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Professor Michael Mainelli, Executive Chairman, Z/Yen Group

[An edited version of this article appeared as “Trade Doesn’t Need Trade Deals, But Financial Services Do”, International Finance Magazine (January – March 2018), pages 20-22.]

Finance Only Exists To Support Commerce, Trade & Investment

Brexit starts, sputters, and stalls. Why is it so hard? Does it matter? The 19th century “Schleswig-Holstein Question” was a twisted mess of diplomatic issues involving two duchies, the Danish crown, and the German Confederation. Lord Palmerston commented on its complexity: “Only three people have ever really understood the Schleswig-Holstein business—the Prince Consort, who is dead—a German professor, who has gone mad—and I, who have forgotten all about it.”

Brexit seems to be Schleswig-Holstein for beginners. As one guest speaker remarked to the Worshipful Company of World Traders earlier this year, “What’s so hard about trade deals? We want to buy your lovely cheap goods, and it would be nice if you reciprocated by letting your economy benefit from our cheap goods”. He went on, naturally, to explain why trade deals can be hard, pointing out that local politics around subsidies and support interfere with negotiations. Local businesses want protection. Short-term deferral of change overrides long-term transformation. The problem is more home than away, as we see in the UK today.

Trade reaps economic benefits from specialisation and comparative advantage, creates prosperity, distributes success and wealth, and collectively enriches all of our societies and communities. Finance only exists to support the ‘real economy’ of commerce, trade, and investment. One financial centre has been the top global centre since the late 1980s, London. A global centre connects to the world not just its domestic economy. It attracts global financial transactions in its own right. There are frequent deals in London that have no domestic commercial interests. A Chinese, Australian, and Swiss deal concluded in London. Due to legal and regulatory complexity, that rarely applies in New York. Despite globalisation, only London, Singapore, and Hong Kong are truly global for all in financial services.

‘America First’, isolationist rhetoric damages perceptions of future US trade, while Brexit rhetoric harms perceptions of UK and European trade. Economists have long studied trade and conclude that free trade benefits everybody enormously. There are nuances. For example, global zero-tariff regimes appear to be better than bilateral trade deals. Consumer safety and quality standards, anti-monopoly enforcement, and avoiding externalities, such as pollution, are genuine complications. Trade causes change, and change potentially harms some jobs in the near term. Plans and budgets are needed for retraining and transition.

The Certainty Of Brexit Uncertainty

Trade in goods repeatedly overcomes many of these issues. Trade in services is, at best, only halfway there. Trade in financial services is hardly free. Finance is not just money. Finance is money plus regulation. Thus, an essential service to free trade in goods and semi-free trade in services is the least free trade of all. And then there’s Brexit.

Government officials frequently state that “business wants certainty”. This is balderdash. Businesses thrive on uncertainty. If there was certainty, there would be no need for markets. All quantities and prices would be known. There would be no change and no opportunity to compete. Businesses realise that the rules of the game need to change and improve over time, or there will be no progress. No, businesses want certainty about how the rules of the game change or will change.

Politicians do not shine on ‘certainty’. Certainty over how the rules will change requires a process that looks ahead, for example following a strict consultation, recommendation, drafting, revision, implementation timetable every so many years. Instead modern politicians react with more laws to most crises. Often these crises are media generated crises and the responses are designed to garner votes rather than solve a systemic problem.

Brexit, almost by definition, changes all of the rules of the game. Trade in goods, services, and labour all change, with a deep rewrite of how money works with regulation. One negotiating team exhibits little professionalism. This is dangerous. Nixon once suggested a negotiating tactic for the Vietnam War, “We’ll just slip the word to them that ‘for God’s sake, you know Nixon is obsessed about Communism. We can’t restrain him when he is angry—and he has his hand on the nuclear button.’” H R Haldeman, Nixon’s chief of staff, wrote that Nixon termed it “The Madman Theory.” Ask sportsmen or chess players about playing with amateurs who love the game. It may be slow but is frequently rewarding. But random and unpredictable poor behaviour just results in bad games for all. The Madmen Theory of Brexit negotiation terrifies businesspeople worried about how the rules of the game will change, yet not terrified about change itself.

One consequence of Brexit is clear. The UK will leave the Single Market and Customs Union. But there is little clarity on anything else, such as movement of people, scale of mutual recognition, or timescales. The most opaque subject is where are we going?

Transition, Trade, And Talent

UK financial services have emphasised “transition, trade, and talent” to the UK government. ‘Transition’ means spelling out where things are headed and the process for getting there. Basically, “where are we going and how are we going to change the rules of the game getting there?” ‘Trade’ emphasises that a no-deal Brexit cuts deeply into what financial services supports in the real economy. ‘Talent’ points out that people come to London for the best financial services in the world, not just the best British financial services.

Financial services is not decamping in toto. There are various responses. To highlight a few:

  • very large financial services firms are unlikely to ‘leave’ London. They will always have an office. But they are changing their domiciles and moving towards EU regulators, thus shifting hundreds of jobs at a time in risk, compliance, regulatory affairs, and core HQ staff. The firms moving most urgently are international banks that use the UK to serve their EU clients. In the absence of confidence about the way ahead, their plans will harden when they change their terms of business with clients, most likely in early 2018;
  • small and medium-sized firms are more likely to leave London if the EU is their principal business. Most smaller firms are not committed to multiple country offices. The more regulated they are the more they will move to service EU clients. Interestingly, a number of ostensibly large firms, Asian or Australasian banks for example, are medium-sized, single office businesses in London. This may force a complete move given a choice of 27 bilateral agreements, or one certain move and negotiating a UK regulatory agreement in future;
  • small and medium-sized London firms controlled by a non-UK citizen are common, think hedge-funds, family offices, some asset managers. EU citizens in particular have not been given any certainty over their personal circumstances since June 2016 and often have the ability to move their business back to the Continent. Individual circumstances matter. Again, the more regulated, the more likely to move.
  • business lines matter. Regulation varies tremendously by sector. For example, the focus is often on banks, but insurance has around 200 substantial brokerages and 100 underwriters employing 52,000 people, 35,000 in the City of London. Some of these are already having difficulty convincing Continental counsels that they will be able to pay claims legally after March 2019, but these contracts need to be written now.
  • Business people live daily in a condition described by Voltaire, “Doubt is not an agreeable condition, but certainty is absurd.” Despite government rhetoric to the contrary, the continuing lack of guidance on where we are going and opacity about the process for changing the rules is rapidly becoming the new certainty. It’s a certainty that will lead to hard decisions that could have been avoided.

Alderman Professor Michael Mainelli is Master of the Worshipful Company of World Traders, and Executive Chairman of Z/Yen Group

Michael’s book, The Price of Fish: A New Approach to Wicked Economics and Better Decisions , written with Ian Harris, won the 2012 Independent Publisher Book Awards Finance, Investment & Economics Gold Prize