Tuesday, 1 August 2017

Brexit & the City of London

Brexit is a big economic and political mess for British imperialism. It also undermines some of the previous plans to boost the City of London’s operations, especially in deals with China. The City will not collapse. But it will lose business as other European Union countries are already aiming to divide up the soon to-be-deceased member’s estate while the body is still stumbling around.
A large proportion of City financial dealing is with the rest of Europe, although London has been pre-eminent because of its worldwide links – including with offshore financial centres, many of which sing God Save the Queen as their national anthem. These European ties formerly helped underpin the City’s growth, but have since been a factor in decline, even before the Brexit vote in June 2016. So problems for British-based finance due to Brexit now add to those resulting from a drop in European economic strength.

Shift in economic power from Europe to Asia

IMF data show that the European Union’s share of world GDP fell from 25 per cent to 22 per cent from 2011 to 2016, a sharp fall in just five years. This was offset by a higher share for the US, and especially so for China, based on their faster growth. Weak economies, massive debts and bad loans also undermined Europe’s banks and led to a cut in their dealing operations – most of which are in London.
A good example of the impact is seen from the global foreign exchange market, which reflects the cross-border deals in the currencies used for investment in bonds, equities and real estate, and the buying and selling of goods and services. From 2013 to 2016, the size of the foreign exchange market had declined for the first time in more than a decade, based on low world growth and problems in banks. The UK’s share of the foreign exchange market fell from 41 per cent in 2013 to 37 per cent in 2016. Although the City still remained by far the world’s biggest FX dealing centre, and the US in second place had a much lower 19 per cent, the US share rose a bit, helped by the better position of its banks.
By contrast, Asian financial trading centres were the clear winners. Singapore’s share of trading rose from 5.7 per cent to 7.9 per cent from 2013 to 2016. Taken together, China’s and Hong Kong’s rose from 4.8 per cent to 7.8 per cent. Though still a small share, this is an astonishing result for China, one backed by the near-doubling in the use of the renminbi in global FX dealing to 4 per cent. This made the renminbi the eighth largest trading currency in 2016, just behind the far more established Canadian dollar and the Swiss franc. Meanwhile, the euro, now the currency of nineteen countries, saw its share slip to the lowest since its inception.

UK politicians: dumber than you might think

The City had a falling share of a falling market even before Brexit,[1] but now faces the prospect of Brexit. A key problem it faces is how far will UK-based financial companies be able to conduct business with the European Union once the UK leaves. Implausible as it may seem, despite UK governments having promoted the financial sector for more than three decades, there is no sign that the current UK government has given this much attention.
Under the Labour governments from 1997-2010, there was also a clear pro-finance policy. This was seen as one of the few competitive UK ‘industries’, one that also provided lots of tax revenues to fund public spending, from income taxes on the high paying jobs and the various duties imposed. Finance supported millions of jobs related to trading in foreign exchange and all kinds of financial securities and insurance services. It also provided international revenues that covered nearly half of the UK’s record-breaking trade deficit in goods that in 2016 amounted to 7% of GDP. Even non-financial UK business services, from accountancy to information technology, are very closely tied into the financial sector, and offset another chunk of the trade deficit. Basically, without the City’s financial business, UK living standards would be lower.
In more recent years, the UK political class has had trouble maintaining support from a disgruntled electorate. Voters worried about pressure on living standards focused on immigration from the EU, so this has led the two main parties, Conservative and Labour, to accept the referendum vote and reject EU membership. They obviously want free access for all UK business to the EU market, but this is not possible under EU treaties for a non-member, unless, at a minimum, that country also accepts the free movement of labour, ie no restrictions on migration from the EU. UK politicians can grandstand as much as they like, declaring what they want from a deal, but the end result will come from a negotiation
With the UK a member of the EU, City-based financial firms can freely do business across the rest of the EU single market, due to so-called ‘passporting’. This means that banks or other financial institutions in the UK can sell their services in all other EU countries, as these are considered part of the same market. Without the ‘passport’, or something very similar when the UK leaves the EU, that ability will either cease or become much more restricted.
More than 5,000 UK-based firms rely on these passport agreements, and some 8,000 European companies also need them to offer services in the UK. So there may be some compromise. But it is in the interests of the remaining EU-27 countries not to make this a favourable one for the UK, or else the longstanding European Union project would risk being unravelled as others considered the exit too.

How to get a piece of the financial action?

Whatever the wider economic and political issues for the UK and the rest of Europe, the UK’s financial business is an area coveted by some of the major EU players. Already, many UK and international banks and other financial institutions have said that they plan to relocate some business into the EU-27. So far it is only on a small scale, and as a precaution so as not to be left high and dry if there are barriers to their UK-based operations doing business in the EU. If it becomes clear that full access to EU financial markets will be difficult, more will follow.
The likely outcome is a piecemeal lopping off of some parts of City business into several other EU locations rather than into one new rival centre. Frankfurt, home of the European Central Bank, is one of the favoured alternatives, but there is also Dublin, Paris, Amsterdam, Luxembourg and others, depending upon where a financial company might already have some existing business.
Ironically, Frankfurt, the main financial centre for Europe’s largest economy, Germany, is a rather provincial town, not particularly attractive to financiers, and is based in country whose politicians have shown little orientation to finance. They have instead been able to benefit from the prowess of German engineering business and have had other ways of promoting German capitalists on their minds.
I do not think that the Brexit effect by itself is likely to add up to a dramatic reduction in the City’s operations. London has built up a series of reinforcing advantages that are difficult to replicate elsewhere, as shown by the several directions in which alternatives are sought. For now, at least, London has very many more international connections than rival financial centres, plus a broad range of financial services and personnel skills that other centres lack. English is the main business language and English commercial law is the foundation for many financial contracts, for example interest rate swaps, the largest traded financial derivatives contract.
The commercial law issue is more important than one might think. Lawyers based in other countries, or sent from the UK, might be trained in the relevant aspects of English commercial law, but legal judgements are based on court decisions. Being part of the relevant legal network is important. It would also take a long time before contracts are changed into another legal system, and that system may not have the specific aspects necessary that have been developed over decades within the UK legal set up.
Furthermore, most other possible centres have also had governments that have been advocates of a financial transactions tax. This will not help them make a convincing case for expanding their role as a financial business centre. Nevertheless, the incompetence of the present British government could make them question favouring London.

What next for the City?

Despite the impact of Brexit and the recent decline in the growth of financial dealing, it will not be easy to dislodge the City of London from its pre-eminent position. London will almost certainly lose business to other financial centres, but it is costly for banks to move even some operations from London to the rest of Europe, estimated at anything from $30-$50bn.[2]
As these decisions play themselves out, British financial elites are planning to secure for the London Stock Exchange the flotation of Saudi Aramco’s shares. This state-owned Saudi Arabian oil company is the world’s largest and the deal would produce big revenues for the exchange and banks handling it. Around five percent of the company might be on sale, but even this is expected to raise some $100bn.
Only a major stock exchange could handle such a large deal. But although New York is the biggest, and Trump’s pro-Saudi politics are supportive, US financial regulations could be a barrier since the Saudis do not like giving much information. London is more lax on that score and has also changed its rules to help its bid for the deal. Furthermore, there could be US legal claims against the Saudis regarding the 9/11 attacks that would impact Saudi Aramco, and this kind of trouble looks more likely to occur in a US court than any such thing in British courts.
One deal, no matter how big, would not point to sunlit uplands ahead for British finance. But the outcome for Saudi Aramco’s deal will be an interesting signal of how far a Brexit-hobbled City can have a future outside the European club. It would also indicate how far Britain’s status as a key player in world politics has been damaged, since the Saudi decision will certainly have that in mind.

Tony Norfield, 1 August 2017

A fuller discussion of City finances in relation to British imperialism, plus Brexit and Trump is available in the paperback edition of my book, The City, available from these sources.
For a brief article on this blog covering the background to the City’s business relating to British imperialism, see here.

[1] The Bank for International Settlements surveys from which this information is taken are conducted in April of the relevant years, so in 2016 it was before the June Brexit vote. Similarly, the UK’s share of the trade in financial derivatives fell back between 2013 and 2016, based largely upon a drop in the volume of dealing in euros.
[2] See this Bloomberg story: https://www.bloomberg.com/news/articles/2017-07-31/banks-may-be-hit-with-50-billion-capital-needs-after-brexit


  1. Hi Tony,

    I have been thinking a lot about the dependence of Britain on financial services to offset the trade deficit in goods. I am wondering to what extent this makes 'Lexit' arguments about a hard Brexit opening up the possibility for a return to an economic model with strong labour rights (collective agreements etc) an exercise in wishful thinking. I found out today that GMB reversed its traditionally pro common market position (http://www.morningstaronline.co.uk/a-9e98-GMBs-new-pro-Brexit-stance-will-help-Corbyn/#.WYSJculLc2w). Would you care to comment?

  2. Response to YK:
    The power of trade unions has been whittled away over the past decades, but this has nothing to do with the EU. Instead it is a function of capitalist markets trying to increase exploitation of the domestic workforce, helped by the pressure of competition from Eastern Europe and Asia, plus changes in the economy that have undermined the unions. Also note that unions did even less for more exploited, part-time, temporary contract workers than for their traditional membership.

    In 1992, the Conservative Government opted out from elements of the Maastricht Treaty agreements, not only from having to join the euro, but also not to accept the EU’s social and employment legislation. Under Labour from 1997, I think the EU social legislation was accepted. This indicated that EU legislation was hardly worse than what the UK had. But that has not stopped developments in labour markets further undermining working conditions.

    These developments, fully backed by all British governments, are not the result of the EU. They result from how most European economies became uncompetitive in world markets, and that is why Macron is trying to change French labour laws, for example.

    On ‘Lexit’: when some on the left try to turn the anti-immigration, nationalist Brexit vote into something progressive, they adapt to reactionary sentiment in the working class. The Brexit referendum vote had nothing to do with ‘labour rights’. It also happens to be very stupid economically, as is becoming clearer every day. However, despite this, the UK government and Labour cannot turn around. That would contradict the desires of the Brexit working class, and they would lose votes!

    This is a big topic. For a fuller review, see my blog articles:

  3. Thanks for your response.

    I have been following your blog for a while and agree with your basic line of argument. I agree that the EU is not/ has not been the driving force between the neoliberal restructuring of UK industrial relations in the last few decades. The pressure of competition, the logic of the capitalist system is to blame.

    I also agree on all the political points you made about national welfarism etc.

    My question is slightly different however. As I understand it, the EU is a particular institutional form of the neo-liberal turn in the world political economy since the 1970s. Membership in the EU comes with acceptance of a whole body of law that is in principle outside the purview of and superior to the national policy making process. Simply put, being a member of the EU means you can't pursue certain policies.

    Second, and more directly related to the point you made about labour market pressures, being in a common market with the EU, the price of labour power as a commodity in Britain is exposed to downwards pressures because its cheaper in the East. Withdrawing from that common market would make it possible to protect the price of labour power by controlling its supply, if a government so wishes.

    My question is, is the above line of argument completely bonkers economically? Note that I am not discussing the matter from the angle of the principle of proletarian internationalism, opposing imperialism etc. What I want to make up my mind about is the following: If Labour won a landslide tomorrow and Corbyn was given a free hand (I am setting aside the issue of Labour MP discipline here) in pursuing his programme, would a hard Brexit followed by a programme of state investment, capital account regulation etc be a workable strategy at least in the short run? Are there any economic reasons why it would not be?

  4. Response to YK:
    EU policy: this was agreed among members, and the UK was one of the main ones deciding it. Many rules relate to operating a single market, eg ones against state subsidy to industry or unfair treatment of companies. For example, no, or very few, limits on taxation or public spending, as long as these are ‘fair’. EU policy would probably limit explicit UK government support to national companies, but if you support that as a policy then that only shows your commitment to national capitalism. The next step would be things like a ‘Buy British’ campaign, and a few steps later would be support for war.

    Labour market: leaving the EU would in principle allow the British state more control over the supply of labour from immigration. Would this really benefit wages and working conditions? I find that hard to believe, since the context of this policy is negative for British capitalists. As it stands now, living standards have been cut post-referendum vote by the 10-15% drop in the value of sterling that is now forcing up inflation. Workers need to defend themselves against attacks on living standards, and that this can only succeed if the strategy is anti-capitalist and anti-imperialist. Otherwise, this is an alliance with national capitalists versus the rest.

    Labour Party policy: these guys want to manage the capitalist economy better, but cannot even add up. The most recent confusion is on student debts/fees, where even the promises are a mess. Labour cannot even produce a popular policy that would confront property interests and do something about the residential housing crisis. A programme of state investment would be a meal ticket for those who cosy up to the government to get subsidies for what they might have done anyway – you need to look at the 1964-70 and 1974-79 Labour government experiences. Policy would be explicitly constrained by what is profitable in market terms for the capitalists doing the business.

    Capital account regulation: regulation could be changed, but it has to fit a country’s place in the world system. Britain is an imperialist power with very extensive ties of investment and trade globally, as well as being a major centre for all kinds of financial transactions. Any significant exchange controls, constraints on the flow of profits or investment, etc, would badly mess this up; even small changes would be a problem unless acceptable by the market. A prospective Labour Government would not do any of this, or at least not for more than a few months. I also think that these are false palliatives. Support for these reveals both a misunderstanding of how the imperialist economy works and underestimates what needs to be done.