French president François Hollande |
The vote to leave makes it more likely the remaining EU member states will vote to give the European Central Bank the authority it needs to force the clearing and settlement of euro-denominated trading into the eurozone, possibly even before the UK leaves the EU, say analysts.
French president François Hollande was emphatic on Tuesday, saying: “The City, which could make its clearing operations in euro, won’t be able to do so any more.”
Such a development would be an opportunity cost for London. Clearing is in place for FX futures and despite the absence of regulatory mandates, voluntary clearing of non-deliverable forwards is also taking place and options clearing is expected to reach the table later this year.
Basel III requirements to pay and collect margin on uncleared derivatives and set aside more capital for derivatives positions will add further impetus to clearing.
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Source: Global Financial Centres Index, Z/Yen Group |
The latest Global Financial Centres Index (GFCI) does not make particularly healthy reading for Paris and Frankfurt, the two cities perceived as most likely to take FX business from London. Paris is ranked a lowly 32nd, while Frankfurt is 18th – a fall of four places from the previous index.
Despite Zurich, Luxembourg and Geneva all scoring higher than Frankfurt, and Munich also coming in ahead of the French capital, Open Europe co-director Raoul Ruparel accepts that – based on infrastructure and labour supply – Paris and Frankfurt are the obvious beneficiaries of any FX flight from London.
“The role of clearing houses in any relocation decision should not be underestimated,” he says. “Deutsche Börse is headquartered in Frankfurt and LCH.Clearnet has a clearing house in Paris.”
This is clearly an advantage for these French and German cities, given the investment required to create a clearing platform and the relatively modest returns.
For example, LCH’s FX clearing service calculates margin requirements 24 hours a day and undertakes the risk netting and settlement of trades on maturity. Yet it made a profit of just €10 million on its FX clearing activity last year compared with group operating expenses of €335 million.
The French government has made overtures to City-based firms, but Ruparel says it is unclear to what extent it would incentivize FX banks to cross the English channel.
“Culturally and socially, France has taken a different approach to the UK in relation to this type of business in recent years and it remains to be seen whether they have the appetite to offer tax incentives,” he says.
Lifestyle and talent
Ruparel also acknowledges that alternative locations will have to offer an attractive lifestyle to persuade traders to move from London and that availability of talent to plug any gaps is an additional consideration.
“London has large numbers of graduates from high-quality universities who have studied finance, business, politics and economics, and are looking for jobs in the City. Other cities would have to rely more on people relocating.”
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Hakan Enver, |
Hakan Enver, operations director at Morgan McKinley, observes that moving FX operations is not a straightforward process and entails substantial costs and risks, for example finding new talent to replace those who choose not to move.
He says that based on his conversations with UK-based bankers, neither Paris nor Frankfurt has the same appeal as London.
“There not only has to be a tax incentive for employees to benefit, it is equally important to recognise that the new location has to be one that is culturally accepting,” he explains.
“Citizens of other European countries working in London may feel differently, but if you asked a group of British bankers whether they would move from London to Paris, patriotism would nudge them towards staying in the UK.”
Ashurst partner James Coiley agrees that trading banks are likely to move business to cities where they already have infrastructure.
“Rather than an aggregating effect, Brexit is likely to lead to dispersal of FX business across multiple locations in the short term, which would favour Luxembourg and Dublin over Paris and Frankfurt,” he says.
The attitude of local regulators might also influence the spread of FX business – Ireland in particular has made it clear it is open for business post-Brexit – although Dublin barely scrapes into the top 40 European cities on the GFCI.
There are other factors that will limit the ability of European cities to pick up the slack from London, including personal tax regimes, where Paris might be at a disadvantage to other centres, adds Coiley.
“Politics will also have an impact,” he says. “Making overtures to FX banks and traders to relocate to Paris may not play well with supporters of the socialist French government.”
Additionally, France has been the most enthusiastic advocate of the proposed financial transaction tax, which research by Oliver Wyman suggests could increase FX transaction costs by a factor of 18.
Gregor Irwin, chief economist at Global Counsel, a strategic advisory firm, says FX business that leaves London is most likely to go to Frankfurt or Paris for reasons of scale and that other European financial centres would struggle to compete.
“In practice, we are likely to see competition between the two, with one of them likely to emerge over time as the winner,” he says.
On the question of whether a delayed Brexit will have any impact on the volume of FX business that might leave the UK, Open Europe’s Ruparel observes that firms will be wary of making rash decisions.
“Overall, the FX community would be leaning towards a slower, drawn-out process, but once there is clarity on the likely future relationship between the UK and EU, they will react quickly,” he says.
