Bankers and Hedge Funds Will Always Love London
(Bloomberg Opinion) - The power of 27 countries against one is often cited as a reason the European Union will prevail in the Brexit negotiations with the UK.
However, the logic is reversed when you think about what could happen to the City of London after the UK leaves, and whether the other cities of Europe can question their primacy in the financial sphere. For financial service providers, a central one-stop shop like London makes more sense than a multitude of different mini-centers like Paris, Frankfurt and Amsterdam. Solitude in this case is a strength.
Hence, it will be difficult to combat trade flows, bankers and ultimately control of the EU's own markets outside London.
The benefits of the English language, English law, and London business ecology are obvious. However, there are three other overlapping factors that guarantee the city's attractiveness to investors: a relatively proactive regulatory mindset, a deep talent pool, and lower trading costs.
Brussels is concerned that three quarters of euro-denominated derivatives are traded and cleared in London, along with nearly half of euro currency trading. That is understandable. In order for Europe to create its own, self-sustaining market, however, it needs to think about what customers - such as London's precious ecosystem of hedge funds - want instead of worrying about market infrastructure or where investment banks are opening branches. In short, it has to follow the money.
London financiers fear that Europe will always prefer the whip to the carrot. Bank of France governor Francois Villeroy de Galhau insists that post-Brexit European banks must restrict the use of clearinghouses in the UK. The iron bar may work in the short term, but business will return to the relative freedom of London unless Europe makes itself attractive too.
Take regulation. The UK Financial Conduct Authority is much more flexible than its European counterparts, which is a key factor for overseas investment firms that prefer London. The Paris-based European Securities and Markets Authority has suffered multiple regulatory violations, particularly by targeting Swiss stock exchanges and trying to control all European equity trading.
Much has been made of an impending English Channel brain drain when it comes to talent. However, a recent EY report cited 7,500 finance jobs that have moved in the past four years. This is well below Xavier Rolet's forecast of 232,000 when he was head of the London Stock Exchange. It is also not a one-way traffic. More than 1,000 euro-area institutions have opened offices in London to ensure they can operate in both countries after Brexit, according to regulatory consultant Bovill.
Yes, US banks are moving assets, but Wall Street still prefers London. This is a forced move, not a desire. American companies must comply with EU regulations in order to enable their European customers a seamless Brexit transition. However, euro-denominated transactions with customers based in the EU are only a small part of what happens in the city. JPMorgan Chase & Co. may move some of the capital, but the major New York banks' risk-weighted assets are still four times higher in London than in the euro area.
Probably the biggest benefit for London is the cost of trading. The main job of a bank's treasury desk, and indeed all traders, is to minimize the capital used in placing deals. The practice of cross margining, where the collateral needed to fund a range of deals can also be used to offset with other trading groups, is particularly important in keeping costs down - and London has built a real magnitude in this area.
Europe's clearing champion, Germany's Eurex, is catching up with cross-margining by allowing collateral for futures positions to be netted with interest rate swaps. However, the range of products and currencies of the London-based clearing houses give them a considerable head start. Being pegged to the euro is a disadvantage here.
High quality clients in the European time zone such as hedge funds and money managers are tied to the UK because of the benefits of trade execution. You are served royally by the global investment banks who offer bespoke financing agreements in every currency and product. The banks' prime brokerage arms stick like glue with their most profitable customers.
By fixating on control of the euro markets, Europe will miss the bigger price.
This column does not necessarily reflect the views of the editors or Bloomberg LP and its owners.
Marcus Ashworth is a columnist for the Bloomberg Opinion, which covers European markets. He spent three decades in the banking industry, most recently as Chief Markets Strategist at Haitong Securities in London.
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