British bank chiefs want clarity they can’t have. Executives from large financial groups met Philip Hammond on Sept. 7 to understand what the UK chancellor intends the sector to look like after an exit from the European Union. But Hammond and Theresa May, the British prime minister, will know that giving detail carries a downside.
Bankers’ yearning for guidance over what happens next is perfectly reasonable. If in the New Year Britain invokes Article 50, the act that would start the official Brexit process, the UK would only have two years to avoid what worried bankers are calling “the gap” – a period between UK institutions losing the right to conduct financial services for EU clients and whatever replaces the status quo.
Two years clearly isn’t enough. American banks would need more than that to set up subsidiaries in the EU should that be needed, according to one senior investment banker. It will also take much longer than two years to devise a “third country” equivalence regime that can replace the automatic right to operate in the EU, which Britain currently enjoys thanks to its so-called financial services passport. It took three years for U.S. and EU regulators to agree on such a regime for central clearing counterparties. The fledgling European Central Bank could be swamped with requests for regulatory approval. Hence most banks are voting with their feet and spending a lot of money on contingency planning.
Even if Hammond were to be specific about what he wants – say, restrictions on freedom of movement and a stamp of equivalence – it might not help banks. The forthcoming negotiation will be undertaken with 27 disgruntled states. The biggest two, France and Germany, have elections next year that may make them less rational and less generous towards the UK. There’s little reason for Hammond to say publicly what he wants when there’s a high chance he’ll come away with less than that.
The frustrating thing for City bosses is that it’s possible to sketch out a more positive future. Imagine French and German politicians soften in their unswerving support of free movement of people – as might happen if migration becomes a big election issue. That might make it easier for the UK to argue for movement restrictions of its own. If so, the dynamic would shift from a tense negotiation, where the UK has to give up something important to control its intake of European migrants, to a more rational debate.
If that is the way things go, then the UK’s negotiating position would be simpler. As regards European capital markets and investment banking revenue – three-quarters of which are transacted in London, according to consultancy Oliver Wyman – a ready-made third-country equivalence regime is about to kick in in 2018, via legislation called MiFID 2. On the basis that UK financial regulation is generally tougher than on the continent, it ought to have a reasonable chance of being deemed eligible for access to Europe’s markets.
There’s another item the UK could ask for too, which is access to activities like deposit-taking and lending. For that there’s no equivalence regime – yet. If Europe were to agree to one, make Britain part of it, and offer some kind of safeguards against it summarily changing the rules in future, the outlook might not be so forlorn. There would be less need for the likes of JPMorgan to move personnel from its London office to continental Europe, or for Deutsche Bank to turn its London branch into a subsidiary. It would retain the cluster effect that drives London’s pre-eminence, and the 24.4 billion pounds of tax the sector paid to the UK exchequer in the 2015/16 tax year.
Whatever the wish list, there is little upside in UK politicians revealing it now. It could just reduce whatever they end up getting. Hence banks have to be prepared for more uncertainty, and the real risk of spending tens of millions of pounds on contingency planning for no purpose.