City London After Brexit
City London After Brexit Simeon Djankov, executive director of the Financial Markets Group at the London School of Economics, was deputy prime minister and minister of finance of Bulgaria from 2009 to 2013. He is also nonresident senior fellow at the Peterson Institute for International Economics. Iwona Borovik provided excellent research assistance. William Cline, Egor Gornostay, Cameron Fletcher, Jacob Funk Kirkegaard, Marcus Noland, Nicolas Véron, and Steve Weisman provided useful comments.
In March 2017 the UK government will apply for Article 50 of the Lisbon Treaty to end its membership in the European Union. This unprecedented step follows the June 23, 2016, UK referendum on the country’s exit from the European Union (dubbed Brexit), the results of which surprised many economists. Business leaders had warned about the negative effects of EU departure on the UK and European economies, and specifically on the City of London. Senior bankers threatened to leave the City if Brexit took place,1 because it will deprive UK-based financial institutions of free access to EU clients and markets.
The City of London may lose up to £18 billion in revenue and up to 30,000 jobs by leaving the single market (Oliver Wyman 2016). The analysis in this brief suggests that these estimates account for about 15 percent of financial sector revenue and 3 percent of employment in the City. Other estimates show similar magnitudes: £14–20 billion in revenue and 70,000 jobs lost (PWC 2016) or 83,000 jobs lost (EY 2017). According to these estimates, for the City of London the direct negative effect of Brexit on the financial sector will be a 12–18 percent loss of revenue and a 7–8 percent drop in employment, clearly significant effects.
City London After Brexit
The Making of the City City London After Brexit
London’s position as a global financial center started to evolve at the end of the 17th century when the first banks set up shop. In 1672 Richard Hoare founded C. Hoare & Co., the oldest bank in the United Kingdom; in 1690 John Freame established Barclays Bank, and two years later John Campbell founded Coutts, originally a goldsmith-banker’s shop (Kynaston 2012).
A century later, another burst of activity defined the City. Francis Baring founded Barings Bank in 1792, diversifying merchant financing from the original wool trade into other commodities and providing services necessary for the rapid growth of international trade. In 1798 Nathan Mayer Rothschild set up N. M. Rothschild & Sons, the London branch of the first global bank, which originated in Frankfurt. With branches in five major European cities (London, Paris, Frankfurt, Vienna, and Naples), the bank made it possible for investors to collect earnings from their bonds in different countries in the currency of their choice (Ferguson 1998). These institutions were the steppingstones toward international banking (Polanyi 1944).
Fast-forward another century and London had become the capital of a vast empire, requiring know-how for global financial management. By 1913 the British Empire administered territories with 412 million people, 23 percent of the world population at the time (Maddison 2001, p. 97). The wide span of government activities and private business attracted professionals from around the world, turning the City of London into the world’s largest agglomeration of financial institutions and talent.
But just a few decades later the United Kingdom emerged from World War II a weakened nation. The economy was in ruins, and the government owed $3.5 billion to the United States for reconstruction. London lost much of its luster as a financial center. By the 1950s it was not much different from Paris or Frankfurt in terms of size and depth of financial services and had fallen far behind New York (Kennedy 2011). For example, in 1954 the New York–based commercial banks held $35.4 billion in assets, compared to $19.4 billion in London. New York also surpassed London in terms of loan issuance, brokering $4.17 billion in foreign loans between
Also see Nicolas Véron, “The City Will Decline, and We Will Be the Poorer for It,” Prospect Magazine, September 2016.
1955 and 1960, compared to $1.06 billion in London.4 Moreover, the London financial markets were based on a structure that was 150 years old and ossified by regulation.
The City recovered somewhat in the 1960s with the introduction of eurobonds, first arranged by London bank S. G. Warburg in 1963. An industry developed quickly, and London again started attracting bankers and lawyers from Europe and the United States. But it was the “Big Bang” reforms of the 1980s that turned the City of London into the leading global financial center it is today. The Big Bang introduced new rules for the financial services industry enabling the switch from traditional face-to-face share dealing to electronic trading. There were three key elements to the reforms: abolishing minimum fixed commissions on trades, ending the separation between those who traded stocks and shares and those who advised investors, and allowing foreign firms to own UK brokerages. By removing fixed commissions the Big Bang reforms allowed more competition; by ending the separation of dealers and advisors it allowed mergers and takeovers; and by allowing foreign owners it opened the City of London to international banks (Martin 2017).
The Big Bang reforms proved prescient. London became the natural focal point of financial activity in Europe when the euro was introduced in 1999 as the currency of 11 EU member states. The contemporaneous internal market policy efforts—for example, the Lamfalussy Process of developing financial service industry regulations used by the European Union— brought further impetus to the growth of the City. Auxiliary service providers such as legal advisory firms developed rapidly, with expertise in not only common law but also the civil law tradition of continental Europe. Thanks to the euro project and the internal market enhancements, the 15 largest legal practices in Europe are all headquartered in London.
City London After Brexit
In addition to the early emergence of financial institutions and the Big Bang financial reforms, there are other reasons for the City’s comparative advantage. One is its time zone: London’s trading day starts as the Tokyo market closes and a few hours before New York’s opens. Second, the widespread use of English around the world gives London an edge over Frankfurt, Paris, or Milan as Europe’s main financial center. Third, the fair and efficient UK legal system is a point of attraction: when there are parties from several different countries in a deal—say, a Dutch firm selling an African business to an Asian rival—they often choose to have the contract drawn up in the language of a country that has clear commercial laws and experienced judges. Fourth, London has highly rated universities that draw international talent and create a pool of well-prepared professionals—in the 2016 ranking of world universities, London and its environs have four among the top 25; only one other European university makes the cut.6 The analysis returns to these special characteristics of London in section