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Passporting Is Essential for The City

I consider the question as to whether The City will suffer a severe impact from the loss of passporting and conclude that it will

Introduction

Some people deny the claim that passporting is essential for the City. For example, Jacob Rees Mogg made the claim below this morning on the Today programme:

“Passporting is mainly retail and UK financial services mainly wholesale.”

This was aimed at supporting the further claim that loss of passporting will not be much of a problem.  Passporting is the regulatory feature whereby financial institutions located in any EU member state can offer financial services in any EU member state.

Distinctions Between Retail and Wholesale Banks

The first thing we need is clarity on the distinction between retail and wholesale banking.  This maps approximately on to what we might call “high street banking” and “investment banking.”

The former are retail banks such as for example RBS or HSBC.  Their primary lines of business involve dealing with retail customers — i.e. individuals — and their financial needs.  They will offer deposit acceptance, interest bearing accounts (often in pre-crisis times with non-zero amounts of interest!) and mortgages.

Photo by Jonathan Miksanek on Pexels.com

Investment banks such as Goldman Sachs or will mostly deal with HNWIs and corporate clients.  HNWIs are merely very rich individuals, who require additional services such as estate planning and access to hedge funds.  Corporate clients will want funding usually.  This is provided by investment banks often by issuing bonds for them on the global financial markets.  (There are also some banks like Citi who are both retail and investment banks.)

Why is Passporting Essential for the City?

So now we see that the Rees Mogg position is approximately that the passport enables banking across the EU to individuals whereas the City specialises in corporate clients.  Rees Mogg is definitely correct that the passport enables retail banking.  Basically, the passport means that a banking licence in any EU member state is a banking licence in all EU member states.  With that in hand, one can be regulated by the ECB, open a branch anywhere in the EU and start accepting deposits and making loans.

So the key contestable element of the claim becomes the one that one does not need to be an EU bank to conduct business with corporate clients in the EU.  One point to bear in mind is that many if not all investment banks which operate in The City will also be banks in Frankfurt.  So they will be fine; but of course London could easily lose a lot of high paying jobs and tax revenue. That is one reason why passporting is essential to the City.

The Impact of Brexit on Financial Services

But to look in more detail, I turn to a report entitled “THE IMPACT OF THE UK’S EXIT FROM THE EU ON THE UK-BASED FINANCIAL SERVICES SECTOR” from Oliver Wyman, commissioned by lobby group TheCityUK.  

https://www.oliverwyman.com/content/dam/oliver-wyman/global/en/2016/oct/Brexit_POV.PDF

This report considers four aspects of the wholesale financial ecosystem:

Sales and Trading

Sales means buying financial assets such as stocks in bulk for major investors; trading is attempting to make a profit by e.g. predicting future directions of market assets.

Wyman suggest that economies of scale mean that:

“banks could move other activities that are not directly restricted into the EU and away from the UK”

Market Infrastructure

This means “clearing.” When there are large volumes of trading — and there is well over £2tn (yes, trillion) of daily foreign exchange trading done in London — there are lots of trades that must be cleared.  This means basically moving cash from the bank that bought something to the  bank that sold it and changing the documentation accordingly.  (Incidentally, this sort of thing is why the blockchain is so interesting.  That however, is not a reason to buy Bitcoin: https://timlshort.com/2017/09/16/bad-arguments-for-the-permanence-of-bitcoin/)

Wyman suggest that fragmentation of clearing across jurisdictions will increase costs.

Due to these inefficiencies, some firms could move their clearing out of the UK

Asset Management

This is managing large investment portfolios for corporate and financial clients such as large EU insurance companies.

Wyman note that inefficiencies will arise if sales/trading desks migrate to Frankfurt or elsewhere. So the benefits of managing portfolios from the UK could be eroded. That could end up

leading some companies to manage a greater portion of their assets from within the EU

Corporate and Specialty Insurance

This is the Lloyds market, specialising in writing large bespoke insurance contracts for major corporate clients.

Here Wyman suggest:

A loss of depth in the marketplace due to the loss of EU-related activity might lead some insurance firms to relocate outside of the UK

Conclusion: Passporting is essential to the City

Taking all of this into account, Wyman conclude that no passporting means:

up to 50% of EU-related activity (£20BN in revenue) and an estimated 35,000 jobs could be at risk, along with £5BN of tax revenues per annum

I therefore conclude that some elements of the Rees Mogg claim are true.  It is indeed the case that passporting is on the face of it more of a retail matter than a corporate one.  But corporate clients are still EU clients in a number of important lines of business.  And losing access to those clients from London desks will cause significant impairment to the UK economy.

Wyman confirm this when they estimate the effects of retaining passporting (or some equivalent regulatory arrangement).  They say that in this scenario:

revenues are predicted to decline by up to £2BN (2% of total wholesale and international business), 4,000 jobs would be at risk, and tax revenues would fall by less than £0.5BN per annum

This is still bad — there are no positives to Brexit — but less severe.  Nevertheless, our overall conclusion must be that loss of passporting is very bad news.

See Also:

The Illusory Truth Effect And Financial Markets

By Tim Short

I am a former investment banking and securitisation specialist, having spent nearly a decade on the trading floor of several international investment banks. Throughout my career, I worked closely with syndicate/traders in order to establish the types of paper which would trade well and gained significant and broad experience in financial markets.
Many people have trading experience similar to the above. What marks me out is what I did next. I decided to pursue my interest in philosophy at Doctoral level, specialising in the psychology of how we predict and explain the behaviour of others, and in particular, the errors or biases we are prone to in that process. I have used my experience to write The Psychology of Successful Trading. In this book, I combine the above experience and knowledge to show how biases can lead to inaccurate predictions of the behaviour of other market participants, and how remedying those biases can lead to better predictions and major profits. Learn more on the About Me page.

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