A chance of showers

UPON joining a panel mulling new regulations for London’s financial industry in 2010, Martin Taylor was confronted with “an operatic chorus” of bankers threatening to move elsewhere if oversight became too strict. Moneymen from all sorts of firms told the former boss of Barclays, a big British bank, that they were on the verge of decamping to Switzerland, apparently a paradise of low taxes and sympathetic regulators, safely beyond the reach of the European Union’s banker-bashing. “The City”, for centuries a mainstay of the British economy, risked losing its status as the centre of global finance, and with it hundreds of thousands of jobs. It wasn’t until Mr Taylor learned that the financiers of Zurich and Geneva were simultaneously threatening to relocate to London that his concerns eased somewhat.

The grandees of the City are often accused of crying wolf, pretending that their industry is about to be devoured by taxes and regulation when in fact they are just trying to protect profits. In recent months, the same chorus that greeted Mr Taylor has joined a new crescendo, complaining of everything from a new tax surcharge on banks’ profits to London property, which is apparently too expensive even for finance types. Above all, the doom-mongers point to Britain’s prospective departure from the EU, the subject of a referendum to be held by the end of 2017. Are their concerns any more plausible this time?

The City appears to be in rude health—and for good reason. Only New York, which is bigger but less international, can credibly be said to rival it. Its trading day spans the planet, making it possible to buy bonds from Asian firms in the morning and sell them to American pension funds in the afternoon. Its workforce is well educated and speaks the world’s de facto business language. Britain’s flexible common-law system is so popular that it is used even in contracts drafted far beyond its borders. The country is more open to trade and capital than most, and London is a more exciting place to live than mooted rivals such as Frankfurt and Singapore.

Rule, Britannia

London’s trading floors dominate the selling of bonds and currencies: twice as many dollars are exchanged there as in America and twice as many euros as in the euro zone. A fifth of cross-border lending is booked in Britain, more than anywhere else in the world. The City boasts more foreign banks than any other financial centre, but banking is just one of its elements. Managers based in London control 18% of the world’s hedge-fund assets and 13% of private-equity funds—much less than America’s share, but double the proportions of 2001. Over 500 foreign companies are listed on the London Stock Exchange, more than on any other venue.

The financiers are supported by a dense network of professionals: London is teeming with lawyers, accountants and consultants of all stripes. Around 8% of Britain’s economic output comes from finance. It generates net exports of $95 billion, almost three times the size of the American industry’s, according to TheCityUK, a lobby group. That is useful for a country with a big current-account deficit.

Regulation has tightened in London since the financial crisis—but it has everywhere else too. Though bits of the regulatory set-up are stern, the British government has recently sent some conciliatory signals. It has tried to mollify big multinational lenders based in London with changes to the bank levy, an expensive and ill-conceived tax on their global balance-sheets. It will be halved, and applied only to local operations. The unspoken aim is to stop HSBC and Standard Chartered from moving to Asia, as they have threatened.

Anyway, other financial centres have their flaws. “If you want to speak to the entire Frankfurt financial sector, you can gather them in a large ballroom,” one policymaker quips dismissively. Paris suffers from France’s leftist politics: François Hollande, its president, declared while campaigning that “the world of finance is my enemy.” Brevan Howard, a hedge fund that noisily moved traders to Switzerland in 2010, is quietly sending them back to London, not least because some found Geneva insufferably dull.

New York is too far from Asia and too focused on its domestic market; its regulators also have a particular penchant for levying multi-billion dollar fines. Hong Kong suffers from its small size: if HSBC did move there, its balance-sheet would be nine times the territory’s GDP. Shanghai looks destined to grow but cannot thrive while investors struggle to get money in and out of China. Singapore is also expanding, but for the time being remains focused on Asia.

Yet the City is not as impregnable as all this suggests. It has lost chunks of its business in the past. Bits of insurance have largely relocated to Bermuda and other warm spots. Fund-management is gravitating to Dublin and Luxembourg. Switzerland continues to attract private-banking clients, despite no longer offering banking secrecy. Big firms of all sorts have moved their back-office and IT staff to other places, both within Britain and beyond. Last year Deutsche Bank startled the City by moving some trading to Birmingham, two hours north-west, to cut costs.

Moreover, the City faces several unique challenges. For one thing, even the shrinking bank levy (which is being cut only gradually) still makes certain activities unnecessarily expensive. Dealing in government bonds, say, is not all that risky but swells a bank’s balance-sheet in a way the levy punishes. To begin with, that may simply prompt banks to set up brass-plate subsidiaries in tax-friendly jurisdictions, to process deals consummated in London. But in time the consequences will grow. “If you move balance-sheet out of somewhere, eventually you move people. Regulators in the new location insist on it,” says Jim Cowles of Citigroup, a bank.

The bonds that unbind

That will compound the problems of the City’s biggest business: the trading of bonds and currencies. This has been shrinking since the crisis, although whether for cyclical or structural reasons is unclear. It has also generated a series of scandals and giant fines, many for misconduct that took place in London. City traders rigged currency markets and fiddled LIBOR, a benchmark interest rate (the “L” stands for London). JPMorgan Chase, another bank, lost $6 billion at the hands of an employee called the “London Whale”. Regulators have even blamed the 2010 “flash crash” of American equities on a London-based day trader (he denies it).

The world over, banks’ trading operations are in retreat. But that is a particular problem for the City, since it has long dominated the business. The other main bit of investment banking—helping firms issue debt or equity and buy one another—is smaller in London than America, since European firms tend to turn to banks, not capital markets, for finance. It has also been growing more slowly because of Europe’s economic weakness (see chart 1).

Meanwhile, the sorts of financial institutions that are growing to fill the gaps left by banks—asset managers, insurers, sovereign-wealth funds and other “buy-side” firms—are far less attached to London than the banks. They can be based anywhere, and are: PIMCO, a bond giant, is headquartered in Newport Beach, a Californian backwater. All have presences in London, but not the deep roots of the banks. If bank bosses follow through on their periodic pledges to locate staff near their clients on the buy-side, jobs will flow elsewhere.

The commodities business illustrates the problem. It was once part-and-parcel of investment banks’ operations, sitting alongside currency and bond-trading desks. But regulation forced many of the banks to spin these units off, shifting them from the sell-side to the buy-side. Before long, much of the activity had moved to Switzerland, which had long been home to a few big commodity brokers.

The centre of financial gravity is shifting, too. As Asia grows richer and its markets gain heft, companies there will presumably chafe at the use of intermediaries half a world away. A trader in Singapore or Shanghai will seem the obvious option.

The opprobrium for bankers that is now commonplace in the West is much rarer in Asia, in part because the region dodged the worst of the financial crisis (although it did have one of its own, in 1997-98). Bankers cannot help but notice the difference in attitudes. Within hours of HSBC announcing it was considering leaving London, Hong Kong’s central bank declared that it would take a “positive attitude” to any attempt to relocate there. Such enthusiasm is unthinkable in London. The only financiers who command politicians’ affections there are the “fintech” entrepreneurs intent on pinching business from banks. As shallow as it may seem, the sudden shortage of invitations to Downing Street and knighthoods for services to finance rankles with even Masters of the Universe.

In previous centuries, finance houses used to base themselves in London because they were British. But the biggest British banks have become relative minnows in recent years (see chart 2). Nowadays the City is to finance what Wimbledon is to tennis: a British venue where foreigners usually dominate. Access to Europe is what attracted foreign firms in the early 1990s: Margaret Thatcher’s “Big Bang” had deregulated Britain’s financial markets just as new European rules made it possible for firms based in London to do business anywhere in the EU. That makes the big threat to the City, the prospect of “Brexit”, especially worrisome.

City bosses tend not to intervene in politics. Yet a striking number of them have spoken up in favour of continued membership of the EU (the City has few Eurosceptics). Their biggest fear is that firms based in London will lose “passporting” rights, whereby they can do business throughout the EU while being supervised only by British regulators.

In theory, a departing Britain might negotiate a treaty with Europe which retained such privileges. In practice, that is wishful thinking. As it is, other EU members relish imposing rules that the City dislikes. “Without a seat at the table, Britain would get skewered by France and Germany, both of which delight in hobbling the City whenever they can,” says one seasoned lobbyist. A survey by CSFI, a think-tank, found that only 42% of City workers imagined that, post-Brexit, firms based in London would get access to European markets on “broadly satisfactory terms”.

In the worst-case scenario, Britain would have to negotiate access for its financial firms country by country. EU regulators would doubtless seek to throttle the flow of money to what would be seen as an offshore financial centre. Pressure might be placed on European pension funds, say, to manage their investments within the bloc. At the very least, certain activities, such as the settlement of transactions denominated in euros, would evaporate.

Brexit would make attracting the best employees difficult too. City bosses already gripe about the difficulty of getting work permits for migrants from outside the EU. Brexit would probably strip current and future European employees, of which the City has many, of the right to work in Britain. The immigration system that would replace the current one has yet to be devised, but it would not be as liberal.

Advocates of Brexit talk up the advantages of escaping from meddling European rules on finance. In one or two respects—notably the caps on bankers’ pay imposed over British objections—that would be a plus. But Britain has lost its taste for “light touch” regulation thanks to the crisis. If anything, it now adapts edicts from Brussels to make them even more stringent.

Polls suggest that Britain will opt to remain in the EU. Banks are unlikely to start shifting functions as long as that remains the case. “It’s not like people are taking their kids out of school,” says Mr Cowles. But reports abound of firms that had been considering setting up shop in London, but are holding off until after the referendum.

Should Britain remain within the EU, and the world economy improve, the City’s prospects would doubtless begin to look much better. A resurgence in trading of bonds and currencies, which many expect when global interest rates begin to rise, would help London regain some vim. So, if successful, would European regulators’ efforts to get local firms to finance themselves with fewer bank loans and more bonds and equity. Moreover, London’s greatest asset has long been its ability to adapt, finding new ways of making money in changed circumstances.

But the City’s ability to adapt would be tested by a shock as deep as Brexit. Meanwhile, the most sought-after jobs in banking today—drumming up money for Silicon Valley tech outfits or advising Asian conglomerates about which firms to buy—are ones from which the City is largely excluded. “The thing about the boy who cried wolf,” one adviser to banks points out, “is that he ends up getting eaten.”