What will really happen if the City leaves the single market?

Q. EU Chief Negotiator Michel Barnier says that Britain cannot have a “bespoke” trade deal that includes financial services. Is he right?

He may have over-reached himself. Barnier also points to a key meeting of EU heads of government in March at which point they will give him his “red lines” for the trade talks. It could be that they take a “hard line” and rule out any agreement involving financial services; or they may leave more room for discretion and negotiation; or they may even order Barnier to reach an agreement that protects the various financial institutions and users of financial services in Europe, i.e. allows them to retain access to one of the world’s leading financial centres of pure liquidity (i.e. lots of money swilling around) and expertise – London, which has created formidable economies of scale and leads the world in “fintech”.

Q. So is it just a negotiating position?

Yes, and necessarily so, in the sense that everything any trade negotiator ever says in public has an element of tactics and bluff to it – and that applies to David Davis too. On the other hand, Barnier’s own belief that the British cannot “cherry pick” the elements of the EU they like and leave the more onerous obligations behind is perfectly sincere, and is broadly shared by the remaining members of the EU.

The experience of phase one of the talks suggests that some pragmatism usually intrudes in the last days before a deadline.

Q. How will Brexit affect the City of London and Canary Wharf?

It depends. If the EU erects substantial barriers to UK financial firms operating in Europe, then some personnel will need to be transferred over to the EU for some functions. Areas that would be potentially affected include trading in financial instruments where clearing is in euros; banks, insurance companies and investment and pension fund managers attempting to sell financial products and advice directly to EU entities, i.e. funds, companies or individuals; and the movement of any professionals seeking to work in the EU post-Brexit. The reverse side of the coin that says the UK can regain control of its borders is that the EU can regain control of its frontiers too. In other words a British banker might be required to apply for a visa to live and work in Frankfurt or Paris, say (though perhaps not for Dublin, if the Ireland-UK “common travel area” survives).

Q. Will jobs be lost?

It is difficult to envisage a set of circumstances in which no jobs would be lost in the short term, and, obviously, much depends on the nature of any eventual EU-UK deal and how much new business can be attracted through deals with, say, China and India, or even the US.

If so-called passporting rights are lost then London-based firms – which could be Swiss, Japanese, British, American, European or Chinese entities – would lose the rights to sell directly into the EU. They would then have to move operations across the Channel.

If the EU insisted on the actual transactions and conduct of business happening physically on EU soil many jobs could go; if they allowed for “brass plate” subsidiaries or branches to operate as mere legal cover (as in tax havens such as the Channel Islands) for the real action in London, then far fewer jobs could go.

Currently British-based firms (which include the London subsidiaries of giant US investment banks such as Goldman Sachs and JP Morgan) in the medium to long term, would suffer from a disadvantage in operating from London in the large – and prosperous – European Economic Area after Brexit. Then again many of those London-based banks and institutions would suffer from splitting their operations around different centres, and lose out on the pool of liquidity and expertise that presently rests in London. The only real winners might be alternative centres outside Europe, such as New York or Dubai.

Q. How many jobs will go?

Estimates vary wildly. Some areas, such as hedge funds or commodity trading would barely affected by Brexit; others such as trading in euro-denominated bonds, shares and derivatives maybe much more so. Ernst and Young have recently estimated “Day One” losses at 10,500, and guesses of up to 75,000 or 100,000 have been bandied about for the longer run. Moreover these are highly paid positions, with tax revenues to the Treasury to match. House prices, fancy restaurants, luxury car dealers and champagne sales in London would be hit.

Q. Who gains?

The general effect seems to be that no single EU centre will emerge to challenge London. Paris is the new home of the European Banking Authority, though much work is still done by the Commission in Brussels, and the European Central Bank stays in Frankfurt. Dublin, Paris, Amsterdam and Milan are the other cities vying for the relocation of jobs. It will be fragmented.

Q. How does Switzerland manage – they’re not in the EU but have famously big banks and a thriving financial services sector? Why can’t we be like them?

This is instructive for Theresa May’s ambitions for a “bespoke” deal.

One of the oddities of Barnier's latest pronouncements is that he states that no free trade deal exists which allows for financial services, yet there is such an arrangement – though only partial – between Switzerland and the EU. The point here is that Switzerland is outside the European Union and the Economic Area, but inside the single market, and therefore does assent to freedom of movement of labour, and has, thus, gained access to the European single market in financial services – but, ironically, only by basing so many of its operations in subsidiaries in London: it has no direct “passporting” rights in some sort of “bespoke” deal. With London outside the EU single market, then the Swiss, like everyone else would move some operations from London to somewhere else inside the EU. The crucial point against Davis is that Swiss financial institutions do not enjoy easy passporting rights. The point against Barnier is that Switzerland does provide an exception, of sorts, to his simple rule.

Besides all that, the EU finds the complication of the Swiss deal irksome, having to keep negotiating on trade every time some new EU Directive or Swiss initiative threatens to create regulatory divergence in areas such as agriculture. The Swiss, on their side, also have no direct say or votes in European law and decision making on single Market rules (in Brexiteer terms they are a “vassal state” or colony of the EU).

Perhaps most tricky for Brexiteers is that Switzerland not only accepts the right of EU nationals to work in their country but they are also part of the visa-free border-free Schengen Agreement. Despite some Swiss pushback on this, it remains formally the case, and, again, suggests the Swiss example might not be that acceptable to the anti-EU forces in the UK.

So the Swiss example may not turn out to be such an encouraging one for the UK's finance sector.

Q. Does the EU’s MFID II change anything? What is MFID II? Can’t we just let London “let rip” after Brexit, free of EU red tape?

MFID II is merely the latest in a long-line of EU regulations, the Markets in Financial Instruments Directive Number Two. Many in the City fear it more than Brexit, as it toughens regulation of financial products and requires more openness and transparency about transactions, for example revealing who is really behind them. It also pushes its jurisdiction beyond EU territory so that any transaction that takes place that affects an EU entity will be covered (including, presumably, in post-Brexit London as well as New York or Hong Kong).

It proves a point, however. If the UK decided it could win more business by ignoring MFID, and deregulating, then it could – except that the EU could retaliate by restricting the ability of London to conduct such business with EU banks and finance houses. It is a perfect and important example of the present convergence v divergence debate. If winning extra business through divergence risks losing even more because the EU will damage that trade, then many would wonder whether Brexit plus MFID II is really better than the status quo (where the UK can influence EU rule making via its voting power and political clout).

There is also the small point that radical deregulation of financial markets helped contribute to the extremely costly banking crisis of 2009, one that vastly inflated the UK’s national debt.