Jacob Rees Mogg Is Wrong To Say That Loss of Passporting Will Not Be A Problem 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

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.

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.

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.)

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.

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.  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, and

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 etc, and so benefits of managing portfolios from the UK could be eroded thus:

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

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.

 

 

 

 

 

The Psychology of Successful Trading: see clip below of me explaining my new book!

 

Getting your trading psychology right and understanding that of others are both essential prerequisites to successful trading in financial markets. I discuss the most important elements of trading psychology in my new book.

Buy the book here:

Thanks to Karine Sawan and film crew for video production.

The Importance Of Hindsight Bias In Financial Markets

Recently, Lloyd Blankfein of Goldman highlighted an important feature of psychology that has impacts on financial markets: Hindsight Bias.

He is discussing whether we are in a bubble comparable to Tulip Mania.  The key point he makes for our purposes today is:

“But, of course, you never really know until you know, he said. “When something happens, 80 percent of the world will remember knowing it … in hindsight.” ”

In psychology, this feature is known as Hindsight Bias.  It means that people falsely believe that they predicted events that have now occurred.  I suspect that this is due to another sort of idea much discussed in philosophy.  The common idea of time seems to be modeled on a ‘moving block’ theory.  This says that while the future is still open and fluid, the past is now fixed.  The fixed block moves forward as time does.  So, since the past is now fixed, it begins to look like everything that happened had to happen.  And since it was inevitable, we must have predicted it, right?

Wrong.  The canonical experiment on this asks people to assess the probability of events from a story of a war between two countries.  The build up is described and people are asked to assess the probability of war breaking out.  It is revealed that the story is in fact an actual description of the period leading up to a conflict between two Asian powers.  Some months later, people decide that since it did in fact happen, they must have predicted it.  They claim now that they gave a much higher estimate of probability than they actually did.

What does this mean in financial markets?  A great deal.  Think about what you are likely to do now if you suffer from this bias, as everyone does.  You will overestimate the probability that you gave to past events. Then, you will over-estimate the probability of your future forecasts being right.  This will make you over-confident at the wrong times and will kill your market performance.

I cover the importance of understanding the biases inherent in psychology in my new book The Psychology of Successful Trading

Hindsight Bias is just one of the many I discuss there.  There are two ways to benefit here in terms of improving your investment returns.  Firstly, you can look out for the biases in your own thinking and correct for them if need be. Secondly though, you can expect these biases to severely effect other market participants and that means opportunity for you.
You can take it from me since I have two relevant PhDs and spent nearly a decade on the trading floor of various investment banks.  Buy the book here:

The Psychology Of Successful Trading