Brexit has presented EU leaders with something of a quandary: should they punish the UK in a bid to preserve their political union, or, in doing so, do they risk shooting themselves in the foot?
To put it another way – will they allow politics to trump economics?
In the immediate aftermath of last June’s EU referendum, French President Francois Hollande fired an early warning shot. His target was London’s world-renowned financial centre, and specifically its increasingly successful clearing industry.
The City, post-Brexit, “will not be able to” clear euro-denominated trades, Hollande raged. “It can serve as an example for those who seek the end of Europe… It can serve as a lesson.”
Since then, a number of politicians, regulators and central bankers from EU countries have struck a significantly more conciliatory tone, with many noting that an open trade deal with Britain is in the best interests of Europe’s economic recovery. “The London financial centre serves the European economy as a whole,” said German finance minister Wolfgang Schauble earlier this month. “London offers financial services in a quality that is not found on the continent.”
Clearing – the process through which trillions of financial transactions are settled – is one such example of a high-quality service provided by London. However, its future remains uncertain. The European Central Bank has previously attempted to drag euro-denominated clearing away from the UK, but lost a landmark case in 2015. In light of the subsequent referendum outcome, many analysts expect the ECB, encouraged by Brussels, to return to the battlefield.
Dragging euro-denominated clearing away from London is, in all likelihood, politically feasible – but any such attempt would be financially catastrophic. The City dominates global clearing not through political tug-of-war, but due to simple economic fundamentals.
Companies throughout the world use the UK capital’s clearing centres because they are efficient and present good value for money. Economies of scale allow for so-called “netting”, a process that reduces margins. Customers are also able to offset their positions and cut margins further; furthermore, they can manage their portfolios at any point in time to lower risk.
Losing these benefits would result in a bill of more than $100bn to Europe’s financial sector, according to research cited by stock exchange boss Xavier Rolet.
The costs are so extensive that ratings giant S&P has brushed off any risk of euro clearing activity being moved away from London. Such an outcome would be “unparalleled among major global markets”, it concluded towards the end of last year.
EU leaders should heed the warnings. It may be necessary to appear tough on the UK – especially during election season – but vandalising Europe’s economic prospects is no way to preserve its political union.