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Brexit: Britain's break away to hurt Europe's financial system, says report

Financial services will lose ability to sell, if Brexit happens with little provision for them

Reuters  |  London, Italy 

UK turns to emerging markets for trade

Like many multinational companies, Italian engineering business Brembo relies on to run its finances. The company, based close to the Alps, makes brakes for Formula One cars and motorbikes and sells them in 70 countries. Hundreds of millions of euros pass through its accounts each year - and is the hub for those flows.

As prepares to leave the European Union, the company says it may now have to shift the centre of its banking operations to Frankfurt. If Brexit happens with little provision for London's financial services, banks, and in will lose their ability to sell many of their services to European companies.

Such upheavals will hurt not just London, say bankers and businessmen, but as well. Financial firms say such shifts will mean the of banking for European companies will have to rise, though it is not clear yet who will pick up the bill - the or their clients.

"At the end of the day it will not be a problem for Brembo, but for our bank," said Matteo Tiraboschi, executive vice president of Brembo, in an interview at the company's headquarters in Bergamo. "We expect to have the same service for the same price."

Brembo's main bank, Citigroup, declined to comment.

Interviews with scores of senior executives from big British and banks, lawyers, academics, rating agencies and lobbyists outline some of the dangers for companies and consumers from potentially losing access to London's markets.

The EU needs London's money, says Mark Carney, governor of the of England. He calls "Europe's investment banker" and says half of all the debt and equity issued by the EU involves financial institutions in

Rewiring businesses will be expensive, though estimates vary widely. Investment that set up new European outposts to retain access to the EU's single market may see their EU costs rise by between 8 and 22 per cent, according to one study by Boston Consulting Group. A separate study by JP Morgan estimates that eight big US and European face a combined bill of $7.5 billion over the next five years if they have to move capital markets operations out of as a result of Brexit. Such costs would equate to an average 2 per cent of the banks' global annual expenses, JP Morgan said.

say most of those extra costs will end up being paid by customers.

"If the of production goes up, ultimately a lot of our costs will get passed on to the client base," said Richard Gnodde, chief executive of the European arm of Goldman Sachs. "As soon as you start to fragment pools of liquidity or fragment capital bases, it becomes less efficient, the costs can go up."

UK-based financial firms are trying to shift some of their operations to to ensure they can still work for EU clients, but warn such a rearrangement of the region's financial architecture could threaten economic stability not only in but also in because so much European money flows through European countries, particularly France and Germany, don't share these concerns, viewing Brexit as an opportunity to steal large swathes of business away from and build up their own financial centres.

alone accounts for 5.4 per cent of global stock markets by value, according to Reuters data. Valdis Dombrovskis, the EU financial services chief, said the EU will still account for 15 per cent of global stock markets by value without Britain, and that measures were being taken to strengthen its capital markets. But he added: "Fragmentation is preventing our financial services sector from realising its full potential."

Industry figures have similar concerns. Jean-Louis Laurens, a former senior Rothschild banker and now ambassador for the French asset management lobby, told Reuters: "If is broken into pieces then it is not going to be as efficient. Both and are going to lose from this."

Money machine

is currently home to the world's largest number of and hosts the largest commercial insurance market. About six trillion euros ($6.8 trillion), or 37 per cent, of Europe's financial assets are managed in the UK capital, almost twice the amount of its nearest rival, Paris. And dominates Europe's 5.2 trillion euro investment banking industry.

London's markets insure French nuclear reactors and Greek ships. German carmakers borrow money for expansion. Dutch pensioners invest their savings.

has the largest foreign exchange market and the second largest derivatives market in the world, accounting for just under 40 per cent of the world's dealings in those markets, while Paris, London's nearest EU rival, handles under 5 per cent, according to the for Settlements.

Each year, euro, yen and dollar trades worth about a combined $869 trillion happen in - more than in all the euro zone countries combined - according to the City of Corporation.

Barclays Chairman John McFarlane told Reuters that a bad trade deal between and the EU risks harming the economy, and that some may decide to abandon some lines of business altogether because they will be too expensive.

"Brexit will put a spotlight on the economic attractiveness of activities you are moving," he said. "Everybody will say, 'If you move, is it worth it financially?'"

Bankers say a number of areas are likely to be affected when leaves the EU. The first is Europe's ability to sell sovereign debt. At present, when a country, say Portugal or Greece, needs to sell debt to keep its hospitals or schools running, it will tap the bond markets, arranged by primarily in London-based firms are currently responsible for trading about 70 per cent of sovereign debt in Europe, according to bankers.

But some are already withdrawing from arranging the bond sales because it is unprofitable. In the first quarter of the year five stopped being primary dealers in various European country bonds, Reuters reported in January.

The chief executive of one of Britain's largest and one of the largest underwriters of European sovereign debt told Reuters the European Central called him asking him not to abandon selling European debt because of Brexit. "They (EU countries) cannot be shut out from London's capital markets," he said. "It's suicide."

The ECB declined to comment.

A second area that may suffer is the selling of derivatives for companies to buy protection against swings in the US dollar or spikes in the price of oil. Bankers say rivals to will offer a smaller array of products and at a higher because there will be fewer offering these services.

A third area likely to be affected is the clearing of derivatives denominated in euros, an activity that dominates. EU policymakers want such clearing, which ensures the safe completion of a trade, to be shifted to the euro zone after Brexit. Financiers say that would bump up trading costs for continental customers that deal in a variety of currencies because they will have to route trades through multiple clearing houses, requiring them to post more collateral to back those trades.

The Futures Industry Association, a global derivatives industry body, says forcing a shift in euro clearing would increase the amount of cash needed to back trades by about $80 billion. German clearing house Eurex, which stands to gain from a shift, said the increase would be a far more modest $3 billion to $9 billion.

The global head of foreign exchange markets at one of the world's largest said if the amount of cash required to back trades went up as much as $80 billion - nearly a doubling of the current amount - then "it's going to stop the market."

While bankers say it is hard to estimate how much extra it will a European company to borrow without direct access to London's markets, the Association for Financial Markets in said in a report early this month that European customers are being overly optimistic if they think lenders will pick up the bill.

The report said for companies similar in size to Brembo "any increase in the of debt funding and derivatives would, therefore, have a material impact on the business, making it less competitive."

Brembo's Tiraboschi disagreed. "As far as Brembo is concerned, we do not have indications for a growth in financing costs linked to Brexit," he said.

Reality check

Last autumn, the British government set about persuading of the risks the EU faces if London's position as a financial centre is damaged. A research paper by Ernst & Young surveying major corporates, including Volkswagen and Airbus, found that companies across were worried about the of funding rising. The paper, which was commissioned by the City of Corporation, a municipal body that runs the financial district, was sent to policymakers across the EU.

The British government predicted that European companies would tell their respective governments they face higher costs and potential disruption, putting pressure on politicians to take this into account during Brexit negotiations.

In a speech in late June, British finance minister Philip Hammond said will only hurt its own if it undermines London's status as a global finance hub. "Fragmentation of financial services would result in poorer quality, higher priced products for everyone concerned," he said.

But Jeremy Browne, the City of Corporation's special envoy for Europe, who has visited 26 EU countries over the past year, said many companies and politicians are willing to accept higher prices in return for sticking to EU principles and not giving any special exemptions.

"They are not getting down on one knee begging their governments to be nice to Britain," Browne said.

The UK Treasury declined to comment.

With formal divorce talks now triggered, the EU is wasting no time in regrouping to try to replicate Britain's financial services on euro zone soil, egged on by the powerful European Central (ECB). In 2015, the EU launched a "capital markets union" project to improve the way companies can raise from stocks, bonds and other securities. That project is now being given more priority, the European Commission said in early June.

The ECB says that a "new equilibrium" may be beneficial in the long term to euro zone looking to take advantage of business opportunities created by Brexit - while an increase in financing costs is likely to be only "modest" in the near term.

Christian Noyer, a former central governor of France, is now wooing financial firms to relocate to France. He told Reuters that if European had time to adapt "they will do exactly the same job" as does now. "I don't believe for a minute it will be detrimental," he said.

At least eight European cities are vying for financial firms to set up entities in Europe, hoping to attract their highly-paid employees. The French government has been the most aggressive, dangling the promise of tax breaks and flexible labour laws to complement the French capital's cultural charms.

The chief financial officer at one of Europe's biggest said he sat through a recent presentation by French officials highlighting the restaurants and nightlife in Paris. "It was all very Moulin Rouge," he said.

A senior German lobbying official, who recently held meetings with the German government, said there is a feeling that is failing to understand that the European project comes first. "British politicians think they are in a position whereby the EU 27 will say, 'OK, there are lots of problems for the EU so we will agree on a trade deal as otherwise the EU will be faced with turmoil as well.' They just don't get it," he said.

Infighting

Bankers are sceptical about Europe's efforts to replicate They say continental is too leery of Anglo-Saxon free-market capitalism - which many politicians and economists blamed for 2008 to 2009 global financial crisis.

London's dominance as a financial centre has been built up over decades and would be very hard to replicate, especially with any speed, given the global talent pool, the widespread use of the UK legal system and the vast amount of money that is managed through London, say executives.

The head of European operations at a large US investment said that if ever managed to reform its labour laws, develop its capital markets and attract a global workforce, then it would mark the decline of as a financial centre. But may miss this opportunity, he said, because of infighting between EU countries and no clear plan for where jobs and assets will end up.

Discord between the euro zone's three largest countries - Germany, France and - initially stalled the ECB's efforts to come up with a way to force euro clearing out of and put it under its watch, three sources told Reuters in May.

"will end up with a hodgepodge of financial centres," the US executive said. This is "a humongous risk," he said. "If becomes so unattractive, we just won't be as big in as we are today. won't win."

Instead, some bankers predict the big gainer could be New York, 3,500 miles away. They say it is the only place that can replicate London's depth of markets and expertise.

(Only the headline and picture of this report may have been reworked by the Business Standard staff; the rest of the content is auto-generated from a syndicated feed.)

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