Did Brexit Wreck the City of London? - Anonymous Banker (Volume V)

I have a friend whose economic and financial analysis is always interesting because it is apolitical. He is a former City economist with decades of experience. Unfortunately, like many people who have something genuinely valuable to add to the conversation, he prefers to protect his privacy in our turbulent political and cultural landscape. But I’ve always found his explanations and insights useful and I think you will as well. That’s why he’ll be contributing to my Substack from time to time as the Anonymous Banker.

This piece is part of a series of articles which attempt to provide an objective, data-based look at the economic impact of Brexit on the UK and debunk the myths peddled by both sides of the debate.

Read Volume I here, Volume II here, Volume III here and the first part of this article, Volume IV, here.

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4.       Fund Management

Since 2016, you may also have seen many headlines along the lines of the one below from the Independent:

Well, that doesn’t sound encouraging does it? Hardly a vote of confidence in Brexit Britain. Whilst these headlines are doubtless factually correct, you have to understand how the fund management industry works to take a view on how much of an issue these trends are. Think of a fund as a pot of money contributed by investors. This pot is then managed by a Fund Manager. From a legal perspective, the pot and the Fund Manager are two entirely different things. It is very common that the pot will not be in the same country as the manager.

This is what is happening when you hear the press refer to ‘offshore hedge funds’. The pot of money for legal purposes is often an entity in the Cayman Islands or other tax havens. However, the money is managed from a flash office in Mayfair or Manhattan.

EU rules dictate that EU assets (pots of money) must be located within the EU. Post Brexit, without an equivalence arrangement between the UK and EU, pots of EU money have been moved from the UK back into the EU. Whilst this is a loss in terms of prestige for the City, the impact is minor financially. The holding of assets is a low value-added activity – think of it like your deposit account at your High Street bank paying you minimal interest.

The value-added activity in this sector is in the actual management of the assets – deciding how these pots of money should be invested. If we look beyond the headlines like those above, we discover that the fund management industry in the UK is in rude health post Brexit. Total Assets Under Management (referred to as AUM in the industry) reached £10 trillion at the end of 2021[1], up 6% on the prior year. This makes the UK the second largest centre for fund management in the world after the United States.

The chart below shows that the UK still dominates the fund management industry in Europe, managing 37% of the continent’s assets as of December 2021. This figure is unchanged on December 2020 (37%), and compares to 36.3% in December 2015 pre Brexit.

Source: EFAMA

UK market share is 2.5x that of the second most important marketplace, France, and equivalent to the share of France, Germany and Switzerland combined.

Surely Brexit has dented global investors’ willingness to work with the UK fund management industry? In fact, some 46% of funds managed in the UK are for overseas clients, a proportion that has risen by 9 percentage points since 2016. Some 65% of the assets managed in the UK are actually domiciled overseas.

Source: The Investment Association Annual Survey, September 2022[2].

Of the money managed from the UK on behalf of overseas clients, some 59% is from Europe. Intriguingly, this proportion grew by 1 percentage point in 2022, the year after Brexit.

5.       Venture Capital

Perhaps at the sexier end of activities the City performs is Venture Capital or VC. VC is the term used to describe investment in very early-stage companies. These can range from just ideas or business plans with no revenues to private companies who have proved their product and are looking to scale it up. It is a very high risk sector, but the returns on an investment in an early stage venture that goes on to achieve Unicorn[3] status can be huge.  Examples of VC backed companies that have had a major impact on the global economy and are now household names are companies like Google, Airbnb, Facebook and Uber. These are all US names and the US is the undisputed leader in this field. Europe has also created Unicorns of its own such as Revolut, Transfer Wise, Klarna and Spotify.

The UK is home to the majority of Unicorns and Soonicorns[4], as the graphic below highlights.

Source: The 2022 European Unicorn & Soonicorn Report, April 2022, i5invest.

In terms of funding, it is clear that the UK continues to dominate European venture capital, and this has continued despite any reservations global investors may or may not have about Brexit. Atomico estimate London venture investment will have reached $19bn in 2022, equivalent to Paris, Berlin and Stockholm combined. This dominance was evident pre-Brexit also – the UK venture capital industry was larger than that of France, Germany, Sweden and the Netherlands combined in 2015. The argument that investors are shunning a post Brexit UK is not borne out by the data.

Source: State of European Tech 2022, Atomico.

VC represents what the City ought to be doing – transferring the capital of savers and investors to fund new ventures that could ultimately yield huge benefits to society, create employment, and incubate the innovative technologies of tomorrow. It certainly seems more virtuous than creaming off profits from customers for moving their money around, swapping bits of paper between each other or taking bets on numbers moving up or down.

6.       Insurance

Insurance is a dry subject but one that London excels at. Similar to the other spheres of activity, London is the world’s largest commercial and specialist insurance market.

Source: London Market Group, International Underwriting Association, Lloyd’s, TheCityUK, The Global City.

The London insurance market provides 56% of global aviation insurance, 55% of global energy insurance and 33% of global shipping insurance. The World Trade Center buildings were insured at Lloyd’s of London, which has a reputation for insuring unique and hard to quantify risks including David Beckham’s legs (£40m), Bruce Springsteen’s voice (£3.5m), Betty Grable’s legs ($1m each), Keith Richard’s hands ($1.6m), Gene Simmons’ tongue ($1m) and Cadbury’s chief taster’s potential loss of taste (£1m)[5].

Conclusion

Whilst the UK media seems to delight in prophecies of doom with regard to the City, its importance as a global financial centre is not lost on German finance leaders. Former German Finance Minister, Wolfgang Schäuble stated that “London offers a quality of financial services that are not to be found on the continent” and that “London’s financial centre serves the whole European economy”[6]. Dr Andreas Dombret, a Bundesbank Executive board member, told the BBC that London would remain “the most important financial centre in Europe”.[7] The tormentor of UK Brexit negotiators, Michel Barnier, was quoted as saying that the EU needed a ‘special’ relationship with the City during the negoitations.[8]

Therefore, one can see why prominent free market Brexiteers argue that the Remainer view of ‘access to Frankfurt’ is akin to looking through the wrong end of the telescope. European companies and institutions are highly dependent on London for raising capital and this has not changed.

Ultimately, the real risk to the health of the City of London doesn’t come from Paris, Frankfurt or Amsterdam but more likely from offshore centres with more accommodative tax and regulatory regimes, such as Dubai. The EU is working hard to reduce its dependence on London (which would be a clear negative for the UK) but this will take a long time to do, and will require the harmonization of many competing interests. Well-functioning markets require depth (the ability to trade without impacting the price significantly), speed of execution together with trust and long standing reputational credibility. This takes a lot of time to nurture and develop.

Brexiteers will likely find much to cheer them in the statistics above. However, it’s important to point out that whilst London is the global venue for many of these financial products, the key players are no longer British firms. This point has been compared to Wimbledon Tennis or the Premier League – Britain provides the infrastructure and the arenas but the real stars are the international players[9] (Andy Murray and Marcus Rashford notwithstanding but you get the point).

Post Brexit, the UK and EU do not have an equivalence arrangement in place, respecting each other’s regulatory regimes. This has been the key driver of the repatriation of EU assets described above. It also limits the ability of UK firms to market their financial services across the EU from one location, as they were able to do when in the EU (so called “passporting”). The lack of agreement on financial services is a lose-lose for both sides – the UK faces barriers to trading in the large EU market that it did not previously face, whilst European firms have reduced access to one of the world’s key financial markets.

In my view, for the reasons outlined above, Brexit has had a limited negative impact on the City of London despite the alarmist media headlines. The City’s global position is undiminished. Despite headlines in 2016 suggesting the banks would leave the City, Brexit has resulted in only circa 7,000 City jobs going to the EU[10] . To put this in context, a narrow definition of City jobs (covering banking, fund management, insurance and other financial services) gauges total ‘City’ employment at circa 1m jobs[11]. ONS data shows there were 587,000 jobs in the City of London in 2021 (i.e. physically in the Square Mile). A wider assessment of ‘City’ jobs to include related activities of management consultancy, accountancy and legal services suggests total employment of around 2.2m.  7,000 roles out of 1m represents just 0.7%. Per the ONS, City jobs grew some 15% from 2017-2021, adding 75,000 jobs post the Brext vote[12].

So why do I argue Brexit is a net negative so far given the impressive numbers above?

Previously London had unfettered access to the EU market alongside its global relationships. Therefore, raising barriers to a large market you previously enjoyed complete access to, without any offsetting new opportunity from elsewhere, must be seen as a modest negative overall.

In the short term, given that the UK is already either one of, or often the, leading player globally in certain financial services sectors, its potential to grow its non-EU business to offset the loss of EU access is limited. Progress on a financial services deal would alleviate this and it is in the interest of both sides to do so over the medium term. The challenge will be finding an accommodation that keeps the UK out of the EU’s regulatory orbit as it seeks to deregulate and diverge from the EU to grow its international business, whilst keeping the EU satisfied that UK regulation is prudent for its firms. This will be a delicate balancing act and it seems unlikely that the EU will be keen to give the UK’s key industry a helping hand.

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[1] https://www.theia.org/sites/default/files/2022-09/Investment%20Management%20Survey%202021-22%20full%20report.pdf

[2] h/t to @semperfidem for highlighting this report on Twitter.

[3] A company with a valuation of $1bn+. If you are lucky enough to get in at the ground stage of a venture when it is valued at say $1m and it succeeds you can see why this sector is seen as the sexier end of City careers.

[4] A company that is expected to reach Unicorn status in the next 24 months.

[5] See https://havenlife.com/blog/craziest-things-insured-lloyds-london/ and also https://www.mcclarroninsurance.com/news/quirky-insurance-risks/

[6] https://www.irishtimes.com/business/economy/germany-s-schauble-wants-reasonable-brexit-deal-for-city-1.2964364

[7] https://www.bbc.co.uk/news/business-39095438

[8] https://www.theguardian.com/business/2017/jan/13/eu-negotiator-wants-special-deal-over-access-to-city-post-brexit

[9] See Philip Augar’s The Death of Gentlemanly Capitalism for a discussion of the Wimbledon effect – “held in Britain, staffed by locals, dominated by foreigners but still generating bags of prestige and money for the UK.”

[10] https://committees.parliament.uk/committee/516/european-affairs-committee/news/171621/government-reluctant-to-engage-with-the-eu-on-financial-services-says-lords-committee/

[11] https://www.thecityuk.com/our-work/key-facts-about-uk-based-financial-and-related-professional-services-2022/

[12] https://www.cityoflondon.gov.uk/supporting-businesses/economic-research/research-publications/city-statistics-briefing