Following the Brexit vote, the race to succeed London as Europe’s financial capital is on. “We know that groups based in the City are planning to leave for Dublin, Amsterdam, Frankfurt and Paris,” the French prime minister, Manuel Valls, told journalists soon after the U.K.’s referendum. Other countries in the European Union are also intent on stealing financial services jobs from the U.K. Even the economy minister of Bulgaria, the EU’s poorest country, invited City of London escapees. In reality, however, London will remain Europe’s main financial center.
There are three reasons for this continued dominance over European financial services:
- The pre-eminence of the British court system in upholding the rule of law, including the protection of creditor and shareholder rights.
- The superiority of the U.K.’s university education in economics and finance over its continental counterparts.
- The U.K.’s tax and employment regulation that is conducive to the industry’s health and profits.
Protecting the interests of creditors and shareholders from the rapacious behavior of competitors or the state is obviously important for attracting financial services. On this score, the U.K. is ahead of the rest of Europe. The World Bank’s Doing Business project ranks the U.K. fourth in the world in shareholder protection, behind only Hong Kong, New Zealand and Singapore.
France is in 29th place when it comes to the strength of laws protecting shareholders, Germany is 49th. In terms of protecting creditor rights, the U.K. ranks 19th in the world, France 79th, and Germany 28th. Of course, the rule of law can improve in Europe so that financial investors feel equally well protected in Paris or Frankfurt. But this process will take years, perhaps decades.
In terms of education, markets increasingly require a sophisticated understanding of economics and finance, as well as in-depth knowledge of the legal architecture underlying financial services. Here, too, British universities lead Europe in offering quality education. In the latest Shanghai global ranking on economics education, there are six UK universities among the top 50 and only three continental European universities (one in the Netherlands and two in France). Four of the top five masters of finance programs in Europe are based in London (the only exception being INSEAD near Paris).
And in terms of tax and employment regulation, the financial services sector in the UK benefits from lower corporate tax rates and more flexible employment laws than Germany and France. In the World Bank’s Doing Business ranking on paying taxes, the UK is ranked 15th in the world, well ahead of Germany (ranked 72nd) and France (ranked 87th). The UK’s lead is even wider in terms of flexible labor regulation. The latter is especially important in the highly cyclical financial sector that annually hires and fires tens of thousands of white-collar professionals.
The finance industry has many fields within it, however, and some parts are viewed as more vulnerable to Brexit. One candidate is foreign exchange trading in the euro—a U.S. $2 trillion-a-day market. Currently, more than 70 percent of euro trading takes place in London, compared with 11 percetn in Paris and 7 percent in Frankfurt, according to Bank for International Settlements data. The European Central Bank has already tried banning clearing houses outside the eurozone from trading the euro. But in 2015, the EU’s highest court disagreed. Hence London’s vulnerability may be overplayed: Brexit does not alter the status quo as the UK has never been a member of the eurozone.
Insurance is another sector that’s European activity is highly concentrated in London and where Brexit may hurt. But the U.K.’s main competitors are in Asia (Singapore and Tokyo) and the U.S. The access that London has to European money is based on proximity and historic relationships, not on being part of the EU. In short, even in insurance markets it is hard to see a rapid shift away from the City of London.
But Brexit may have a negative effect on London’s position as the world’s best-regulated financial center. Following the uncertainty around its EU exit, Asian and American markets could take some business away from the City of London. The government’s knee-jerk reaction to this development may be to erode some of the UK’s financial regulation in an effort to attract more investment. Such a response would be unfortunate as London has attracted a lot of talent because it is a place for clean business practice. This possibility notwithstanding, London is unlikely to lose its crown as a global financial center.