Brexit and the City

London’s financial industry grapples with the biggest demerger in its history

Finance

This is a deal which has no precedent. Plenty of countries (28, to be precise) have joined the European Union, but none has asked to leave. In the summer of 2016 David Cameron, casually assuming the British people would stick with the status quo, made no contingency plans for Brexit. In 2017 the City of London, with some trepidation, will face the consequences.

Not even the smartest quant can predict the precise terms of divorce or the exact date of British withdrawal. A few brave souls say it may never happen. Yet in 2017 a degree of clarity will come when Theresa May’s government formally invokes Article 50 of the treaty on European Union, declaring Britain’s intention to leave the EU. She has said she will do so by the end of March.

Once Article 50 is triggered, a two-year clock starts ticking for the completion of talks on separation. The government will spell out the trade-offs, such as access to the single market and accepting the principle of freedom of movement and the supremacy of the European Court of Justice. In 2016 immigration fears trumped business as usual; in 2017 the ledger may look a little different.

The tension between being a rule-maker and a rule-taker will become evident. The City will press for certainty on divorce terms; Mrs May will want to retain flexibility. She will have one eye on the French presidential election in April-May. Victory for the far-right Marine Le Pen, though improbable, would signal “Frexit” and the possible end of the EU.

The City is an ecosystem where big beasts such as the wholesale banks (JPMorgan Chase, HSBC, Goldman Sachs, Barclays and Standard Chartered) roam alongside omnivores such as the insurers Aviva, Prudential and Legal & General. Asset managers, footloose private-equity firms and hedge funds are in the mix, supported by thousands of accountants, lawyers and tax advisers of every national stripe.

Each will weigh closely whether to sit tight in 2017. They will watch to see if Brexit negotiations tilt towards a clean break (short, sharp but risky), an amicable mutual adjustment (positive but protracted) or a hostile divorce (messy and very expensive). “The closer to the real economy, the more exposed you are to Brexit. The more you play a financial game, the less you care,” says one City executive involved in Brexit preparations, though small, domestic insurgents like Virgin Money and Metro Bank will also be less exposed as long as they do not grow by much.

In 2017 three words will enter the vernacular: “equivalence”, “passporting” and “transition”. Wholesale banks, which provide loans, debt financing, bond and equities trading, and deposit-taking, are highly regulated under EU law. They will seek to preserve their passporting rights to trade in EU jurisdictions or secure something equivalent. At a minimum, they will want transition arrangements to ensure that commercial deals struck with clients do not slide into a legal no-man’s-land between, say, 2019 and 2021.

Some firms, fearing that their access to the single market risks being compromised, may simply bolt. No one expects a collective rush for the exit. (People still love living in cool London, despite the cost of housing.) But lines of business will trickle away, with Dublin, Luxembourg, Amsterdam and Paris among those already holding out enticements.

Re-bonjour, Barnier

A familiar Gallic face will re-emerge in 2017. Michel Barnier, the ski-loving scourge of the City in his earlier guise as the internal-market and services commissioner in Brussels, will make a comeback as the EU’s chief negotiator for Brexit. He will encounter David Davis, a bruiser with no love for bankers, who will handle negotiations under supervision from the Cabinet Office.

Expect few breakthroughs and plenty of brinkmanship. A bespoke deal will be hugely complicated. The City risks forfeiting advantages such as euro-clearing, but can counter with a bid for offshore renminbi. As a whole, financial activity in London will slowly shrink, though that was happening anyway as a result of post-crash regulation and low interest rates. “It will be more like a slow puncture,” says one business leader.

Many will be surprised at the City’s willingness to retain EU legislation once dismissed as intrusive, such as MIFID II (covering financial markets) and, less so, Solvency II (for insurance). That will be the price of something close to the associate eu membership for Britain, which some technocrats have in mind—unless opinion hardens and the government opts for a “naked exit”.

Neither Britain nor the City can expect a better deal from the eu than was previously offered by membership. On that point, there is unanimity in Brussels, Berlin and Paris. To paraphrase Voltaire, the price of Brexit must be high enough pour décourager les autres.

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