Since the vote to leave the EU there has been speculation about the future of the City of London’s status as Europe’s financial centre, and the UK losing one of the jewels in the crown of its economy.

Size of workforce and tax take

The banking sector contributed £24.4 billion in PAYE and corporate taxes in 2015-16. A recent report published by the City of London Corporation estimated the total tax contribution of the financial sector at £71.4 billion, and 1.1 million jobs.

Not all of that contribution is at risk from Brexit. A different study commissioned by TheCityUK (which promotes the financial services industry) estimated that, in a ‘worst case scenario’ under which the UK and EU failed to reach any agreement on financial services market access, 31-35,000 jobs could be at risk along with £3-5 billion of tax revenue per year.

What is passporting?

EU legislation gives UK banks, insurers and investment firms what are commonly known as ‘passporting’ rights to provide a broad range of financial services to clients across the EU – either cross-border or through local branches – while remaining regulated solely by their ‘home’ state.

If the UK were to leave the EU without a Free Trade Agreement covering financial services, UK firms would no longer be allowed to sell their financial products into the EU using their regulatory authorisation provided by UK regulators. UK firms would either have to seek authorisation in each country in which they wished to sell products, or set up European subsidiaries through which they could continue to sell, but be regulated by EU authorities.

How many firms in the UK use passports to sell financial services
to the EU?

According to the Financial Conduct Authority, there are currently around 5,500 UK firms holding between them around 336,000 passports. The largest number of firms with passports are found in the UK’s insurance and investment sectors. However, the number of passports alone does not necessarily indicate the scale of activity of UK firms in the Single Market. A firm can have a passport without using it. It is generally agreed that investment banking activities – including rights to trade over-the-counter products, and providing advisory services – are particularly reliant on passporting arrangements.

“Euro clearing” and the EU

Clearing is the process by which an intermediary (known as a central counter party, CCP) stands between the buyer and a seller in a transaction.
If either the buyer or the seller defaults, the CCP fulfils the obligations of
the defaulter.

The importance of clearing has greatly increased since the financial crisis, as a result of a G20 commitment to move more derivatives trading away from bilateral, over-the-counter transactions, to CCPs. London is currently the world’s largest centre for derivatives clearing in euros, handling three-quarters of all transactions, with an average daily value of €504bn.

Brexit clearly raises the possibility that UK CCPs might lose the right to serve EU clients or to clear euro-denominated contracts. The European Commission is already preparing legislative proposals, to be published in June, which could force UK CCPs to relocate. Counting in the UK’s favour is that the Commission has already reached an ‘equivalence’ decision in respect of CCPs located in the USA allowing them to serve EU clients and clear in euros.

While the volume of daily transactions by UK CCPs is considerable, the number of jobs and profits directly related to clearing is not. In 2016, LCH Clearnet Ltd, the largest of the four UK based CCPs – and the only UK-owned – made profits of €63 million, employing 687 full time equivalent staff. However, there are concerns that, if CCPs are forced to relocate, their UK-based clients will be obliged to follow. A report by EY last year estimated that there could be 83,000 related job losses in London over the next seven years if euro clearing was forced out.

Is there more to the City than finance?

Despite Brexit, and the potential loss of financial passporting, there are intrinsic reasons why the City of London may continue to prosper:

  • The UK’s time zone allows it to act as a bridge between the trading hours of the US and Asia.
  • The English legal system is globally respected for being stable, impartial, and independent from Government. Many of the world’s international commercial contracts covering banking and financing, maritime and shipping, and mergers and acquisitions are written using English law.
  • The use of English as an international language
  • The presence in the City of ancillary industries necessary for financial services, such as law and accounting.

Policy options

No other non-EEA country at present has negotiated full access to financial services markets. In a ‘no-deal’ scenario, UK firms would lose much of their access. The Government may wish to pursue a negotiation that prioritises access to specific markets, such as euro-clearing and investment banking services, in order to mitigate the loss of passporting rights.

This article is part of Key Issues 2017 – a series of briefings on the topics that will take centre stage in UK and international politics in the new Parliament.

Image: City cluster by diamond geezer. Creative Commons Attribution 2.0 Generic (CC by 2.0)

What are derivatives?

A derivative is a financial instrument that derives its value from the performance of an underlying asset, such as a stock, bond, commodity, currency or market index.

Have banks already begun to move staff?

Various banks have said they plan to move staff in the event of Brexit:

  • Deutsche Bank – 4,000
  • UBS – 1,500
  • Morgan Stanley – 1,000
  • Goldman Sachs – 1,000
  • HSBC – 1,000
  • JP Morgan – 300
  • Barclays – 200