Blog Post

Stealing London’s financial crown would bring both benefits and responsibilities

After Brexit, several major cities across the EU27 are looking to take over London's financial activity. While there are plenty of benefits in hosting a major financial centre, it also comes with significant risks and responsibilities.

By: Date: November 17, 2016 Topic: Finance & Financial Regulation

Several major cities across the EU27 (the EU28 minus the UK) are eagerly looking at the financial sector in the City of London. Some are even putting together incentive packages to lure business away from London after Brexit.

The potential benefits are numerous: high-quality jobs in financial services, expansion of ancillary services such as legal support and consultancy, better access to finance for corporates, higher tax revenues for the government, and prestige for the city and country. All in all, capturing some of London’s financial activity could give a boost to the (local) economy.

However, hosting a major financial centre also comes with significant risks and responsibilities. Most importantly, the country’s authorities are responsible for the supervision and stability of the incoming financial players and markets.

Banks and other financial firms currently based in London will of course want to keep on doing business with clients across the EU. If there is any major loss of passporting rights, they will have to set up a separately licensed subsidiary to do this, or upgrade one of their existing entities in the EU27.

This fully-fledged subsidiary can replace the London entity’s passport for EU27 clients. Early estimates suggest that the EU27-focused activities can amount to 30 percent of overall financial activities in the City. This relocation will be inevitable if London exits the single market – an outcome that is looking increasingly likely.

The first step for a city on the receiving end of a relocation would be to grant authorisation to the (new) subsidiary. The local prudential supervisor will do this in tandem with the ECB, the banking supervisor in the Single Supervisory Mechanism, if the new banking entity is based in the Eurozone and its assets exceed € 30 billion. Because these banks are carrying out financial market activities, they will also need a licence from the local financial markets authority (for example, the Autorité des Marchés Financiers in Paris).

Do the local supervisors have sufficient resources to process a surge of authorisation requests in a timely fashion? And do these supervisors have the right level of expertise on investment banking and trading activities? Perhaps not. Until now, the European supervisory expertise in these areas has been more or less pooled in the UK, within the UK Prudential Regulatory Authority (which is part of the Bank of England) and the UK Financial Conduct Authority.

The next step is to supervise these new players and markets in their work. Again, do the local supervisors have the resources and the skills to do so? Unfortunately, fraud and miss-selling are not uncommon in the financial sector and do also happen in wholesale financial markets (remember Libor, forex fixing, miss-selling of CoCos to retail clients, and others).

The Irish central bank governor, Philip Lane, has rightly warned against a regulatory race to the bottom. While the ECB plays a leading role on the prudential side, the European Securities and Markets Authority (ESMA) has only a coordinating and advisory role. The final responsibility rests with the national authorities for securities markets.

The final step is crisis management. The key players in the forex, securities and derivatives trading are the large banks. Who picks up the pieces if any of these large banks gets into trouble? The national central bank would be responsible for potential Emergency Liquidity Assistance (ELA) if and when needed.

Next, the national government forms the fiscal backstop. Of course, new bail-in rules will reduce the size and likelihood of public support, but the potential bail-out costs are not zero. Are the hopeful incoming countries aware of these responsibilities and exposures?

At the strategic level, the EU27 might want to think about the design of a vibrant financial system to serve the financing needs of their corporates, governments and households after Brexit. Should the financial system and related architecture remain predominantly national, or should we consider a more integrated financial system?

In the former case, fragmentation might lead to a lack of liquidity in the dispersed markets and subsequently to higher funding costs for corporates. In the latter case, a more integrated financial architecture might help preserve the benefits of integrated markets with central clearing (which allows participants to net margins and collateral across currencies and products).

We advocate three institutional changes to support such an integrated financial architecture. First, the banking rule-making body, the European Banking Authority (EBA), should be relocated from London to a capital in the EU27.

To prevent staff defections and a loss of expertise, we suggest a rapid informal EU27 decision along the lines of “should the UK leave the European Union, the EBA will relocate to [insert city name]”. This can be done without awaiting either confirmation of Brexit or the broader debate about post-Brexit EBA reform.

Second, the Banking Union needs to be completed to ensure effective prudential supervision and crisis management (including the fiscal backstop) at the euro-area level.

Finally, the Capital Markets Union should be upgraded with a central role for ESMA to ensure effective conduct supervision.

We thus advocate a tightly integrated EU27 financial architecture, so that financials can relocate to various cities without that being a problem. An interesting example is the United States with an integrated regulatory structure and financial sector, while financial market activities take place in New York and Chicago.

 


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article More on this topic
 

Blog Post

Boosting the resilience of Europe’s financial system in the coronavirus crisis

Europe has a heavily bank-based financial structure, but bank-based financial structures are associated with higher systemic risk than market-based financial structures. The higher level of systemic risk in Europe suggests caution when pursuing policies that stimulate risk taking and debt creation by banks, especially in the wake of COVID-19. Priority should be given to financial diversification and equity finance.

By: Joost Bats, Aerdt Houben and Dirk Schoenmaker Topic: Finance & Financial Regulation Date: July 17, 2020
Read article More by this author
 

Opinion

The EU’s Opportunity to Turn Its Markets Toward the Future

Meeting the fiscal demands of COVID-19 will require the European Union to borrow on capital markets more than ever, and for European pension funds and households to look more widely for ways to build their nest eggs safely. The EU should take the challenges of the pandemic and Brexit as a chance to get its financial infrastructure house in order.

By: Rebecca Christie Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: July 16, 2020
Read article More by this author
 

Podcast

Podcast

One rule to ring them all? Europe's financial markets after Brexit

What effect will brexit have on Europe's financial markets?

By: The Sound of Economics Topic: European Macroeconomics & Governance, Global Economics & Governance Date: June 26, 2020
Read article More on this topic More by this author
 

Opinion

How will COVID-19 impact Brexit? The collision of two giant policy imperatives

The United Kingdom left the European Union on Jan. 31, 2020. Now, the U.K. must decide whether and how to extend the transition period, currently set to expire at the end of 2020.

By: Rebecca Christie Topic: European Macroeconomics & Governance Date: May 19, 2020
Read article Download PDF More on this topic
 

Policy Contribution

The European Union’s post-Brexit reckoning with financial markets

In the negotiations between the European Union and the United Kingdom over their future relationship, we see a high probability of a weak contractual outcome, given the dominance of politics over considerations of market efficiency.

By: Rebecca Christie and Thomas Wieser Topic: European Macroeconomics & Governance Date: May 13, 2020
Read article More on this topic More by this author
 

Podcast

Podcast

Banks and loan losses in the pandemic turmoil

The current pandemic is shaking the financial system. How can banks react ? Is a consolidation of the financial system in Europe needed in order to respond to this crisis ? Will our economies suffer from this pandemic as much as they did in 2008 ? This week, Giuseppe Porcaro is joined live by Guntram Wolff and Nicolas Véron to discuss banks and loan losses in the pandemic turmoil.

By: The Sound of Economics Topic: Finance & Financial Regulation Date: March 25, 2020
Read article More on this topic More by this author
 

Blog Post

Banks in pandemic turmoil

The banking system is critical to society and requires attention and support. In doing so, however, tough love is preferable to complacency.

By: Nicolas Véron Topic: Finance & Financial Regulation Date: March 24, 2020
Read about event
 

Past Event

Past Event

ONLINE ROUND TABLE: Future of the EU-UK science cooperation

How do we rebuild and keep the science cooperation between the EU and the UK?

Speakers: Michael Leigh and Beth Thompson Topic: European Macroeconomics & Governance, Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: March 17, 2020
Read about event More on this topic
 

Past Event

Past Event

The Sound of Economics Live - The Brussels effect: How the European Union rules the world

This was a live recording of an episode of the Sound of Economics, Bruegel's podcast series. The discussion centered around the book of Anu Bradford, The Brussels Effect.

Speakers: Anu Bradford, Ashoka Mody, Giuseppe Porcaro and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: March 3, 2020
Read article More on this topic More by this author
 

Opinion

Realpolitik of the day after Brexit

Compromises hammered out in the next 11 months, by both British and European negotiators, will dictate the UK’s economic landscape for decades to come

By: Maria Demertzis Topic: European Macroeconomics & Governance Date: January 31, 2020
Read article More on this topic More by this author
 

Opinion

Britain faces a triple contradiction

If Boris Johnson can negotiate agreements that are better than the EU system, it would be a serious challenge for the 27

By: Jean Pisani-Ferry Topic: European Macroeconomics & Governance Date: January 30, 2020
Read article More on this topic More by this author
 

Podcast

Podcast

The science of Brexit

On Saturday morning, the United Kingdom will wake up outside the European Union. After 37 years of collaboration, how will Brexit affect research and innovation in Europe and in the UK? What should be the next steps undertaken by both in order to maintain the same level of cooperation? This week, Nicholas Barrett is joined by Maria Demertzis, Guntram Wolff and Michael Leigh, Senior Adjunct Professor of European Studies at the Johns Hopkins University, to discuss a post-Brexit agreement for research and innovation.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: January 29, 2020
Load more posts