The saviour of the British economy?

A safe pair of hands. Over and over again, British media outlets have used these words to describe Theresa May, the new Prime Minister. She is said to be stable and reliable, and yes, a bit boring. But maybe that’s exactly what the country needs now, after all the excitement that her predecessor David Cameron provided the UK with.

Similar things are being said about Theresa May’s new chancellor, Philip Hammond. The 60-year old has already held several ministerial posts – he was Foreign and Defence Secretary, among others – and has, contrary to many of his colleagues in the House of Commons, had a “real” job before becoming a Member of Parliament 19 years ago. After his studies at Oxford University, Hammond worked for a company that sells medical appliances, spent some time in South America as a consultant for the World Bank and became a partner at a consultancy firm.

Prior to the British EU-referendum on the 23rd of June, Hammond was part of the Remain-camp. It is expected that he will try to negotiate a deal under which the City of London can maintain its passporting rights into Europe, a crucial factor for London to keep its status as Europe’s leading financial center. At the same time, the Conservative will have to stabilise the British economy and regain trust from international investors. Thanks to its high budget and current account deficit, Britain will continue to rely on foreign funding – even more so, should there be a sharp recession looming.

Philip Hammond has had an eye out for the prestigious role for a while. Already in 2010, when the Conservatives formed a government with the Liberal Democrats, the man with the grey mane uttered his interest for the role as a Chief Secretary in Her Majesty’s Treasury, the second most important job after that of the Minister. However, at that point in time, a Liberal got the chance.

Thus, Hammond started in the Department of Transport before becoming Defence Secretary in 2011 and Foreign Secretary in 2014. A Member of Parliament, Hammond has represented Runnymede and Weybridge since 1997 – a constituency that voted Leave although their MEP supported Britain to remain in the EU.

Philip Hammond will now have to make use of his vast experience in order to reassure international investors that the UK is still a good destination for their money. “We don`t turn our back against the world”, he said after his appointment. Hammond pledged to take “whatever measures” needed to help stabilise the economy and retain Britain as an attractive destination for firms to invest.

It remains to be seen what this means for his tax policies. On Thursday, Hammond declined to comment on the announcements made by his predecessor George Osborne to slash corporation tax to 15 percent. Hammond is known for his support for low taxes. Nevertheless, it is still too early to tell whether Hammond will engage in, as some critics such as Pascal Lamy, the former head of the WTO, have claimed, extensive tax dumping in order to keep companies from leaving the UK after the divorce from the EU.

There is more to watch out for. There are two areas where Hammond could clash with his new boss fairly soon. First, there is fiscal politics. Hammond has a reputation of being a “fiscal hawk”. Nevertheless, he cannot just continue what George Osborne started in 2010 when he embarked on a massive austerity program that still is not finished. Prime Minister May has been very clear in the past days that the government’s first goal should not be – as planned before – to generate a budget surplus by 2020 but to make sure that more people benefit from economic growth and prosperity (assuming, of course, there is still something left to share after Brexit).

We might get a first glance of his fiscal plans when he presents the Autumn Statement in November. Different to what then chancellor George Osborne announced before the referendum, there won’t be an emergency budget. Experts like Kallum Pickering, the UK economist at Berenberg Bank, thus expect some more fiscal loosening in the short run whilst more cuts are being postponed towards the end of the Parliament.

Besides fiscal policy, there is a second topic that holds vast potential for conflict, the so called passport for the City of London. This framework allows banks headquartered in London to sell their products on the continent. Should the City of London lose these rights, several thousand jobs could be moved to Frankfurt, Paris or Dublin. London would subsequently lose some of its attractiveness for international banks. Hammond seems to be all too aware of this. On Tuesday, he stated at the British Bankers Association that the financial industry will be possibly hit the hardest by Brexit. “I know and understand the importance of passporting”, Hammond said.

Theresa May though not only needs to satisfy the banks, but also those 17 million Brexit-voters of which many requested the European Freedom of Labour Movement to be scrapped or at least reduced. Leading EU-politicians such as Jean-Claude Juncker, the President of the European Commission, or Angela Merkel, the German chancellor, have already made clear that there is not too much room for negotiation here. Access to the Single Market and passporting can only be sustained if the four freedoms remain in place. So where will that leave the two safe pairs of hands?

 

 

 

 

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Hedge funds and a potential Brexit

It was a catchy story that the FT reported on Tuesday. According to the piece, hedge funds are commissioning their own exit polls for the 23rd of June in order for them to place their bets accordingly. Ideally, a vote for Brexit will be a stunner for an industry that has seen its profits decline quite significantly since the start of the year. The “hedgies” are now expected to gamble on the pound and on pound-derivatives, amongst other financial products.

For their private polls, the hedge funds are making use of the framework set out by the Electoral Commission. It states that polling is allowed unless the results are published before the closure of the polling stations at 10 PM on the 23rd of June. Not only hedge funds but also banks will be interested in getting an early impression of the possible result of the referendum, as it is very likely that it might affect their business, both in the short and in the long run.

The market currently foresees a drop in sterling in the magnitude of around ten percent, should there be a vote for Brexit. Some experts go further than that, predicting an even sharper decline. Last week, the rating agency Standard & Poor’s made big headlines with a prognosis that a vote for leave could cost the pound its reserve currency status. “A decision by Britain in favour of leaving the EU in the June 23 referendum could jeopardize the British pound sterling’s position as a reserve currency and the associated benefits to the credit rating, in our view”, the analysts wrote in their report.

In case of a Brexit-vote, central bank reserve managers “might prefer to reallocate toward assets with less headline risk than the GBP”, they concluded. With sterling having lost more than seven percent against the euro during the last six months, the route of travel in case of a decision for Brexit is obvious. This became clear again on Tuesday when an ICM phone poll which saw the leave campaign in front led to a surprise fall in sterling, after a nearly month-long recovery in May.

Hedge funds, wealth managers and stock traders will try to benefit from swings in the pound before and after the election. Mike Amey for example, Managing Director and Portfolio Manager at Pimco, tries to prepare for all possible outcomes on June 23rd: “We believe that portfolios can be structured in a way so that they will benefit from a vote for remain and that they are hedged, should there be a different decision”, Amey commented. For that reason, Pimco is buying bank bonds and gilts with five- and ten year maturities and sells British pounds for US-dollars. You can be pretty sure that Mike Amey is not the only one preparing his portfolios for referendum day. But not many are as willing as he is to talk about it.

So far, the hedge fund industry is perceived as being in favour of Brexit, whereas the big banks are seen in favour of remaining in the EU. There are prominent bankers who have spoken out in favour of Bremain, e.g. Jes Staley (Barclays), Gary Cohn (Goldman Sachs) and John Cryan (Deutsche Bank). Equally, you have prominent fund managers that are publicly in favour of Brexit, e.g. Jon Moulton (Better Capital), Savvas Savouri (Toscafund) or Crispin Blunt (Crispin Odey). A letter in favour of Brexit signed by more than 100 City grandees seems to underline the thesis that “hedgies” and other financial service providers are for leaving.

However, according to the industry body AIMA, this is more perception than reality. I recently spoke to their deputy CEO Jiri Krol and asked him whether it was true that the hedge fund industry was primarily for Brexit. He disagreed. “I don’t think you can draw the picture in black and white – banks for remain, hedge funds for exit”, he said. In his opinion, the lines are much more blurred than they appear to be.

Interestingly, he addressed one of the core points that I had been thinking about that day. Is it true that a vote for Brexit could free the financial industry from existing regulation? Given that financial markets these days are becoming more, not less regulated, not just in the UK and the EU but also in the US and in China, I reacted quite sceptically when I first heard that argument.

Krol, as one of the leading representatives of the industry, seems to be thinking similarly. “For some reasons, people think regulation would change dramatically for hedge funds if the UK was to exit the EU”, he explained. That, according to him, is a false conclusion: “Nobody really thinks that the UK government will dismantle the existing framework”, Krol said. In some areas, for example the issue of dealing commissions for financial advice, the British Financial Conduct Authority actually made recommendations that went further than those of its European counterpart. “In this stance, the UK was at the more hawkish end of the spectrum, not at the more liberal”, Krol concluded.

In his opinion, arbitraging between different legal frameworks will not make a lot of sense. “The dream of sailing the seas in an independently designed and separate framework is not a serious possibility”, he said. In any heavily regulated industry, there would be continued heavy regulation. Not only the UK’s adoption of financial standards like Mifid 2 and the FSB´ stability mechanism but also events like the Anti-Corruption Summit that took place in London earlier this month should remind hedge fund managers who advocate for Brexit that it is very likely that we will see more, not less regulation of financial markets in the years to come.

And, by the way, if they want to continue advertising in the EU, they also need to follow the existing framework that applies to funds that do business in the EU. “There isn’t really a case for a freer, less regulated financial industry”, Jiri Krol stated.

 

 

 

 

Brexit: Implications for London

It’s been nearly three years since I moved back to London from Shanghai. For its part, London, the city in which I studied, pretended I had never really left. Not much had changed in 2012 and 2013, so I quickly got back in to my London life.

Since then, the city has been doing well. During the past three years, I have watched London’s population grow to over 8,6 million, a new peacetime record. I have observed the completion of the Walkie Talkie and the Cheese Grater, two stellar new skyscrapers in the City of London, and learned that there are more than new 400 high-rises under planning here in London – a sign of the huge architectural change that the city is undergoing.

I have heard it called “the greatest city on earth”, a description that ex-mayor Boris Johnson used when advertising the city to foreign investors. I have seen the night skies illuminated by numerous red lights, a testimony to all the construction work going on in London. I have seen house prices rise ever more (they are now at levels beyond most people’s reach) and noticed Chinese, Kuwaiti and Russian billionaires pouring money into London real estate and assets.

These are all indications that London is an attractive, thriving international city that stands out in comparison to other European cities. Londoners of course don’t compare their city with the likes of Berlin, Frankfurt or Paris. It’s New York and Hong Kong that they refer to when talking about other great, international cities.

However, a vote for Brexit could fundamentally change London. Over time, the capital could lose some of its great attractions for people, businesses and investors for whom London has been an easy entry-point into the continent, a bridgehead into Europe. “We would survive – but we would be diminished as a country and as city”, London’s new mayor Sadiq Khan said on Thursday.

Standing below a 1.5 ton piece of art (the so-called “flying table”) hanging from the ceiling in the “Second Home”, a co-working space in London, he explained to around 200 guests the potential consequences of a Brexit for London. According to Khan, the son of Pakistani immigrants, the capital has always been an open city, a city that welcomed otherness, new ideas and different approaches. “A Brexit would have serious consequences for London as a city”, Khan said.

That not only refers to the huge amount of continental Europeans who are working in London, thanks to the freedom of movement (I am a beneficiary as well). It also refers to those businesses in London that are doing business with the continent and that will be in limbo after a Brexit-vote on the 23rd of June, given that it is far from clear what kind of economic relationship the UK and the EU would have after a vote to leave.

One of the sectors that might be hit hardest is the financial industry. It creates around eight percent of national GDP and contributes around 13 percent of UK corporation tax receipts. Of the over than one million jobs in the British financial industry, one third is in London, in the City and in Canary Wharf – right across the street from where I work. In contrast to countries like Germany, under Margaret Thatcher the UK decided that services and banking, not industrial production and manufacturing, would be the basis of the UK economy. That has led to a significantly different structure than that of for example Germany where manufacturing still plays a much more important role.

The centre of this economy is London, Europe’s leading financial hub. Other financial centres, such as Luxemburg, Paris or Frankfurt, look pale against the dominance of London. “Nearly 40% of European assets under management are managed here. We’re home to around 40% of the world’s foreign exchange trading and 50% of derivatives trading”, Jonathan Hill pointed out last Monday at the London School of Economics (LSE).

The EU Commissioner for Financial Stability, Financial Services and the Capital Markets Union was quite clear in his assessment. “Last year, London was once again rated by the Global Financial Centres Index as the world’s most competitive financial centre – hardly a sign (by the way) of a City drowned or strangled in red tape as is sometimes claimed”, the Brit stated.

The key to London’s success is not just its historic role as the leading trading hub for Europe, but also the Single Market and the EU-passporting regime. Thanks to this, British firms and banks can do business wherever they choose in Europe. From their base in the UK, they can provide services and capital to 27 other EU-countries. “They can lend freely into the single market, and they do”, Lord Hill stated. In 2015 alone, British banks lent over one trillion euros and took deposits of over one million euros across the EU.

The scheme also works the other way around. It not only provides access to the EU, but also to the UK, and to the City of London in particular. Due to that, 20 percent of banks operating in the UK are headquartered elsewhere in Europe. American, Asian and African banks use London as their European headquarter and trade into Europe from here. “Half the world’s financial firms have chosen to base their European headquarter in the UK”, Hill said.

As a result of this integration, the surplus from Britain’s trade in financial services has more than doubled – from 23 billion pounds in 2014 to 58 billion ten years later. “This (…) is a success story of which we should be proud, and which we should be keen to keep”, the Commissioner reiterated.

It is exactly this which is at stake. According to economists, London risks losing some of its weight as the leading financial centre in Europe. A country that did not join the Euro and still uses the pound, the UK has nevertheless been able to attract a lot of transactions denominated in Euro. In case of a Brexit, this could change – why bother going via London if the UK does no longer use the passporting system?

As a consequence, many banks could move at least some of their business to continental Europe in order for them to make sure that they are able to access the single market. “There are 75 foreign banks in London”, a female CEO of a financial fund told me last week, “just guess how many of them would move?”

It’s a tricky question, given that many banks have gone quiet on this recently. However, a few have stated what they are planning to do. HSBC for example would relocate around 1000 bankers to Paris whereas Deutsche Bank has announced that they would move parts of their business from London to Frankfurt, should there be a vote for Brexit.

“The American banks would move to Dublin, the German ones to Germany, the French ones to France”, the CEO of the fund mentioned earlier explained to me. Add to that the uncertainty – it will take at least two years if not longer for the UK to negotiate it’s exit – and you end up with a pretty bleak short term outlook for the City of London. PwC estimates that there will at least be 70.000 to 100.000 fewer jobs the British financial industry by 2020, should there be vote for Brexit.

The problem with this is that it could take years, if not decades until we are able to investigate the size of the damage that a Brexit would do to the City of London. There are not just European competitors like Frankfurt, Paris and Dublin that want to increase their share but also international financial centres like Hong Kong, New York and Singapore that might benefit from a gradual decline of the City.

I don’t have a crystal ball. I am not a forecaster. But I do think that British voters should be aware that these days, nothing is carved in stone anymore. Not even the role of the City of London.

Reporting the Referendum

Tomorrow, it´s just one month to go before the big day. On June 23rd, the UK votes on whether it wants to remain a member of the European Union or not. It´s a historical decision, for sure. Finance Minister George Osborne called it a “once in a generation decision“, while Prime Minister David Cameron has warned peace in Europe could be at risk if Britain votes to leave the European Union.

For journalists like me, covering the referendum campaign proves to be a tough one. The debate is becoming more heated, more vitriolic and less rational, the closer we get to referendum day. Both sides are making claims that are hard to check and prefer to talk past each other instead of precisely addressing each others arguments. During the next month, I will use this blog as a means to share my views and experiences on reporting the referendum.