Financial centres react to Brexit bombshell

Of all the likely scenarios of post-Brexit jousting between financial centres being painted by both qualified pundits and self-styled commentators, the most likely shifts in power and wealth are of New York gaining and London losing.

This is one of the key conclusions drawn by Christian Edelmann, head of the global corporate and institutional banking and wealth and asset management practices at financial consultancy Oliver Wyman.

Despite the huge uncertainty following the election of president Donald Trump, the US has a much stronger position than post EU referendum-London, its banks are better capitalised and it has a bigger investor base, fuelling an expected natural flow of assets westwards across the Atlantic. 

The anticipated number of jobs to vacate the UK is predicted to be in the region of 10,000, with losses predominantly in derivatives, clearing, investment banking, plus some asset management, with 60,000 estimates “at the high end”. Mr Edelmann’s discussions with US and global banks indicate that when it comes to arbitrage transactions, London institutions will simply not be able to keep up with US standards of quality.

Banks have long been thinking of ‘offshoring’ middle and back office staff from the UK to cheaper destinations and Brexit could provide the political trigger for such economic decisions. 

“Banks have been under significant cost pressure for years and they have been looking to see whether they can afford to have back office staff based out of London or not,” says Mr Edelmann. 

Nearby destinations and city offshoots such as the Channel Islands are not only too costly but too small to fulfil these functions. It takes a full scale financial centre such as New York to accommodate required numbers of staff. 

“Given the size of New York, it has the potential to absorb 15 to 20,000 newcomers and a broader infrastructure. It has exchanges, clearing houses and settlement solutions. You don’t have to build it from scratch,” says Mr Edelmann.

Yet few material decisions about shifting staff have been made, with only a few agreed “at the edges”. Many institutions, particularly the Asian banks, are reviewing future investments, deciding whether to target the UK or Europe as a whole. Such a decision could involve a ‘pullback’ to the US, with UK operations downsized.

A done of reality

At the City Of London, Mark Boleat, chairman of the policy and resources committee for issues affecting London as an international financial centre, remains realistic. “When Britain leaves the EU, London loses a bit of its attractiveness for some institutions. This could lead to some business going to New York, but it depends on what the US government does with tax and regulation.”

Of the 2m jobs which depend on the city of London, he admits up to 75,000 could be at risk and advocates working towards continuing to make London an attractive destination by reaching out to global institutions for new opportunities, rather than lamenting the loss of small pieces of business. After all, few banks will be prepared to change homes to exploit marginal differences. 

“I’m not downbeat, I’m realistic,” says Mr Boleat. “We have a number of institutions saying they will move some of their activities from London, so we have to get used to it, there is no point in denying it. There is no point in saying London is every bit as attractive as it once was.”

Providing the UK government brings in the right policies on tax, financial regulation and immigration, financial firms will continue to locate to the British capital, he believes.

“London is a dynamic economy: we gain business and we lose business. We just need to make sure we gain more than we lose,” he says, expecting the balance of employment in London to continue to swing away from banks towards media and telecoms.

Early talk of shifting staff to other continental centres such as Frankfurt and Paris was “overblown”, claims Oliver Wyman’s Mr Edelmann. “You can count on one hand the number of English-speaking schools in Frankfurt,” which would certainly not be able to absorb an influx of more than 50,000 financial workers as originally forecast. Rival continental centres would struggle to “replicate London’s broader ecosystem” of schools, culinary and cultural experiences, he says. 

France on the other hand is held back by political considerations, linked with tax and highly unionised labour. Only those firms such as HSBC, with established legal entities in Paris, would be able to move substantial numbers of workers there. Mass moves to Amsterdam or Madrid, recently discussed, are also unlikely.

“Parts of businesses will go here and there, but there will be no sure-fire winners,” says Mr Edelmann, although there are some potential disruptions on the horizon.

Clamp down

Even though most mutual fund houses now base their operational centres of excellence in Luxembourg, including risk and regulatory reporting functions, portfolio management is still typically carried out in the UK. 

But this could still change and outlines one of the biggest potential changes to the dynamics of the financial centres landscape. “The biggest question is: do we keep the rule of portfolio management delegation or not? The UK is primarily a portfolio management hub and home to the sell side too.”

Under international law, the rules allowing funds to be administered in a centre such as Luxembourg and managed in London or New York have never been called into question, but there is a possibility that the post-Brexit European Union could clamp down on this practice. “It is a tail risk and the biggest risk there is for the asset management industry,” believes Mr Edelmann.

Dublin, like Luxembourg, is also well positioned to attract funds business, given its language expertise and the legal set-up of the financial centre and funds structures. 

“A few banks with an existing Dublin set-up are looking at doubling down,” but no firms without the Irish infrastructure would consider moving to the Emerald Isle, he believes.

“Banks are asking themselves: what do we already have and how can this be capitalised? These decisions are made around which legal entities they already have and what can be leveraged to run the business at minimal friction level. People will not just move their funds company to Paris or Dublin.” 

The Mediterranean centres of Malta and Cyprus “at the edge may see a little spill-over” from Luxembourg or Dublin, but are still lagging the twin EU funds domiciles in terms of quality of set-up.

Cross-border boom

Amin Rajan, CEO of the Create Research consultancy, not only expects Luxembourg and Dublin to maintain their “powerful” status as domiciles for Ucits funds, but he predicts the Irish capital will gain from a projected revival in hedge funds, profiting from an increasing internationalisation of the investment industry and greater volumes of cross-border sales.

“This is what history tells us: Toyota and Apple are going down this route. We are seeing Apple products produced in Taiwan and sold in China.”

The funds sold out of cross-border domiciles such as Luxembourg and Dublin will be managed in an increasing number of investment centres, potentially taking business from London, believes Mr Rajan, with knowledge accumulated by more qualified chief investment officers in regional capitals such as Paris, Milan, Frankfurt and Amsterdam.

One major winner for outsourcing could be Warsaw, believes Mr Edelmann, with the likes of Citi, Credit Suisse and UBS already having established Polish offices for their private banking operations. The only thing standing in the way of Warsaw’s rise as a regional financial centre is political uncertainty, fuelled by the current right-wing government, he believes.

A major shake-up to the European status quo is unlikely because “Europe needs London as much as London needs Europe,” he concludes. “Access to finance and capital markets has always been driven through London for the rest of Europe. You can’t replace this overnight.”

The “base case”, he says, is that both Europe and the UK are likely to recognise their mutual dependency and get away from the “we are better for you than you are for us” rhetoric. A potential deal “will not materially damage London as a financial centre,” he believes. “If we don’t reach this deal, then both sides will lose.”

But not all are so optimistic for London’s ability to cut a favourable deal. “This requires exceptional leadership, which we do not have,” says Create’s Mr Rajan. 

Switzerland may also have suffered slightly from the UK’s problems, as “any deal they had considered [with Europe] is now on the back burner,” says Mr Edelmann. The core proposition for Zurich and Geneva is further honing the wealth management model, he says, with their investment management experiment having largely failed.  

“Success will depend on the service quality that Swiss wealth managers can provide in a fully transparent world. In terms of stability and currency, in an increasingly unstable world, Switzerland still has big advantages. Instability is very much playing pro-Switzerland at the moment.”  

London lives on

EU membership is only important for certain sectors of financial services business, not for the whole industry, says the City of London’s Mark Boleat. Investment banking and insurance both particularly require an EU presence and he expects parts of banks’ businesses, rather than whole companies, to relocate. “It’s almost certain that we are going to lose some jobs, but it remains to be seen how many,” he says. 

Many other cities including Dublin and Luxembourg are now hungry for London’s financial business, following the referendum, but only those few who do not already run funds from these hubs will transfer any staff there, believes Mr Boleat.

He is still waiting for the market and European authorities to decide if the clearing of euro trades can carry on in London and admits it would be a blow if it had to stay within EU borders after Brexit. He also talks down any speculation of London being given more independence and issuing its own visas for city workers. 

“I can’t see a city state taking root in London,” says Mr Boleat, despite the current trend of devolution of certain powers for welfare and education to cities, including London. 

“We can’t make laws on visas or put in our own regulations. But clearly we want to influence these policies to make sure London remains attractive.”

Malta’s custody conundrum

One of the key challenges for the Mediterranean island of Malta, where it lags behind more established EU fund centres such as Luxembourg and Dublin, is a lack of major custodians to service the increasing number of fund houses looking to be based there.

The only specialist custody player to have such a presence is Citco. But Joe Bannister, chairman of the Malta Financial Services Authority, the regulatory body, says he is “in discussion with three or four” other institutions, expecting positive results. The signing of another custodian would help service the upswing in enquiries, particularly from boutique investment houses, which Malta has been experiencing since the UK’s Brexit referendum.

“We are seeing more small to medium-sized managers who will fit in quite well in Malta,” says Mr Bannister. “Decision making is much easier for these smaller players.”

The sweet spot for Malta lies in boutique and managed account players, especially those involved in structured finance, typically managing around €500m ($528m), employing five or six staff. Board members, key decision makers and portfolio managers are normally based in London, with the operations staff in Malta. 

The tiny country has had more than 100 enquires from insurance  companies since the referendum and has been caught by surprise by the interest on this side, with the first round of licences from these discussions expected to be confirmed by Easter.

Luxembourg’s international appeal

Much of the recent interest in Luxembourg as a funds base, following the UK’s Brexit vote, has come from firms in Asia, particularly Hong Kong, Tokyo and Taiwan’s capital of Taipei, says Denise Voss, chairman of Alfi, the country’s promotional body for funds.

Her forthcoming visit to Chile, Colombia and Peru is also expected to yield potential clients, as is a later foray into the North American funds market.

A key focus will be “US and Japanese funds that have used London to access European markets”.

There are also Alfi initiatives under way to promote Luxembourg as a destination for infrastructure investments and green funds, through the Luxembourg Green Exchange.

Access to labour will be a major factor for the Grand Duchy. “The Brexit impact in terms of Luxembourg taking on additional staff could be a challenge for the companies,” says Ms Voss.