they did when Lehman Brothers went bust in 2008. It’s true that Britain would be free to uncap bankers’ bonuses. But would that really be a populist priority post-Brexit?
Some eurosceptics think the City would be better able to act as the world’s financial capital if it was cut free from Europe. The opposite is likely. The City enjoys economies of scale from being Europe’s financial capital. Without that position, it would be less competitive and its ability to serve fast-growing markets in the rest of the world would be compromised.
There are, of course, half-way houses between Norway’s position and relying simply on the WTO. The damage to the UK’s financial services industry would then be somewhere in between that suffered in these two scenarios. Far better to stay in the EU and push to enhance London’s role as Europe’s and the world’s financial centre. The City should campaign for this vigorously.