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London banking will struggle to escape Brexit trap

The free movement principle of the EU means that all individuals of member states receive an EU passport. They can settle in any other EU country and enjoy the same rights and benefits as any other citizen of the host country.

It is perhaps less obvious that the EU passport also applies to businesses, including banks. If, say, an American bank has been authorised to be in Britain, it is automatically entitled to operate in any EU country. It is this quintessential element of EU membership that has enabled London to become the banking capital of Europe.

Now that the UK has voted for a Brexit from the EU, we don’t yet know what kind of arrangements the two sides will agree. They may end up being more favourable than the total separation envisaged by Article 50 of the Treaty of the European Union. But unless the UK is still inside the single market, at least as part of the European Economic Area (EEA), this passporting right will be gone.

This is why there are widespread fears about how the banks are going to keep their main European headquarters in London, particularly those that are non-EU. There is likely to be a surge in requests for banking licences on the continent, even from British banks. Hence numerous international banks are reportedly considering their options. Substantial numbers of the City’s circa 700,000 jobs might shift.

Capital gains

The most likely beneficiaries will be the other main European financial centres – Paris, Frankfurt, Milan and Madrid – though smaller players will seek gains, too, including Luxembourg, Amsterdam and Dublin.

The European Banking Authority (EBA), currently located by the River Thames, will almost certainly be among the departures. It is one of the EU’s three overseers in the financial services sector. With the insurance regulator (EIOPA) already based in Frankfurt and the financial markets regulator (ESMA) in Paris, Milan has emerged as the early frontrunner to provide the EBA’s new home.

The global investment banks will probably incline to Paris, both because of ESMA and because there is already Europe’s second-largest market for trading securities in the form of Euronext Paris. HSBC chief executive Stuart Gulliver has indicated that 20% of his 5,000 investment banking staff could be bound for Paris, for instance. In a similar way, mutual funds and pension funds would find a natural location in Frankfurt, since they come under the EIOPA.

Paris trading. EPA

There is unlikely to be one big winner from any reorganisation. The 2008 financial crisis revealed major cracks in the eurozone, broadly dividing the north and south of the continent. Where in the past the major investment banks have tended to have just one major European headquarters, they might now decide to operate out of several smaller centres on the mainland and to take different strategic approaches for different parts of the bloc. This might be a suitable move for cautious new times, given the uncertainty that Brexit has created.

These players will probably retain a reduced British operation for similar reasons. We might also see European banks setting up in London that were previously able to service the UK market from the mainland. This at least means we are unlikely to witness a catastrophic mass migration from the Square Mile.

It is also worth emphasising that we are certainly not talking about all jobs. Within investment banks, for instance, there is a threat to the clearing services that London houses provide for trading euro-denominated financial instruments. French president Francois Hollande has already said that they can’t stay in the UK. This won’t affect the clearing of financial instruments denominated in other currencies, however.

Equally, it may no longer be possible to directly buy and sell the shares or bonds of EU-listed companies in London post-Brexit, but it won’t affect the trading in other companies or other markets such as commodities. In some areas, such as derivatives trading, no longer having to live with EU regulations might even be an advantage – albeit potentially making the markets more volatile, too. Also potentially less affected will be other merchant banking services, such as mergers and acquisitions.

On the other hand, UK insurance companies will no longer be able to offer insurance within the EU without a licence within one of the member states. I should also stress that the different sub-sectors of financial services may not all be protected if the UK ends up in the EEA – instead of an automatic right to a full passport, the different areas it covers would need to be agreed.

Scotland’s opportunity

If Scotland does vote for independence in the next couple of years, it could be a unique opportunity for luring banks to Edinburgh or Glasgow – as has already been suggested. In particular, Edinburgh’s “City” is presently small but not negligible, hosting the headquarters of Tesco Bank and Sainsbury’s Bank, insurance firm Standard Life and a substantial amount of fund management.

Edinburgh’s financial district. Ross G. Strachan, CC BY-SA

The central bank of a new independent Scotland would be entitled to authorise banks to trade across the EU as soon as the new country was granted membership. This could engender a new Scottish enlightenment, attracting banks and investment firms from all over the world.

It certainly sounds better than the alternative in which Scotland leaves the EU with the rest of the UK. If the likes of Tesco Bank and Sainsbury’s Bank were interested in expanding to the single market, they too would have to establish operations elsewhere in this scenario. Scotland’s financial waters could end up stagnant for decades as a result.

With this much at stake, the UK’s formidable banking lobby will doubtless be gearing up over the next couple of years to make the best out of a very difficult situation. At this stage, however, it looks as though the EU passport will be lost unless the UK accepts free movement of citizens.

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