Lex letter from London: City’s alternative futures, from cowboy capital to green oasis

Dear readers,

The City of London has been many things. Roman trading outpost. Financier to the British empire. Deregulated yuppie playground. Now it needs another reinvention. Brexit is eroding its position as Europe’s main financial hub. Alternative futures are prophesied.

This article offers a reality check for four of the main scenarios, giving odds on each. Readers’ thoughts are welcome via email at Lexfeedback@ft.com or in the comments field at the end of this piece.

The first scenario is the easiest to prejudge — it already looks dead in the water:

Repressed rule taker (odds 20:1)

Incumbent businesses benefit from the status quo. Most City bosses therefore hoped Brexit would bring little disruption. The UK would mirror EU financial regulation to the delight of co-operative EU politicians and regulators, they imagined. The capital and capacity of banks, brokerages and exchange groups would stay in London, yielding economies of scale.

The EU has shot that optimistic fox using ammunition supplied by Boris Johnson. The UK focused on fishing — economically trivial at a national level — in striking a trade deal. It ignored finance, one of the few industries in which the UK has national advantage.

The EU did not grant “equivalence” for City businesses to operate on an equal footing with locals in its continental markets. It is now unlikely to do so. Keeping the UK out in the cold helps EU financial centres — for the moment. By requiring EU investors to progressively move trading and clearing to the EU, the EU can ensure wodges of non-EU capital switches too. Liquidity attracts liquidity.

Consider trading in EU equities. Before, more than half of this business was transacted on London platforms. In the past five days, less than a fifth was, according to CBOE data.

The measly benefit of sticking to EU rules can be summarised as “do no further harm”. Instead, the UK hopes to reap benefits by diverging from the EU pattern. One brighter vision this inspires is:

Singapore-on-Thames (odds 3:1)

The south-east Asian financial hub is in some respects an appealing model. It is an offshore centre for an entire region where the rule of law applies in commercial transactions. London’s analogous hinterland would be Emea countries, with extra zing provided by US-Asia transactions brokered in London.

Singaporean regulation is seen as flexible but reasonably robust. Blow-ups among commodities groups such as Hin Leong and Noble have not improved the financial centre’s reputation. But London has plenty of meltdowns too — supply chain financier Greensill, for example.

Singapore is also a liveable city state where many expatriate financial folk are happy to stay for a few years. One reason is that top rate personal income tax is 22 per cent. Corporate income tax is 17 per cent.

That would not work in the UK. The government, which wants to “level up” is raising corporation tax to 25 per cent. But rock-bottom tax rates need not be a deal breaker for the Singaporean model any more than authoritarianism, another habit the UK should not copy.

A bigger problem is the competence of the Financial Conduct Authority to pursue the agile, economically driven style of regulation characteristic of the Monetary Authority of Singapore. This combines activity as a quasi-central bank with policing financial markets.

The slow-moving UK watchdog has reductively focused on consumer rights since its inception. There is pressure in government for the FCA to take fuller account of UK economic interests. That would require deep reform of the organisation by the Treasury.

The phrase “Singapore-on-Thames” has a dual meaning, incidentally. It suggests shady foreign practices to some Britons. That is not borne out in surveys from the likes of consultancy Z/Yen, which rate Singapore highly. However, a regulatory race to the bottom is a real danger for the UK, conjuring this nightmare:

The cowboy capital (odds 7:1)

The UK is planning to deregulate. Possible moves include: permitting premium-listed companies to give founders shares with extra votes; dismantling parts of Mifid II reforms; and reworking Solvency II capital buffer requirements for insurers.

On their own, none of these are particularly objectionable. The danger is that the UK will deregulate too hard. Bad money would then drive out good as shysters replaced honest brokers. The City would suffer a net loss of business. That phenomenon was exemplified by the Vancouver Stock Exchange, described in 1989 by Forbes as “the scam capital of the world”. The VSE’s lax standards and lousy reputation meant it was shunned by serious investors. It was eventually absorbed by another exchanges group.

The UK already has form for laxity. Wall Streeters smugly pointed to a “London problem” of light regulation in the wake of the financial crash, although the cause of this was homegrown US mortgage-backed securities. Subsequently, London lured listings for Kazakh and Indonesian miners whose compliance with UK-style corporate governance rules was poor.

These days, London aims to pivot away from the carbon-intense resources groups that flocked here for financing. Instead, pundits hope for a:

Lean, green funding machine (odds 5:1)

Raising money for renewable energy businesses is no harder than doing it for polluters. You just need a critical mass of capital and expertise. Carbon transition is a good trend for London to embrace because it is complex, involves large sums and will take a long time.

There are some obstacles. The biggest is that the UK at present has limited international credibility in green finance. The government has not even issued green bonds yet, unlike France, Germany, Italy, the Netherlands and Sweden. Total issuance in that asset class, including corporate bonds, stands at $58bn for Germany. The UK brings up the rear with $13.7bn, according to the Climate Bonds Initiative.

The UK stock market lacks big renewables companies. Orsted, Europe’s standout renewables group, is listed in Copenhagen. Wind turbine maker Vestas is quoted in Denmark too. Shares in its rivals, Siemens Gamesa and Nordex, trade primarily in Madrid and Frankfurt.

London does have plenty of legacy hydrocarbons businesses such as BP and Shell, which its financiers could help re-engineer.

London also boasts a trade in carbon derivatives. Intercontinental Exchange operates a futures market in European emissions permits, which dealt in the equivalent of 12.2 gigatons of carbon last year.

In May, ICE will start auctions of UK permits and a parallel futures market. But this will be smaller than the European equivalent. ICE is moving the latter to Amsterdam in June, partly because of the EU’s refusal to grant equivalence.

If wishes were horses, beggars would ride

The mismatch between the UK’s green finance aspirations and its credentials is pretty painful. You might say the same for hopes of turning the City into a world fintech hub. There are great fintechs in the UK. But the US will attract more listings as long as valuations are higher and liquidity is greater. This is why Irish-rooted payments group Stripe plans to float in New York.

If the City is to thrive in any of the new métiers proposed for it (apart from “cowboy capital” with its obligatory saloon pianos and shoot-outs), the UK government will have to do more than commission think-pieces from Conservative peers. The UK needs a financial strategy as much as an industrial one. The government of Margaret Thatcher had a plan for the City in 1986. It was called the Big Bang. Her successors need to rethink London’s financial cluster again.

The EU’s refusal to grant equivalence could prove to be its biggest mistake. If it continues on its exclusionary way, it may, through heavy regulation, build walls that keep foreign capital out as well as keeping EU capital in. That could be very helpful to the City.

Enjoy the rest of your week,

Jonathan Guthrie
Head of Lex