Wait and hope

OPINION polls suggest that Brexit won’t happen. Ladbrokes, a bookmaker, is offering 4-to-1 against. But pollsters and bookies have been wrong before: what if on June 23rd Britain chooses to quit the European Union? The world’s biggest banks, for which London is a second home if not their first, have plenty of other worries: profits are thin, regulators nagging, investors impatient. The referendum is an extra headache they could do without. Banks must nevertheless be braced for turmoil should the odds be upset. And if Britain votes to leave, they will face an awkward decision: should they shift business away from Europe’s financial capital?

Banks do not have to answer that question yet. They hope they never will. Already under pressure to cut costs, they are not spending oodles on contingency plans and won’t until they have to. For now, they regard the referendum chiefly as a market event, with a known date, which could cause volatility and strain liquidity. The most obvious place to look for trouble is in the exchange rate, where there has been some pre-poll turbulence. Between the turn of the year and early April sterling slid by 9% against the euro. Now it is only 3% down—and in fact a mite stronger against both the euro and the dollar than when the referendum was called in February.

After a vote to leave, such moves would look like gentle undulations. Options markets have been pricing in an immediate drop of 4% in the pound. Looking six months or a year ahead, economists, moistened forefingers aloft, guess sterling might plunge by 15% or even 30%. The OECD, the IMF, the Treasury and others predict severe damage to Britain’s economy (scaremongering, cry Brexiteers); the euro zone could suffer too. None of this is good for London-based banks—though sharp traders may profit from gyrating currencies—or for their corporate customers.

Repo plan

In readying themselves, banks have been helped by the strengthening of supervision since the financial crisis. Regular inspection of their defences, both internally and by central banks, has become routine. Supervisors are promising ample liquidity. The Bank of England will hold three extra “repo” auctions around the referendum, in effect an offer to lend money to any banks that can provide common securities as collateral. Big British banks have access to foreign currency through other central banks; the Bank of England has swap lines with its peers in the G7 and Switzerland.

Volatility, in short, can be managed. The EU’s “passport” rules, under which a financial firm in one member may serve customers in the other 27 without setting up local operations, are another matter. European subsidiaries of non-EU banks receive the same treatment, which allows American, Swiss and Japanese firms to cater to the whole of Europe from their bases in London. Goldman Sachs is probably the most extreme example, with 6,000 of its 6,500 European staff in the British capital; it is building a new London office, due to open in 2019. Partly thanks to the passport, notes TheCityUK, a trade body that opposes Brexit, London boasts around 70% of the market for euro-denominated interest-rate derivatives, 90% of European prime brokerage (assisting hedge funds with trading) and more besides.

Without a deal to renew or replace them, banks’ passports will expire if Britain leaves. Such a deal could be struck. The EU’s rules allow for non-members’ regulatory systems to be deemed “equivalent” to its own; Britain would be desperate to keep its financial industry; banks would surely lobby hard. Even so, legal costs are likely to rise, simply because banks would have to comply with two separate (though consistent) sets of rules. And agreement may not come easily. No other non-member, TheCityUK points out, has full passport rights. Britain’s ex-partners may well be unforgiving: French and German politicians will not want to look soft before elections due next year, and will anyway be hoping to poach financial firms.

Nothing would be decided quickly. Britain would remain a member for two years (possibly more) after starting the exit procedure, while it negotiated the terms of its departure. But the clock would be ticking: banks would have to make plans. Since the crisis, supervisors have preferred banks to have separately capitalised entities in separate jurisdictions. EU regulators may press them to make their minds up, and move capital and people—most likely, to places where they already have subsidiaries. The head of at least one euro-zone bank fears it would become much harder to clear euro transactions in London.

Banks are loth to talk about what they might do (at least in public, and so close to the poll), and no one will make firm plans before they have to. But HSBC said in February that it might shift 1,000 people, around one-fifth of its staff in London, to Paris, where it has a subsidiary, formerly Crédit Commercial de France. Deutsche Bank’s co-chief executive, John Cryan, told the Financial Times last month that it “would be odd” to trade European government bonds and currency in a non-EU branch of a German bank. Others suggest that operations will be built up in Dublin (partly because of Ireland’s liberal labour laws) and Luxembourg.

London has defied gloomy predictions before. It became the euro zone’s financial capital even though Britain stayed out of the single currency. Its pull is probably too strong for any big bank to leave altogether, or for a sudden decline. Besides banking expertise, it boasts an army of accountants, lawyers and other auxiliaries. People like to live in its huge, bubbling melting-pot.

But at the very least, there is likely to be a fragmentation of Europe’s financial industry if Britain quits: more business in other centres, less in London, and probably less overall. Economies of scale in Britain would be lost, while other places would be too small to compensate. That means higher costs that financial firms can ill afford after eight grinding post-crisis years. No wonder they hope that Britons will vote the problem away.