London frets future as money hub with Europe excluding U.K.

First step toward banking union comes Jan. 1

London Financial District London Financial District

London’s attempt to maintain its financial muscle while boycotting Europe’s move toward a banking union risks isolating the city from its major trading partners and undermining its status as the world’s top money center.

The European Central Bank will become the main regulator for the biggest banks in the 17-nation euro region as early as Jan. 1, the first step toward a banking union, European Union leaders agreed last month. Britain has said it won’t take part and is negotiating to retain London’s influence within the single financial market. Last night, U.K. Prime Minister David Cameron lost a vote in the House of Commons on the nation’s contribution to the EU budget, highlighting the division within Britain over its European partnership.

The danger of a banking union that doesn’t include the U.K. is that Britain’s voice in setting the rule-making agenda will be weakened as the ECB gains new powers, bankers said. Trading in euros, now centered in London, could shift to Frankfurt or Paris in Europe’s core and be regulated by the ECB, said Thomas Huertas, a former U.K. representative on the European Banking Authority, which drafts financial rules for the 27-nation EU.

“If there is a European banking union and a notable missing member of that is the U.K., then that will likely hurt London as a major financial market,” said Jay Ralph, the management board member responsible for asset management at Munich-based Allianz SE, Europe’s largest insurer with 1.75 trillion euros ($2.27 trillion) under management. “A strong pan-European banking union ex the U.K. will have negative implications for Europe and the U.K.”

London’s Strengths

London, the world’s biggest center for foreign-exchange trading, cross-border bank lending and interest-rate derivatives, has 251 foreign banks and more international firms than any other financial center including New York or Frankfurt, according to TheCityUK, a bank lobbying group.

The City, as London’s financial district is known, is home to three-quarters of the EU’s foreign-exchange trading, including 42 percent of euro trades. Banks located there conduct about 62 percent of trading in euro-denominated, over-the- counter, interest-rate derivatives, the group said.

A European banking union that gives the ECB new supervisory powers will create an “inner core” of euro-region nations that sidelines the rest of Europe, including the U.K., said Huertas, who now works for Ernst & Young LLP in London. Two sets of regulations for so-called inner and outer Europe would mean U.K. banks wouldn’t have as easy access to European markets, he said.

Single Market

“Most dollar capital-market business and most dollar business for the domestic U.S. market occurs inside the United States,” Huertas said. “It’s entirely possible that euro business moves from London to the Continent.”

The concern for U.K. banks is that “you end up with a policy-weighting toward the euro-zone banks because they’re in aggregate bigger -- that could damage the single market,” Douglas Flint, chairman of London-based HSBC Holdings Plc, Europe’s largest bank, said in an interview. A banking union “has to be done in a way that preserves the integrity of the single market in financial services so that banks within Europe but not within the banking union are not disadvantaged.”

David Walker, chairman of London-based Barclays Plc, Britain’s second-largest lender by assets, echoed Flint.

Timing Uncertain

“Because we are not in the euro area, their shaping the union and equipping the European Banking Authority will be less sensitive to our concerns,” Walker said on Oct. 17 at a British Bankers’ Association conference in London. “We will see some undermining of the single market, some protectionism of the financial-services sector.”

Much of the structure and timing of a banking union remains to be negotiated, and that is adding to uncertainty in London, according to senior executives at U.S. and European banks in the City, who asked not to be identified because they aren’t authorized to discuss companies’ positions.

In addition to common supervision, a banking union could mean that governments share the costs of winding down failed lenders and guarantee deposits, or leave that to national regulators. In the meantime, a central supervisory authority could allow the region’s bailout fund, the 500 billion-euro European Stability Mechanism, to directly recapitalize firms, breaking the link between sovereigns and their lenders.

The U.K. doesn’t want to be part of a banking union because it doesn’t want to be responsible for paying for failed banks in Spain and elsewhere in the euro area, according to top government officials. Britain should stay outside because the plan is designed to address the “vicious circle” between sovereign debt and banks in those countries, Deputy Prime Minister Nick Clegg said in a speech last month.

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