‘Brexit’ fallout: On financial services, Britain snatched defeat from the jaws of victory

Just over a year ago, British financial traders were celebrating a landmark court victory over their European rivals. The Luxembourg-based General Court had overturned a demand by the European Central Bank that clearing of trades in euro-denominated assets take place only in countries that use the euro as their currency.

British Chancellor of the Exchequer George Osborne hailed the ruling as “a major win for Britain” that preserved London’s place as Europe’s dominant financial center. Given that Britain was a member of the 28-nation European Union but not of the Eurozone — it retains its own currency, the British pound — the ECB ruling could have forced tens of trillions of dollars in currency and securities trading to leave London and move to Ireland or the continent.

Today that court victory lies in tatters, and the prospects for the London financial services industry are dire. Last week’s British vote to leave the EU will mean that Britain can no longer claim that the ECB’s directive unfairly discriminates among members of the union.

London’s financial center, known as the City, will almost certainly lose the right to clear euro trades, but that’s only the tip of the iceberg.

“Hedge funds, asset management, investment banking, OTC derivatives, private equity, and marine insurance” are all vulnerable to the flight of business and personnel from London to wannabe major financial hubs such as Dublin, Paris and Frankfurt, says Amin Rajan, chief executive of the British financial consulting firm Create Research.

The potential economic hit is staggering. Britain has maintained a $26-billion surplus in services trading with the rest of the EU; without that inflow, its overall services trading with the EU would show a $13-billion annual deficit.

The sector employs nearly 1.3 million workers at relatively high salaries, an important foundation for the London economy. That may help explain why London delivered a strong pro-EU vote in last week’s referendum, unlike the rest of England.

A report prepared for TheCityUK, a trade group for the financial sector, estimated that “Brexit” would lead to job losses of 100,000 and a shrinking of the sector by as much as 9.5% in value by 2020, relative to business as usual. Although those losses would diminish over time, the sector would still be smaller by about 4% in 2030, according to the report by PriceWaterhouseCoopers.

British government leaders have been trying to put the best face on the consequences of withdrawal for the financial markets. Before London securities markets opened Monday, Osborne, the nation’s senior treasury official, declared that “Britain is ready to confront what the future holds for us from a position of strength.”

Boris Johnson, the Conservative Party politician who became a leader of the “Leave” campaign — the Brexit — and is given the best odds to succeed departing Prime Minister David Cameron, wrote in a Sunday Telegraph op-ed that “there will continue to be free trade, and access to the single market…. We will be able to do free trade deals with the growth economies of the world in a way that is currently forbidden” by EU regulations.

Yet other observers see little cause for complacency that Britain will be able to obtain trade terms with the EU anywhere near as favorable as it had as a member. The City’s preeminence as a financial center caused no little resentment among rival European centers outside Britain, and they and their governments are not likely to afford a non-EU Britain any of its former privileges.

“In general, the rest of Europe has tolerated the City rather than being very comfortable with it,” says Samuel Tombs, chief U.K. economist for Pantheon Macroeconomics. “It’s going to be very hard for us to maintain our dominance.”

Almost inevitable is the loss of London’s prized “passporting” rights, which allow financial services located anywhere in the EU to serve clients anywhere else in the union.

Passporting justified the domiciling of thousands of professionals by U.S. banks in London, a perch from which they could range freely over the continent. JPMorgan Chase said even before last week’s vote that whole platoons of its 16,000 staff in London might have to relocate if Britain split from the EU. The insurance marketplace Lloyd’s is bracing for what one insurance partner called “seismic” losses of business as firms abandon London for cities from which they could still serve EU clients.

Not only bankers would go. With London’s dominance has come a vast infrastructure of lawyers, accountants, technology workers and more, which also would have to relocate. That could render the PriceWaterhouseCoopers estimate of 100,000 job losses “optimistic,” the firm said. It could also have long-term consequences: “This loss of critical mass could have an impact on the U.K.’s status as an international finance center,” the firm said.

No one is sure yet what form a refashioned Britain-EU trade relationship would take. With Cameron having announced his plan to resign by October, no one is in place to open negotiations or even start the formalities for Britain’s withdrawal. Under EU rules, the negotiations must wrap up within two years of Britain’s formal declaration of its intent to split.

“The U.K. finance sector is faced with the worst form of political and economic paralysis imaginable,” Rajan says.

None of the alternative trade arrangements seems especially advantageous. One is the so-called Norway option. Under that scenario, Britain can gain access to the 30-nation European Economic Area, the so-called single market, without being a member of the EU, much as Norway and Iceland do. Among the drawbacks, however, is that it would have to accept some of the same EU laws, including the free movement of people, that have been so controversial in Britain.

“I can’t see that flying, given the weight of immigration as an issue in the referendum debate,” Jonathan Hill, who until his resignation Saturday was Britain’s highest-ranking EU diplomat, told the Financial Times over the weekend.

Another problem is that those rules and regulations would be enacted without any input from Britain. “The voices that would be present without Britain there — the voice of the French financial services industry, German industry, Dutch, Irish,” Hill said, “will clearly be heard … without the British voice in there to balance.”

Having to apply the rules of the single market without being able to shape them “hardly seems like an improvement in terms,” Megan Greene, chief economist of Manulife Asset Management, commented just before the vote. “The saying, ‘If you’re not at the table, you’re on the menu’ comes to mind.”

Or Britain could choose the “WTO scenario,” in which it loses the preferential trading rights granted EU countries by 50 outside trading partners — at least until it could negotiate replacement agreements with each of the 50.

But such bilateral agreements typically cover only the trading of goods, not services. That’s a problem for Britain, where services account for an unusually large share of the economy: 8%, compared with an average of 5% among other EU countries.

Until then, Britain would be subject to tariff and other barriers limited only by World Trade Organization rules. But the average tariffs imposed among WTO countries with no special agreements is 9%, a heavy burden in a free-trade world.

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