The City is a global financial giant that will more than survive after Brexit

On just about any measure you care to choose, the City of London comes out top of the charts across all Europe’s capital markets from derivatives to bond trading.

The numbers speak for themselves: the UK has a 93% share of euro-denominated interest rate derivatives, 89% of all OTC derivatives trading and 83% of all euro-denominated derivatives trading across the European Union.

Britain also dominates foreign exchange with 84% of FX trading in all currencies and 76% of all euro-denominated FX trading across the EU, where at least one side of the trade is the euro.

There is more: about three quarters of the rest of world’s bank assets in the EU are located here. The UK also has nearly half of total assets under management in the EU and 43% of trading in the EU27 shares are carried out on UK-based platforms while two-thirds of trading in EU27 bonds is conducted through the City.

Added together, these activities account for a third of all capital markets activity in the EU across the main 25 different sectors. Put another way, the UK’s share is nearly double that of France, and more than France and Germany combined. Capital markets in the UK are also roughly twice as deep relative to GDP compared to the rest of the EU’s member states.

So, when Britain leaves the EU at the end of the month, the loss of Europe’s biggest and deepest pool of liquidity blows a huge hole straight through its capital markets infrastructure.

Perhaps more disturbingly for the EU, the UK’s departure could push up the cost of capital for European companies. Without full access to the UK, bond markets in the EU could also be around one fifth smaller. Equity markets will shrink by around one quarter while pensions assets and assets under management will be about a half smaller.

Brexit also means the continent will have a much smaller global footprint. At present, the EU is the second biggest capital market in the world with a combined share of 22% of global activity. For context, that is nearly half the size of the US, but a big lead over its nearest rival, China.

At midnight on December 31, that changes. The EU’s capital markets will shrink. Their global influence will diminish. According to a fascinating new report published this week by New Financial, the bloc’s share of global activity will fall from over a fifth to around 13%, roughly one third the size of the US and about the same as China.

For the EU, the timing of Brexit could not come at a more sensitive time. This shift in the balance of financial power is happening just when EU’s leaders hope to exert more influence at a geo-political level. Or in techno speak, they wish to have more “strategic autonomy”.

Will Wright, managing director of New Financial, says the report’s findings are a stark “wake-up call” for the EU, which now needs to drive its own banking, finance and capital market capabilities to develop deeper, mature markets.

Politically, it is entirely understandable that the EU would want to transfer as much trading across the Channel as it can. However, such a move is not without economic risks: on both sides of the water. As the report suggests, if the EU tries too hard to launch a “land grab”, this may lead to higher fund-raising costs for European companies. Analysis suggests that trying to switch activities away from London and to the EU could cost business as much as EUR 20 billion.

There would be other negative impacts: the loss of decades of financial experience and a loss of competitiveness within EU markets, which may even trigger some business to go further afield.

The New Financial report also points out that Brexit exposes how vulnerable European companies are to bank lending: around 77% of all corporate debt comes from bank lending in the EU27 with corporate bonds representing just 23%. Banking on banks at such a fragile time – and the huge rise in bank lending to help bolster company balances during the pandemic – may prove tough in the difficult climate ahead.

There is one area which the UK may lose out, and that’s trading in EU-27 stocks. Unless the EU and the UK agree an equivalence regime by the end of the year, trading stops. While this would not be a massive blow in terms of loss of employment or revenue, it’s a business the City would prefer not to lose.

Once you take out the UK’s slice, France will be the biggest capital market in the EU with a share of around 24% compared to Germany on 20%. And once Brexit is complete, the French and Germans will inevitably so all they can to entice business out of London and onto the continent.

Yet some of us are old enough to remember how long both Paris and Frankfurt have been trying to win more European and international trading business for decades. They have failed to build financial centres of scale that can rival the City.

Perhaps there is a clue in the way French and German leaders position themselves in this battle for finance: they talk of repatriating business. But this misses the point: the trading that takes place in the City has not been stolen from these centres because most of it was never based in continental capitals in the first place.

It’s no surprise then that attempts by Deutsche Borse’s Eurex Clearing in Frankfurt to “take back” euro clearing have already faltered, partly because of Covid but also because of a reluctance by foreign banks to move their operations without fully understanding the consequence of their actions.

Even President Macron’s attempts to lure foreign banks to Paris with big tax-breaks and other incentives such as free schooling has failed to attract more than a few banks setting up new offices and adding a few thousand jobs. (Although you do have to wonder whether such incentives break state-aid rules?)

There are endless reasons why the City has become such a hub for international trade over the last 40 years. They are well-rehearsed but worth repeating: the time zone, the English language, and a legal system which is practiced and emulated around the world. More recently, London can now boast some of the best restaurants, shops and galleries in the world ( if they are ever to open again), which bankers’ – and their partners – are reluctant to give up in favour of moving to a more brutal city such as Frankfurt or to a busy but more chaotic Paris.

Yet there are other more intangible reasons for the City’s success: its cosmopolitan bankers and traders have always been swift to innovate, invent and create new products in a flexible regulatory environment.

Will Brexit change this status quo? And to what degree will the City lose its edge to the continent? Will the City’s traders jump ship and help turn Amsterdam into the new centre for trading, as some say, and will Frankfurt become the favoured destination for investment banking?

It’s early days. Some of the big US banks are already on the move. An EY report earlier this year estimated that banks have moved 7,500 employees to the EU and shifted about £1.2 trillion of assets to centres such as Dublin and Luxembourg. In the scheme of things, they are tiny moves.

But they are moves that the big US houses can easily afford and they need to hedge their bets as the EU has not granted firms that access.

Without equivalence, firms operating across Europe’s financial capitals will lose their passport to offer services across the EU. They will have to rely on the bloc granting the UK so-called equivalence for them to do business with customers in the region.

Yet despite those tentative moves across the Channel, New Financial’s report concludes that most EU-related and euro-denominated activity will stay in the UK. Even now, with equivalence still up in the air, the worst case scenario is that London may lose some 10% of its business but will more than make up for those losses because of the freedom that being outside the single market will bring in terms of freedom from regulations such as Mifid II.

It’s a tiny sliver of business. Compare that forecast to the Cassandra-like warnings floating around in 2016. Remember those warnings from Oliver Wyman’s consultants who predicted Brexit would lead to Armageddon in the City with at least 35,000 jobs going and tens of billions of revenue being lost. What do they have to say now?

The late Peter Meinertzhagen, one of the City’s finest corporate brokers, used to say the reason the City prospered over the last century was because the Brits are “pirates and hustlers by nature and magpies by behaviour”. Like most pirates, they welcomed fellow foreigners to join in their raiding. As Meinertzhagen also said, it was that extraordinary openness to new talent and ideas which led to the creation of so many new services from insurance to money markets to eurobonds. Today London’s strengths lie in FinTech and digitisation. And there will be more.

Read the report yourself – New Financial: What do EU capital markets look like? By Panagiotis Asimakopoulos.