(Bloomberg Opinion) — There hasn’t been much balance in the overheated debate around the post-Brexit trade settlement between Britain and the European Union. So it was a welcome surprise to see former Morgan Stanley President Colm Kelleher describe Europe’s capital markets as “not fit for purpose” recently.
It’s good to see an acknowledgement that maybe the EU doesn’t hold all the cards as the two sides wrangle over how the financial services industry will operate after Britain’s departure. European capital markets are “neither large nor deep enough to support economic growth or to buffer it in hard times,” Kelleher said in a pre-dinner speech reported by the Financial Times.
Morgan Stanley’s former second-in-command recognizes that Europe’s fragmentation is a major impediment when it comes to financial services, with the bulk of the industry’s expertise and capital centered in London. As such, a hard break between the U.K. and the EU will damage the bloc by starving it of liquidity.
I’d go further and say maybe Europe needs the City more than the City needs Europe. For sure, both sides would lose if they failed to reach an amicable agreement, but can Europe really countenance its financing drying up with nothing to replace it in time?
The solution for Europe, as Kelleher and many others acknowledge, is a proper capital markets union for EU members with a single over-arching regulator and rulebook. But that’s not going to be resolved this year — or probably even this decade.
As such, the EU’s chief Brexit negotiator, Michel Barnier, should resist those on his side who are fighting yesterday’s battles. It’s unfortunate that he’s already dismissed British requests for concessions on the idea of regulatory “equivalence” for financial services (where London’s finance firms would have access to the EU so long as the U.K.’s rules are similar to those of the bloc). The City is worried that Brussels can revoke equivalence whenever it likes, but Barnier’s team is refusing to budge on offering a longer notice period.
Comments from the French foreign minister, Jean-Yves Le Drian, that the two sides will “rip each other apart” raise an alarming prospect, especially if it means we reach the end of 2020 with no agreement. Shutting off U.K.-based entities from participation in European banking and corporate business — be it lending, advisory work, trade facilitation or deposit-taking — would hurt the City, but it would be an act of European self-harm, barricading off a vast resource of well-capitalized and well-governed market infrastructure.
Could Europe’s banks take on everything the City does? Absolutely not by the Dec. 31 deadline for trade talks. Risk appetite is borderline non-existent among the continent’s lenders, and particularly not beyond national boundaries. Yet trillions of euros of debt comes due every year.
And that’s before you get to the detailed stuff: legal advice for English law (which governs many bonds and loans), derivatives clearing, London’s exchanges, commodities trading, the list goes on. The City’s real edge is in innovation: putting together cross-border and multi-product deals that can’t be done in small European nations.
Absolutely, the EU should try to get its act together and build a proper financial infrastructure. But its record is poor. The story of the MiFID II regulatory reforms has been an unhappy one. The European Securities and Markets Authority seems to be a regulator that wants to overreach. Its ill-advised decision to deny equivalence to Swiss stock exchanges and a demand for oversight over European equity trading of the largest U.K. companies post-Brexit are worrying.
On London’s side, the EU’s markets are still a significant business. Not having open access to a huge market on its doorstep would imperil its role as the world’s financial center. That’s why the row over equivalence is so troubling. Surely the U.K. Financial Conduct Authority can be treated as a gold-plated regulator for overseeing European-related finance.
The EU should look through its single market purity for its own — and the greater — good and come up with a workable arrangement with a neighboring regulator it has relied on for decades. This will buy it the time to build its own capital markets. Eventually , the EU may rely less on the City — just not yet.
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Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.