Why is Goldman Sachs going short on London?

This is the Good Business column by Maggie Pagano, exclusively for Reaction subscribers 

For a man who claims to be ‘doing God’s work’, there is something less than divine about Lloyd Blankfein’s cryptic threats that Goldman Sachs may have to rethink its future in London post-Brexit.

Blankfein’s latest missive warning about the uncertainties of the Wall Street firm’s commitment to the City came from the skies again, this time via a Twitter picture. He sent a tweet with an aerial shot of GS’s new £350m European HQ which is currently under construction, and just a stone’s throw away from its present Fleet Street HQ. More appropriately, the new building is closer to St Paul’s Cathedral.

This is what Blankfein tweeted: “In London. GS still investing in our big new Euro headquarters here. Expecting/hoping to fill it up, but so much outside our control. #Brexit”.

The threat is implicit. Blankfein will have known precisely the impact his words will have on an already jittery City, manna from heaven for those arguing for a long transitional deal, if not pulling Brexit altogether.

Indeed, he is using the same scare tactics that Goldman, along with the other big US and overseas banks, have been deploying every since they were part of the Project Fear campaign ahead of the referendum.

It’s Blankfein’s second threatening tweet. The first, which was even more provocative, was sent a couple of weeks ago when he was in Frankfurt looking at another of GS’s new buildings. It’s less grand than the London HQ but due to be ready at the beginning of 2019 – in the nick of time for the Article 50 deadline. This was his tweet: “Just left Frankfurt. Great meetings, great weather, really enjoyed it. Good, because I’ll be spending a lot more time there. #Brexit”

You can see why Blankfein and Co are so nervous about what sort of deal the government is negotiating with the EU over financial services. The so-called ‘vampire squid’ has much to lose – or at least thinks it has much to lose.

Goldman is a big beast in London – one of the first US banks on the scene after Big Bang – and one of the biggest employers with 6,000 staff.  It’s London machine has been a phenomenal success and its tentacles run deep – over the last thirty years it has won many juicy M&A mandates, has a great roster of European and international clients, and has advised the UK government on many initiatives; some would say too many. What’s more, GS International, which employs around a fifth of its worldwide staff in the City, is the most profitable part of the firm. In 2016, pre-tax margins were some 50% higher in the London business than those in the rest of the world. (Most overseas banks make more money in the City than elsewhere).

So what game is Blankfein playing? Is he playing one of arbitrage between London and Frankfurt, trying to scare the UK government into offering tax breaks and incentives for GS to keep most of its employees here rather than move them across the Channel. A trader by background, the question is, is Blankfein shorting or going long on London?

If so, then it’s a crude and dangerous game: and hardly one to win over the UK which has been a most generous host to GS for decades.

Or is he – and Blankfein is not the only bank boss to be accused of this – still holding on to the groupthink that Remainers remain fixated by which is that the loss of passporting rights, and other contractual details, will be damaging?

Or is there another explanation, one that is frankly rather more plausible. Which is that most bank chiefs – and even their advisers – have not done their home work properly and don’t understand even the basic law surrounding the UK’s relations with the EU ? That’s the view of Barney Reynolds, head of the global financial institutions advisory & financial regulatory group at U.S. law firm Shearman & Sterling in London, and one of the City’s saner voices arguing against claims that the Square Mile will be destroyed if the UK falls off a cliff-edged without an alternative trade agreement in place.

Reynolds – who has his own proposals for a UK-EU deal – has persistently argued that a ‘no deal’ situation will neither be a bad thing for the City or indeed, the big banks and assets managers. He bases his view on the law.

In a new paper published this week, Reynolds also argues that fears of a cliff edge Brexit for certain types of financial contracts, in the event of there being ‘no deal’, are unfounded. Indeed, he suggests that recent concerns expressed by the Bank of England and Germany’s regulator, BaFin, that firms will lose out because of a loss of passporting rights in a cliff edge for certain types of financial contract are misguided.

Au contraire. Reynolds claims that by combining human rights law, and taking maximum advantage of reverse solicitation regimes, there should be no material “cliff edge for the performance of existing financial contracts or the servicing of existing customers resulting from Brexit.”

Blankfein & Co should take heed. Reynolds also tells me that there is nothing in “European law to say that people could not come to London to do business after Brexit if they so chose. Nor is there anything to prevent European banks from setting up London subsidiaries from which to do that business. London is where all the money is – and the people with the money call the shots.”

Passporting, according to Reynolds, is hugely overrated, and came at a cost to the UK because our laws were harmonised with more bureaucratic EU law. But because all the big banks have branch offices, he reckons there will be no great loss of business and that most trading and risk management will stay in London – which is where the money is.

Reynolds has bigger fish to fry: his concern is the UK will go for an equivalence deal in which banks are given access to EU markets if – and only if – the EU regulations are followed to the last dot.

That, he says, would be disastrous and the worst of all worlds as the City’s ‘standards’ based approach to regulation would be coupled with the EU’s high-minded rules approach. The result?  As always, the UK would gold-plate the rules, we would end up with more red tape and be a rule-taker with EU countries racing to the bottom, offering tax incentives for companies setting up offices in their territories.

Quite rightly, he says walking away would be better than this option. But the best option would be to go for a form of equivalence agreed by the UK and the EU to “mutually agreed international principles rather than submission to EU-prescribed rules.”

Put another way, rather than the EU telling the City what to do, the City and the EU should work together on principles set at the international level. Reynolds also believes the existing EU framework for equivalence could be updated before Brexit so that UK and EU firms would be guaranteed “evergreen” access to the other’s market –  locked in with a new bilateral UK-EU agreement.

Although controversial, the Treasury is said to be looking seriously at Reynolds’ proposals. So should DExEU. They need all the fresh ideas they can get.

And Blankfein? He should stop his mischievous tweeting and invite Barney Reynolds out for lunch to find out what the law says rather than what he thinks it says.