London has peaked as Europe’s capital markets hub. But how much of the business it will lose is still to play for. Bankers’ faith that only some functions need go looks misplaced. The stage is set for a drawn-out poker game between banks wanting to stay in London and continental regulators who hold a strong hand.
The bizarre and unprecedented experience of Brexit is
reaching its climax. Living through this rolling carnival of events and
clashing opinions is like watching a surreal film — the happenings are wild,
nothing makes sense and we have no idea how it’s going to end.
Brexit might be called off altogether; the UK might skid
over the cliff and leave the European Union without an agreement; the whole
thing might get delayed; or the deal negotiated by Theresa May might be
implemented, leading to a sudden flooding back of the reassuring sense that
British pragmatism wins out in the end and a workable compromise is always
Whatever happens, historians will make it look like the
outcome was inevitable. We, in the middle of it, know the opposite is true.
Curiously, considering how sensitive and prone to
over-reaction they are, financial markets have been remarkably calm so far. And
the way financial players are preparing for the legal and operational changes
Brexit will bring is also fairly ordered, compared with the chaos in the
Essentially, this is because financial firms have to plan,
operationally, for the worst possible outcome — a no deal Brexit. Failing to do
so would be grossly irresponsible. At the same time, no one involved wants that
scenario, if it happens, to be a disaster movie — so it will not be one.
“This is a one-off seismic event which is unprecedented,”
says Etay Katz, financial services regulation partner at Allen & Overy in
London. “It creates a need to be accommodating for a period of time. If
regulators stick by the letter of the law they will not allow much business to
be conducted. They have to flex the rules to allow for an orderly transition.”
Flying without a passport
Every investment bank in Europe’s capital markets has been
making sure it has the requisite permissions to carry on business in the EU if
the UK leaves without a deal. That would mean the UK losing its passporting
rights and becoming a lawless alien, as far as EU regulators were concerned.
“It is very clear that the passport is required for a great
variety of so-called investment services,” says Katz. “These are services in
securities and derivatives which include underwriting, intermediation, sales,
acquisitions, primary and secondary market activities.”
In practice, all firms of any size will need to establish a
subsidiary in an EU country, with the relevant licences for the business it
wants to conduct, thereby gaining access to the whole EU market through
passporting. And this is what they have done. A subsidiary is a separate
company, which can be regulated in the country in which it is based. A branch
has no legal personality and is just a limb of another entity, which may be
overseas and regulated in another country.
A choice of red carpets
Setting up new subsidiaries, or repurposing existing ones,
is achievable, though not easy or cheap. Regulators in every EU state are eager
to welcome new arrivals. One thing has become much clearer: which cities will
benefit from business moved out of London. For virtually all banks, it is one
of four cities ringing London: Paris, Frankfurt or Amsterdam, plus Dublin for
administrative, rather than front office business. It will not be winner takes
all: each will gain substantially.
Luxembourg will increase its existing role as the venue of
choice for registering investment funds. One headhunter says Frankfurt is
picking up a lot of the administrative jobs that go with this, though, as it is
cheaper than Luxembourg.
The next question is much more difficult. How many and which
of the staff serving EU clients need to be based in the EU? This is an
immensely complex issue, considering the great variety of investment banking
services, regulated under different regimes, and the global nature of capital
“There is no hard law that says ‘if you have this sort of
business, you must have those sorts of people dealing with it’,” says Simon
Gleeson, partner in the financial services practice at Clifford Chance in
London. “This is not a point that the European authorities have been
particularly interested in.”
All the banks know it is not enough just to put up a brass
plate in Frankfurt and move a couple of compliance people there — even if the
deal-doers left in the UK now work for a branch or subsidiary of the Frankfurt
“Everybody has the same rules, including the UK,” says
Gleeson. “If you are going to have authorisation to operate on my territory,
that business has to be run from my territory in such a fashion that I as
regulator can monitor it and get my hands on the people doing it if I need to,
and ensure that there is sufficient capital in my jurisdiction if something
goes wrong. Those principles are common to everyone, so the question for the
host supervisor is simply: ‘what does “enough” mean in this context?’”
Bagsy not me
Not even the regulators have a settled answer yet. As for
the investment banking world, it is thick with different ideas.
Some believe trading and salespeople are the only ones who
need to move — advisory and origination bankers can stay in London. Others say
risk-taking executives need to be in the EU; or that client coverage bankers
must be. Are debt capital markets bankers client coverage? Or can that role be
taken by local corporate bankers, with DCM acting as a team of product experts,
flown in from London to advise on details?
The bond syndicate function is a particular puzzle,
combining as it does elements of risk taking, product expertise, client advice,
deal origination and sales. Some banks are moving syndicate people to the EU,
or have a contingency plan to do so; others deny this is necessary.
For the time being, very few bankers are contemplating
moving, and even fewer have actually gone. “The assumption is that there’s
going to be a deal, so this will be a 2020 issue, not 2018,” says Gleeson.
“Every time we’ve looked at it, the view we have come to is that the proposed
numbers are getting smaller rather than larger. What the European regulators
are saying is the minimum necessary staffing to get and maintain an EU authorised
subsidiary. I’m not aware of anybody who’s planning on moving significant
numbers of people.”
But regulators certainly have the power to demand more. “A
reasonably small European firm, with a disproportionately large and senior
staff sitting in London, would be a very unpalatable story to sell to the home
regulator,” Katz says.
A desire to avoid this “fat branch” syndrome is why, he
says, the big banks have not so far converted their UK operations into branches
of their new, much smaller, EU 27 subsidiaries.
There are two reasons why there are no simple answers.
First: no country has ever left the European Union before. Even the existing
arrangements for non-EU banks operating in the EU do not provide useful
precedents. Nearly all have EU subsidiaries or branches, which, in practice,
hold most of their staff active in Europe. Some may be dispersed across the
continent, but the subsidiary’s host regulator has never minded, since the
chain of command ran through the European HQ.
As for staff outside the EU serving EU clients, on a
substantial scale, there is little or no precedent for it.
The EU does have an equivalence regime — a system for
deciding that a foreign country’s financial regulatory system is equivalent to
that in the EU, and hence that services can be provided cross-border. But the
only zone in which it has been used is central counterparty clearing —
something very relevant now to the fate of LCH, the London clearing house for
most swaps. In the MiFID II world of investment firms, no country has ever been
The result is that regulators are having to decide how many
staff are “enough” as they go along.
And here comes the second reason this is confusing. Each EU
country has its own regulator, making its own decisions. The result, not
surprisingly, is a wide dispersion of outcomes.
Add a dash of politics to the mix — regulators feeling they
must be patriotic and woo bankers to their office towers and restaurants — and
there are incentives both for regulators to be lenient to firms, to attract
them, and later to crack the whip, insisting they bring over more bankers.
Katz says that for more than a year now, the European
Central Bank has been trying to get a grip on this process, so as to rein in
the regulatory divergence and make sure regulators do not cut banks easy deals.
“That has slowed the process of new authorisation down quite considerably,”
says Katz. “Any new bank application is processed by the local regulator but is
ultimately granted by the ECB these days. There is some leeway, but on concepts
like the brass plate and outsourcing, you should expect a level playing field,
although it is far from straightforward for the ECB and Esma to achieve that.”
Reluctance to move
This muddle hardly sounds like the orderly transition
referred to above. Yet there are two other forces acting on the situation and
keeping it contained.
One is inertia. The banks, at this stage, want to move as
few people as possible. This is not out of principle (as if!), but to avoid the
costly and potentially disruptive fragmentation of activities between different
centres. And much more powerful than that is the immense difficulty of moving
large numbers of highly skilled and paid staff to another country.
Recruiting locally on the continent is impossible. The local
talent pools are much smaller and any suitable candidates were snapped up
months ago. But how many bankers want to move, when they have partners with
jobs in London, children at school, homes and friends?
Many will end up being weekly commuters, and this, together
with its edge in the glamour and cultural interest stakes for those who do
move, means Paris has an edge in the race. Two and a half hours on the
Eurostar, with wifi some of the time, are preferable for most to traipsing through
miles of departure lounges at Frankfurt or Schiphol.
France, with an investment banker as president, has also
been on a charm offensive, offering breaks from France’s high personal tax
rates. “Somebody described it to me as ‘trust us, we won’t behave like the
French’,” said a capital markets specialist.
Early on, some banks thought they could save money by this
process, swapping expensive London bankers for cheaper ones on the continent.
With a few exceptions — European banks pulling people back to their domestic
HQs — that now seems laughable. Bankers are having to be bribed to move, with
hefty relocation packages, including school fees and housing allowances. All of
this is pure cost for the banks, with no upside in higher revenue potential.
They are likely to claw it back by making job cuts before long.
One tactic banks could try so as to avoid moving staff may
be to use an outsourcing model. The Amsterdam entity, for example, could buy in
services such as DCM expertise from the London unit, much as banks already
outsource business processes to India.
Cards in the hand
Acting against this friction is the second force — the power
of national and EU regulators to compel banks to move assets, staff and capital
to the EU. They have time on their side, and just about everything else.
But opinions diverge about how this tug of war will play
out. Gleeson paints a fairly benign future for London. If a Brexit deal similar
to May’s is agreed, the UK will leave on March 29, 2019 with a transition deal,
keeping its passport until 2020, or longer if transition is extended.
“If at that point what is agreed is an equivalence regime,
then nobody has to go anywhere,” says Gleeson.
Others see serious obstacles to that. “The processes are
irreversible — nothing is going to be halted,” says Katz. Even if May’s deal
were passed, the best outcome he can foresee for London is that “the migration
of activity will be orderly rather than chaotic — a proper transition from
where we are now to a position where the passport is no longer available”.
“Equivalence in its current form works only for an insufficient
volume of the business, and would need to be expanded very substantially to be
underpinning business models,” says Katz. “Even the expansion of equivalence
which is potentially on the cards would take years to work out.”
In any case, he adds: “the Europeans are now rethinking the
whole concept and whether they need to place further safeguards, rather than
relaxing the regime”. Some countries have talked of requiring line-by-line
equivalence of legislation, a much more stringent test than equivalence of
It is not clear what incentive the EU side would have to
play ball with the UK, and an equivalence deal would oblige the UK to keep its
financial services laws very close to the EU’s forever.
Gleeson sees mileage in it, however. He argues that the
political declaration agreed by May with the EU sets down that if an
equivalence arrangement is agreed, any change to it would be based on formal
consultation, ensuring that it could not be ended arbitrarily, but only after
due process and with appeals.
“If the choice is between worrying about an extremely
unlikely event [an abrupt end to an equivalence deal] and having to mess up
your business by moving hundreds of people around the continent, I can’t
imagine many going for the latter,” Gleeson says.
The long withdrawal
The opposite view is that no bank would want to take the
regulatory risk of waiting for the equivalence deal to be negotiated and then
relying on an arrangement that could be seen as politically fragile. Meanwhile,
the regulators in the EU would use their power to gradually crank jobs across
Katz delineates three phases. In the first two years, he
argues, a skeleton staff will go, to get the EU subsidiary going and show good
faith to the regulator.
In the second two year period, “the authorities in Europe
will start insisting on more staff being onshore in Europe, as the banks in
Europe ramp up their balance sheets.”
What happens after that will depend, Katz argues, on whether
local “ecosystems” of talent have developed in Paris, Amsterdam and the others,
which “start having their own dynamics”.
In his view, “We are going to land somewhere much more
pragmatic than the legal texts suggest. London is not going to be reducing its
dominance any time soon.” However, over a long period, chunks of the business
will be broken off as it will no longer be feasible to run them from London.
Bankers are, rightly, focused on the short term — on making
sure their businesses can continue to function through the coming weeks and
months. They are trying to keep things the same as much as possible, and many
believe they can get away with only superficial change. In any case, there is
little point making plans for what might come further ahead.
But many signs point to a very different investment banking
landscape in future. Europe may have five banking cities instead of one —
unless Paris or another becomes pre-eminent and acts as a centre of gravity,
because all the heads of DCM or investment banking want to be together at the
heart of the action.
Ironically, a Brexit enacted at least partly to stem a tide
of immigration from the EU looks likely to end with Britain desperate to avoid