The UK’s Brexit strategy for the City of London is quietly taking shape. Alongside reassurance that any immigration controls would still “facilitate movement of highly skilled people between financial institutions and businesses”, the chancellor of the exchequer stresses the mutual benefits of the status quo. “I genuinely believe that London delivers not only for the UK but for the European Union as a whole,” Philip Hammond told parliament this month.
Emphasising the mutual benefits of trade alongside London’s historic advantages of incumbency, scale, language and timezone creates a compelling narrative. The more the City helps clients in continental Europe, the easier EU divorce negotiations can be. Britain and the EU can continue as close friends rather than intimate partners, the argument goes. For the City, success requires a general deal to prevent the EU writing new location-specific regulations that could prevent financial services exports from London.
One example concerns the clearing of euro-denominated derivatives. The European Central Bank sought to shift this largely London-based activity to the eurozone in 2011 to enhance its regulatory oversight of the eurozone financial system but Britain successfully challenged the proposals at the European Court of Justice. The court ruled the ECB did not have the powers to require settlement of euro securities in the eurozone. The ECB capitulated but not for long. Senior officials in Frankfurt say privately that British offers to operate equivalent regulations on securities clearing after Brexit would be “too weak” for them and they will need to revisit the subject.
Success for the City requires negotiating a continuation of financial services passports, which allow financial services to cross borders seamlessly. Official data this week show UK-based companies hold 336,421 passports to operate abroad under EU directives, outweighing the 23,532 passports issued in other member states to operate in the UK.
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Any financial services agreement will be tough when Britain is making many demands of the EU. The broader problem with appealing to mutual advantage is that all sides of the coming negotiations must roughly agree on the benefits derived from current practice. Unfortunately, a prevailing view on the continent is based on Adair Turner’s 2009 provocative statement that many of the City’s activities are “socially useless”. Numerous subsequent financial scandals have only toughened attitudes.
Even in areas where all sides agree there are mutual advantages, Britain’s negotiating hand is weakened by the economic rents generated in financial services. Part of the City’s success is rooted in the brilliance and hard work of its people. But we have to be honest that another part of City firms’ ability to charge exorbitant fees results from licences to operate, a lack of effective competition, barriers to new entry, opaque services and advantages in exploiting information.
These rents tend to be appropriated by lucky employees in financial services, who receive a large wage premium compared with people in other sectors with similar skills and education. Consequently, UK tax authorities benefit from higher revenues at the expense of the tax authorities in the rest of the EU.
Other EU countries have no interest in economic rents remaining in London, so they will want to balance the losses their companies suffer from throwing sand in future UK-EU financial services trade against the possibility of repatriating some rent. Sometimes the outcome will favour the continuation of the arrangements but Britain and the City would be unwise to assume a positive outcome just because London provides valuable services.
Where we see mutual interest, they see economic rent.