Brexit and the City: implications for EU capital markets

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By Professor Andrew Mullineux, Professor of Financial Economics, Research Associate at the Lloyds Centre for Responsible Business
The Department of Finance, University of Birmingham

Banks and other financial institutions are preparing for Brexit (and a potential ‘no-deal’ Brexit) by opening and moving staff to offices in EU cities. We can expect to see this trend continue, in which case, what are the post-Brexit prospects for London as a financial centre?

London is a well-established global financial centre and currently the most important financial centre in the EU. There are many well-known advantages to establishing offices in London (time zone, legal system, language), which means it may retain its thriving international business in the long run. Currently, however, there is a growing focus on establishing Asia and reasserting Wall Street as the world’s financial centre.

Brexit poses numerous risks to London and the EU, such as:

  • Increased costs of some financial products and services previously produced inside the Single Market
  • Increased risk of financial instability during the immediate post-Brexit transition period
  • Damage to the EU’s flagship Capital Markets Union (CMU) project

The CMU project was conceived after the 2007-9 financial crisis and the subsequent 2010-12 Eurozone crisis. The project launched in recognition of the heavy dependence of the EU on its fragmented banking sector, spearheaded by European Commissioner, Lord Hill. He later resigned from the position, following the Brexit referendum.

The EU’s fragmented bank-dominated sector contrasts markedly with the US, and to a lesser extent the UK. The UK and US debt (bond) and equity capital markets are much more developed and provide a much greater share of finance to the business sector. The prompt recovery of the US financial sector and their ability to deal with post-crisis bank debt problems contrasted starkly with the EU.

The CMU aims to better allocate capital in the EU, reducing reliance on banking. This approach would take advantage of the free movement of capital in the EU and could potentially reduce the fragmentation of small and medium-sized enterprise (SME) financing.

The improvement in allocation would reward responsible policies with regard to:

In order to be successful, the CMU would need consistency in bankruptcy laws, assuring bankruptcy protection along the lines of US ‘Chapter 11’ procedures. ‘Benchmark’ (ideally zero risk) bonds and bills for the capital markets would need to be established. There are numerous proposals concerning how such ‘Eurozone bonds’ might be created through joint issuance by participating states. So far, opposition has tended to come from states with stronger credit ratings, such as Germany.

The capital markets would operate more efficiently if taxes – especially on the profits of corporations and interest, capital gains and dividends – and securities trading were harmonised. In addition, the bias within tax systems towards debt relative to equity financing through interest ‘expensing’ or ‘deductibility’, should be addressed.

A ‘no-deal Brexit’ would prevent London from performing its naturally central role in the CMU project. If a deal is negotiated and accepted, the softer the Brexit, the greater the role London will play.

At the moment, it is seeming likely that Brexit will bring about more fragmentation of the EU capital markets. Specialist financial sectors are expected to develop in major cities hosting regional capital markets. This means markets will be more widely dispersed and participation will be further-reaching than the current London-dominated system.

This could possibly accelerate the switch away from banking-dominated systems in the EU to better serve the regions. Furthermore, in this digital age, EU cities serving as capital market hubs could be fully networked to form a genuine Capital Markets Union.

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