ALTIF Transcripts: The City Contra Mundum

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You might remember that during the Brexit referendum, and through the period till Britain actually left at the start of 2020, there was a lot of talk about what our departure would mean for the City of London. Yet despite some talk of a financial Waterloo with business moving to places like Paris and Dublin, there wasn’t really the seismic shift that some had expected. About 10,000 jobs moved or 4%, according to EY. But now nerves are being set at jangling by stories claiming that, zut alors, the French stock market is now bigger than the whole blighty’s. But save your splattering at this national humiliation. It’s not quite true according to our chumps at the Financial Times. With a market capitalization of $2.89 trillion, British domestic shares are still worth a whisker more than France is $2.83 trillion. And if you add in all the international equities and ADRs that sort of Depository Receipts, based on shares traded in London, the gap is much wider $6.2 trillion to 3.7. But some still think it’s all a bit close for comfort. So we thought it was a suitable moment to cast a look at how the City is faring under Global Britain. Is it still a global powerhouse? Or is the great party over. Of the wholesale business done in the City around 20 to 25% came from the EU before Brexit? That’s a big chunk. Are there signs this is trickling back across the channel? Now we’re very opposed to groupthink on this podcast, so we thought we’d get a Frenchman to discuss these issues. And we’re very pleased to welcome Nicolas Veron, economist, financial services expert at the think tank Bruegel in Brussels and the Peterson Institute in Washington. Welcome, Nicolas.

Nicolas Veron 2:10

Thanks for having me.

Jonathan Ford 2:14

But I thought we would start off to just kick off by talking a little bit a bit about the stock exchange numbers that have got people excited. And in parts, of course, this reflects, you know, changing stock market values. UK shares are supposed to be quite cheap, and also currency movements. Does any of this really matter? Is there anything really significant happening here?

Nicolas Veron 02:30

Yeah, I don’t think it should be fetishized. And as you said, there are different ways to look at the numbers also, Paris Stock Exchange is part of an integrated European group- Euronext , with listings also in Amsterdam, Brussels, Lisbon, Dublin and other places. So it’s difficult to compare apples to apples, I think what may be significant is the kind of direction of travel which is that London is less dominant than it used to be that has a long way to go. But I think the more important thing is that equity markets are just one part of the much broader landscape of the City of London and the City has never been only about equity markets, or even mainly, at this point. It’s very much about derivatives and other market segments. So I hope we will take a holistic approach.

Neil Collins 03:21

I wondered whether the headline figure was just there to make us sit up and take notice. Because share trading is a diminishing part of London’s activity. And it doesn’t seem to be short of innovation of products. And indeed, as far as I can see, its market share in a large chunk of these things is actually improving rather than deteriorating.

Jonathan Ford 03:47

Well. That’s an interesting point. I mean, I think Nikolas touched on the question of derivatives, foreign exchange all the areas where the City of London has been very dominant in recent years. And although it’s still pretty strong in those areas, there are still… there’s a slight shine of slippage in terms of market shares, versus where we were even three or four years ago, in both of those areas. But I don’t know what you make of that. Nicola, do you think there are signs in broader terms, businesses beginning to ebb away from London,

Nicolas Veron 4:21

So I would be nuanced on this. We have the latest numbers from the Bank for International Settlements, which publishes a reference survey of derivatives market activity, and indeed, it does suggest a little bit of erosion of London’s position, but London is still the main place, together with New York, but more international than New York, where this trading takes place – especially in foreign exchange, and rates. So that position remains very central to the global financial system. I wouldn’t say it has increased if anything, it has decreased a bit, but it’s very prominent. And this is of course cleared at the London Clearing House specifically, it’s quite clear. And that’s a matter of policy discussion, of course. The question is London is benefiting from a clustering effect, right? All these transaction, all this liquidity clustered in London during the time when London was part of the European Union. And the question is, will it stay in London long term? While London is no longer part of the European Union? And that question has a lot to do with discussions about prices and disruptive events. So in a business as usual scenarios, things have inertia, and two business days in London because it is in London. The question is how resilient that is, we had a little bit of an episode in September, but that was short lived. I think this issue of resilience should keep us awake in our discussion today.

Neil Collins 05:51

Well, given the fact that we have scored an impressive own goal on the budgetary side, that we’ve just raised taxation for the highest earners in the City. Do you think that London is seriously threatened with losing ground in a significant way elsewhere?

Nicolas Veron 06:13

Brexit is a negative for London as a financial centre, there’s little doubt about this, because think about it. London was onshore for its entire European Union. Now it’s offshore for the European Union. It’s a third country in the jargon. So it’s still an onshore market for Britain and Northern Ireland. But that’s its backcountry, if you think of it in kind of hardball terms. Again, it’s a simple equation, London used to be onshore for the UK onshore for the EU, offshore for the rest of the world. Now, it’s onshore for the UK offshore for the EU, offshore for the rest of the world, and there’s a lot of business you can attract as an offshore financial centre. And so the question is, how does it match the positions that London has right now?

Neil Collins 06:57

When you say that, do you think that it’s going to improve? Or are we condemned to gentle decline as the services migrate slowly to the remaining members of the EU?

Nicolas Veron 07:11

The EU right now is extremely reliant on London as a financial centre – to an extent that is almost unparalleled for an offshore financial centre. So that’s probably going to decline to – EU reliance on London – it hasn’t happened entirely into transition, smooth Brexit. So if you look at it, right now, this transition has been mild, but there is still a lot of cross-channel business or cross-CFI end business, which probably is unsustainably high given that London is offshore for the EU. So then the question becomes, what is the ripple effect of that, in terms of business that London does with the rest of the world? And here, you can look at two sides of that equation. One is, maybe London will be able to be more competitive thanks to Brexit, because it can deregulate and do things, and lower taxes, well, not clear that’s happening. And the other side is against this clustering effect. So you have less of a critical mass, if London loses business from Europe, it is no longer the bridge head to Europe for international businesses, then does it have the same synergies with other lines of business with the rest of the world as it used to have? And I think the answer is probably no, but we understand very little about it. And so we will learn a lot from what we will observe,

Jonathan Ford 08:29

I suppose one of the things which I wanted to ask about, you talked about, we were on a sort of journey of discovery as to what happens when you make quite substantial changes to a big financial centre like the UK, to what extent can we see when we talk about these market share numbers and relative numbers, what they partly reflect is growth that’s happening elsewhere in the world. And as people have pointed out, the most fast-growing part of the world in the financial services businesses is in Asia. And Europe, both with and without the UK has been a diminishing proportion. To what extent are we releasing absolute shifts? Or are we just, for example, seeing the fact that Asia effectively is growing its market share in these markets and growing faster than any of us are?

Nicolas Veron 09:21

I mean, if we want this discussion to be about Brexit, there is a counterfactual of no Brexit. So though, in a way, it’s a question of the opportunity cost of Brexit. Would the UK have gained more business if Brexit hadn’t happened? With Asia, there is this very interesting dynamic that has to do with Hong Kong. Because, you know, something is happening with Brexit and London, but something is happening in Hong Kong, which is probably even more powerful. Now. I’ve implied that moving from onshore to offshore was probably not great news for London. But the crux of this situation is that for Hong Kong moving from offshore to onshore in relation to mainland China, is probably not great news, either. That says something about China. But clearly Hong Kong is suffering, we can discuss to which extent, from basically being integrated into Mainland China on a number of dimensions. Now, that’s an opportunity for London. Clearly, it’s an opportunity for Singapore, perhaps even more, but it’s an opportunity for London because there is a lunch that used to be Hong Kong’s, and it’s no longer going to be Hong Kong’s to a certain extent.

Jonathan Ford 10:24

Yeah, I want to just take a step back for a second and go back to look at the way in which London grew in the past. And most of what is there now was sort of built in that period from 1960, when first of all, the Euro markets opened up, partly just as a way of breaking through the capital controls. The Eurodollar market, the Eurodollar markets. And then obviously, we have the European Union and the growth of London’s business there as well, when that was what you call an onshore market. People now look at the City in the post-EU world and they say, well, what is the next great growth opportunity for finance? And some people think it might be green finance, some people think it might be financial technology. Do you think there is anything any great growth, opportunity that’s out there?

Nicolas Veron 11:19

It’s interesting to remember is that the Eurodollar markets, which clearly have been completely transformational for London, and have played a huge role in making the city of London what it is now, this started from geopolitical arbitrage by the Soviet Union, access to US dollar for Soviet. Yeah, this is well known. I’m not saying something particularly provocative. But  the rise of London as an alternative century to New York, was entirely a Cold War story at the beginning.

Jonathan Ford 11:47

And that’s because the Russians didn’t want to put their dollars in American banks, because they thought they might not get them back.

Neil Collins 11:53

It was also a rather serious tax angle. If you repatriated your dollars, you would pay tax, and there was a great advantage in leaving them in London.

Nicolas Veron 12:03

That’s right. The reason I’m mentioning that is that we’re experiencing a dramatic change in our mental maps of the world, compared to the heyday of globalisation, we can discuss when that stopped. But we’re certainly past a peak, maybe past the peak, we don’t know. And so there will be a rerouting of a number of financial suits, certainly from China, it is being said by various credible sources. I don’t think it’s an official number. But it’s very plausible that just in the last one or two years about I think 1,500 family offices have relocated to Singapore, this is a huge number as these things go.

Jonathan Ford 12:39

So this is capital flight, really, this is people moving their money out of China.

Nicolas Veron 12:42

Exactly. And people moving their money from mainland China, or from Hong Kong, actually to Singapore. The point I’m making here is that the world is changing fast in terms of you know, who’s willing to do business with whom, to me, the big question is where will London be in the geography of financial flows of the next few years and decades, shaped by a new geopolitical environment? And that question is as much about geopolitics than it is about London?

Neil Collins 13:13

Can I just sort of change tack a bit and ask about your views on regulation? Are we headed in the right direction? Or are we giving ourselves more problems from regulation than the reforms are designed to deal with? Is it possible for the regulations to keep up with the financial innovation that is happening all the time, particularly in London?

Nicolas Veron 13:43

So the regulatory community in London, centred on the FTA, the Bank of England, and maybe a few other bodies, is widely recognised as extremely competent, market savvy, nimble. So on this, I would say London certainly has a comparative advantage, we can discuss how much, but it’s doing pretty good. The question, of course, is, how does that fit into a political environment in which of course, regulators can advise legislators and the executive branch, they can make a number of decisions on their own, but at the end of the day, is their space of action is shaped by Westminster and Whitehall.

Neil Collins 14:24

I’m sure that our regulators would be delighted to hear you praising them. But we narrowly avoided a very serious problem only last month, when the regulators totally failed to see the problems with the pension funds.

Nicolas Veron 14:41

I didn’t include the pension regulator or whatever it’s called into the list of entities I praised, maybe that was an oversight. My understanding and I haven’t read the full post-mortem of what happened in September-October, is that there was a quirk to the regulatory architecture that had consequences, in terms of pensions not being supervised with as demanding supervision as other market segments, but tell me if I’m wrong about that.

Neil Collins 15:08

No, I was just going to say that I’m not sure that it was the fault of the Pensions Regulator. I’m not sure what the public pensions regulator, how it fits into the regulatory jigsaw. But it’s certainly a very serious blind spot, and caused a massive crisis, which was only solved by the Bank of England injecting huge amounts of liquidity into the system.

Jonathan Ford 15:31

I wanted to come back to the question you raised earlier about geopolitics. And, you know, the example you gave of the Soviet Union and their role in helping to create the Euro markets…

Neil Collins 15:46

It’s the Eurodollar market, quite important. 

Nicolas Veron 15:49

The  Eurodollar markets – when that all happened, people didn’t think oh, well, obviously, that’s going to lead to a massive offshore bond market. And similarly, at the moment, the world as you say, is very confused. How do you see the kind of geopolitical world and how it might impact on the kind of financial sector?

Neil Collins 16:07

A modest little question, I think you’ll agree.

Jonathan Ford 16:11

It’s a very modest question. I’m just interested if you can say a bit more about what you see about it because I think our listeners would be quite interested.

Nicolas Veron 16:16

I think the short answer is pretty easy, because everything is in flux, right? So the big question here is China, the US and the rest of the world, leaving Russia aside, because Russia is cut off for now, we’ll see how that develops. But leaving Russia, Iran, North Korea aside, you have this huge space between China and the US. And we have a relationship between China and the US, which is – has been deteriorating very rapidly in the last four years. But you have a rest of the world, which by and large, wants to keep doing business with both sides. And that very much applies to the UK. I’m not saying symmetrically because if the UK has to choose, of course, it will choose the US. But there is this idea that it would be nice to be in an open world where transactions are possible, wherever it makes sense for business. How is that going to play up in the next few years is anybody’s guess,

Neil Collins 17:06

As they say, forecasting is always difficult, especially for the future.

Nicolas Veron 17:09

Yes, yes. Yes, yes. Yes, very good. Now I want to put the boot on the other foot, because we’ve been talking a lot about the UK and how it will fare. Turning it on its head, what do you think will happen with EU, and how will it reorganise itself to attract more business? Do you think that the EU will create its own financial centre? And if so where will it be?

Nicolas Veron 17:36

So it’s a bit difficult for me to speak about that, because I’m a European citizen, but I’m also a French citizen. So the way the system works, Paris is my hometown. I grew up there. So I’m probably more biased than I’m even willing to accept. I have been surprised by the early developments of that piece of the game. I was expecting Amsterdam to do quite well and they’re doing quite well. But between the two main kind of general purpose financial centres we have in the EU, which are Frankfurt and Paris, I was expecting Frankfurt to do better and Paris to do not as well as they actually did. So the way it’s shaping up at this point, is that maybe just because it’s a big city in a way that Frankfurt is not, Paris looks like the centre of attraction, despite its shortcomings, which are the fact that basically, it’s part of France. And France has a government which is not super finance friendly, by tradition, but currently, the French government is probably more finance friendly than average it has a President who understands finance very well. He’s a banker, in that sense. Maybe that explains why Paris has been doing I think, comparatively better than many people expected, including myself. So at this point, I would say the money is genuinely on Paris, but it’s early days.

Jonathan Ford 18:51

But do you think that the EU could cluster everything a bit like London into one centre? Or do you think it will always be quite decentralised because of the nature of it?

Nicolas Veron 19:00

I think you really have to compare it with very large economies. The natural point of comparison are the US and China. In China, you have four centres that matter, or three and a half. You have Beijing where all the banks are located. You have Shanghai, where the government is promoting the capital markets. You have Hong Kong, of course, which has legacy and international capital flows. And you have Shenzhen, which is why I was saying three and a half because it’s not clear that Shenzhen and Hong Kong are separate, where you have also innovation and high-growth technology-driven firms. So that’s China. In the US you have a lot of asset management in Boston derivatives in Chicago, and innovation in the Bay Area. And of course, you have New York. I think if you think of the EU it’s probably going to be something comparable. I mean, there will be some specialisation. One centre might gain dominance in a number of segments of financial intermediation, but I think the EU is in a way too big to have a single financial centre for sure. To a certain extent the role of London in the last two decades has been a historical outlier.

Jonathan Ford 20:06

So I want to ask you, How optimistic are you about the outlook over the next sort of five years for the financial world? Do you think it is a period which is perilous, given what’s happening with interest rates? And the general adjustment that is taking place after the pandemic, and all the rest of it? Or do you think we’ll carry on seeing vigorous growth?

Nicolas Veron 20:31

Are you looking more at growth? Or are you looking more at stability.

Jonathan Ford 20:35

I think stability – I’m afraid I’m gonna have to go with stability.

Neil Collins 20:41

We’ve had a sort of sugar rush, haven’t we over the last decade with zero interest rates, which was gone on for far too long. And now we’re getting back to a sort of dose of reality. And I think higher interest rates are bound to have an impact on growth. So I would say, a period of quite painful interest rates and very little growth.

Nicolas Veron 21:06

On stability. I think it is remarkable how the marketplace has been able to take this monetary policy regime change in its stride. And this observation applies both to the US and to Europe. It is absolutely remarkable that in the US you have moved from the Fed that was doing what it was doing until, you know, a year or so ago, to a Fed that has been right, raising rates, I think at an unprecedented pace, I think, or certainly a very high pace that hasn’t generated market instability in the US. The system has coped with the change of expectations in a way that I think is really a case of a dog that hasn’t barked. In the European environment, well, we have discovered a pocket of fragility with UK pension funds. So there is that. The European Central Bank is very mindful of the need to not be too abrupt in its monetary policy regime change because of the risk of financial instability. And I think so far the system has been pretty resilient in the EU as well, certainly looking at it in a Europe centric way. And that probably includes the UK, and Europe has a bank-based financial system, the banks are better supervised and regulated than they were 15 years ago. So that probably means the risk of massive financial instability is less serious than it was 5 to 15 years ago, call me a fool for saying something like that. And probably I will be humbled by the developments going forward.

Jonathan Ford 22:37

If you had to list the main risks for the City of London in the next few years and risks for the EU financial system in the next five years, what would be the top of your list?

Nicolas Veron 22:49

So far, the City, the UK looks brittle. You remember as a famous word of Dean Acheson ‘It has lost an empire and not found a role’. At this point the UK has lost an EU membership but not really found a new ground, a new sense of direction, or at least that impression if it gets looked at from the outside. Probably looked at from inside things are much clearer in terms of, you know, sense of direction.

Jonathan Ford 23:10

NO

Neil Collins 23:15

I fear you’re right about that

Nicolas Veron 23:17

So you’re right about immigration, will the UK be open to talent coming from outside going forward? It has been very open to talent from outside in the past. And I’m looking at political risk in general Northern Ireland, Scotland, there are a number of unsettled issues. And of course, I’m talking about the relationship with the EU, because it has gone through ups and downs. There are still a number of unsettled issues. And I think the UK-  just look at the map. The UK is dependent to a certain extent may be limited on the stability of its relationship with its continental neighbours. For the EU? Frankly, I think the biggest risks right now is the most visible one. There’s a war just on our doorstep. And I think this can be potentially very destabilising. So far it had looked like public opinion into EU, by and large, has been willing to take some hardship, but it’s only the beginning of the season, not even to winter at this point. And we will see how that evolves over time and how that affects the political and ultimately policy dynamics that are resulting from this huge external shock. So I would put that front and centre.

Jonathan Ford 24:21

There we go.. we’ve covered a lot of ground Nicola.

Neil Collins 24:29

It’s very interesting stuff. We will obviously have to go live in Singapore.

Jonathan Ford 24:30

We’re all going to move there now you do realise that.

Neil Collins 24:36

That was a long time in finance with Jonathan Ford and Neil Collins. Reduction editing by Nick Hilton. And our sponsorship partner is briefcase dot news. If you enjoyed the show, please rate and review it on your podcast app because that will help new listeners find us