Less regulation means more business for the City, right? It’s not that simple
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Version 0 of 1. A post-Brexit ‘Big Bang 2.0’ is the last thing finance needs: the rules are what make London an attractive place to do business, says investment banking analyst Dan Davies Being a specialist in financial services regulation is a great way to make sure you never talk about your job at parties. It’s complicated and it’s boring and the only times it’s ever in the news are exactly the times when everyone hates you because something has gone badly wrong. Nevertheless, it’s important, and it ought to be in the news a bit more at the moment, because one of the UK’s biggest industries, in terms of output, employment and (yes) tax revenue is under serious threat. After more than 20 years in this business, I’ve come to the conclusion that almost nobody understands the single most important thing about the City of London from an economic point of view. And that’s that regulation isn’t a constraint on the financial sector – it’s a vital commodity input. What do I mean by that? I mean that, for example, it’s a false hope when the chancellor tries to claim that by being “nimble” with stock exchange listing rules, the City of London can claw back enough market share to make up for the business it’s going to lose as a result of Brexit. Together with his talk of a “Big Bang 2.0” – a reference to Margaret Thatcher’s financial liberalisation in the 1980s – it seems clear that Rishi Sunak is working off a wrong economic model, which is not any less wrong because it’s shared by nearly everyone working in the industry, and by nearly all the external critics of finance. The model is one where you can run the financial services industry hotter or colder by, effectively, grabbing hold of a big dial and twisting it in the direction marked “REGULATION” or “DEREGULATION”. Plenty of City people voted leave pretty much based on this exact model; they thought that Europe had twisted the dial too far towards regulation, and that an independent Britain could turn it back the other way. The trouble is that “regulation” is not an undifferentiated quantity that you can pour out more or less of. Each individual regulation is precious and unique, interacting with all the others to produce a complicated, occasionally bizarre but basically coherent system which constitutes the fundamental environment in which it’s possible to do financial business at all. And like maritime safety rules or pharmaceutical industry standards, where “every rule is a tombstone” – the majority of them are on the books because of something that’s gone badly wrong at some point in the past. That means that if you try to have a bonfire of the regulations, you’re also going to have a bonfire of the actual industry. The great competitive advantage that the two world capitals of finance – London and New York – possess is precisely that they’ve got rules for nearly everything. That means that things are predictable, contracts aren’t going to depend so much on interpretation and the financiers can spend their time worrying about the actual financial risks, the ones which arise partly from the uncertainty of the world and partly from the fact that a few hundred very clever and quite greedy people are trying to rip each other off all the time. In the context of the City of London and Brexit, this way of thinking about regulation gives you another way of looking at the problem. Basically, you can divide the British financial industry into four parts. First, you’ve got stuff that’s basically domestic, or related purely to Asian or American clients with no European angle to them. This is the stuff that you wouldn’t expect to be affected by Brexit. Then you’ve got purely European stuff, things where it’s obvious it has to move to the continent because it was hard to justify it being here in the first place. Although the Bank of England governor has to make a show of things, I really haven’t met anyone in the industry who doesn’t agree that the European Central Bank has to have control over its own currency’s futures markets. Then there are two other categories. Things which are Europe-related, but not so much that they couldn’t be done in London if it were more convenient to do so thanks to that extremely useful legal system, all those experienced English-speaking specialists and so on. And finally, there’s what you might euphemistically call “offshore” business: things that people do in London because they don’t want to be caught doing them back home. These are usually tax and secrecy shenanigans, where the work is done and the fees are charged in London, but the legal ownership of assets is scattered across a tangle of Commonwealth states with poor transparency arrangements. It’s these two last categories that could be affected by regulation. The dream of the libertarians, of course, is to massively inflate the last category. But it’s a dangerous dream, because there is a more or less straightforward tradeoff between that category and the one I listed immediately before it. The more dodgy stuff you allow, the further your regulatory system departs from that of Europe, then the less acceptable a substitute you are for ordinary Europeans and the people who want to do deals with them. And that matters, because the one thing that the libertarian right and the anti-finance left have in common is a tragic misunderstanding of the size of the “dodgy offshore stuff” niche in British finance. It’s not that big, certainly not when compared with the very significant part of the current UK financial sector that does more or less straightforward deals with staid European corporate treasurers and regional savings banks. The fact is, unfortunately, that Brexit was a disaster for the financial services industry and there’s nothing much that can be done about it. The Europeans are going to use it as an opportunity to try to grab market share and we have a very limited ability to stop them. Any attempt to try to use our own regulatory system as a competitive advantage will make things worse; we’re bound to lose output and employment and we’ve gained exactly nothing in terms of independence. There is no pot of gold at the end of this rainbow. Dan Davies is an investment banking analyst |