Did David Cameron really have any choice last week? Maybe not.
The Telegraph argues that France and Germany threw down the gauntlet when they wrote an open letter to Herman Van Rompuy on Wednesday, setting out – among other things - their commitment to a ‘financial transaction tax.’ “The letter was the writing on the wall for Cameron. He either had to agree to a financial transaction tax or to use Britain’s veto,” it claims.
Much of this is true. The imposition of the FTT required unanimity. By bundling the tax up with their proposals for closer fiscal unification, the French and the Germans made it nearly inevitable that the UK would decline to cooperate.
After all, the UK clearly has most to lose. John Major suggested in November that London would raise 80%- 85% of the FTT’s revenues. In reality, financial transactions would simply shift to the US or Asia: when Sweden imposed a similar tax in the 1980s, between 90-99% of its traders moved to London.
In this context, the UK’s compliance with a financial transaction tax intended to help save the eurozone looks neither reasonable nor realistic. Financial services generates £50bn a year in taxes and employs 2 million people in this country. Neither France nor Germany are imposing new taxes on their key industries, so why should the UK be any different?
The answer is that the financial services industry is seen as the main protagonist behind the eurozone’s problems and therefore deserving of retribution. As Nigel Farage (admittedly hardly a friend of the EU) suggested recently: "Every time the bond markets twitch I can see the finger being pointed at those awful Anglo Saxons in the City of London."
However, so-called ‘Anglo Saxon speculators’ are the symptom rather than the cause of the euro’s woes. As Martin Wolf points out, the eurozone’s problems are almost entirely due to trade imbalances between the member states.
Nor is the proposed FTT the only recent European threat to financial services in London. Throw in various provocations, such as Sarkozy’s claim that Paris is becoming the European centre for business as taxes rise in the UK, or the European Central Bank’s attempt to rule that clearing houses can only operate in the eurozone (thereby torpedoing London’s current position as the EU’s biggest hub for financial clearing and shifting business to Paris and Frankfurt) and Cameron’s stance last week looks like the conclusion of long term provocation.
Nevertheless, it’s hard not to argue that the British PM overplayed his hand.
Rather than simply refusing to concede the transaction tax, he asked for a series of additional safeguards for the UK financial services industry, including that:
• Any transfer of power from a national regulator to an EU regulator on financial services would be subject to a veto.
• Banks should face a higher capital requirement.
• The European Banking Authority should remain in London instead of being consolidated in the European Security and Markets Authority in Paris.
• The European Central Bank be rebuffed in any attempts to rule that euro-denominated transactions take place within the eurozone.
In the context of efforts to prevent a eurozone meltdown, this list looked petty and ill-conceived. “We were talking about big things, saving the euro, and he was asking for peanuts. It was not the time or place,” one Central European diplomat told the Financial Times.
"His reasoning appeared to be: 'you want treaty change, I want treaty change', 'I need something because you are asking for something'," another ‘official’ complained of Cameron's stance.
As a result, Britain looks exposed at a time when European financial services regulation continues apace. On most financial regulatory issues (taxes excepted), the UK holds one vote among 27 members, making consensus-building mandatory. Hugo Dixon pointed out yesterday that France has often tried to undermine the City, but has struggled to find enough allies to support its position - until now.
As if on cue, Olli Rehn, Europe’s economic affairs commissioner stated today: "If [Britain's] move was intended to prevent bankers and financial corporations of the City from being regulated, that's not going to happen."
From here, there are several worst case scenarios.
In one, a retributive EU makes it difficult for Asian and US banks to deal in euro- denominated products without a base in the eurozone, a potentiality mooted by the Times. The City currently handles at least half of all euro-nominated transactions, making such a move disastrous.
In another, the proposed Financial Transactions Tax goes ahead without the UK, but in a way that damages London nonetheless. Lawyers point to rumours that the tax will be levied based upon the domicile of an institution, not the location of a trade. In this case, the London operations of a Deutsche or BNP Paribas would be affected.
In yet another, the Eurozone falls apart and the UK is seen as culpable because it obscured the legitimacy of the new 26 nation bloc at a time when clarity was paramount. In this situation, the future for the UK in Europe surely looks bleak, even though the proposed changes will arguably do little to resolve the eurozone's underlying issues and prevent collapse.
On the other hand, however, it can be argued that Cameron has strengthened the City long term.
By taking a stance against the EU, he has arguably appeased his own Eurosceptic back benchers, making a referendum against EU membership less likely. On this reading, the UK’s continued membership of the EU looks more secure – not less.
Equally, if – all things being equal - the financial transaction tax goes ahead and the UK remains in the EU, the City can only get stronger. Trades currently made in Paris and Frankfurt would almost certainly be redirected through London. Even if the transaction tax is imposed on institutions as opposed to trades, BNP and Deutsche could always simply set up new UK-based subsidiaries to avoid it.
Yet, this is surely naive. In the circumstances, it’s hard not to see Europe implementing measures to protect its own financial services industry. Retaliation can’t be ruled out.
The way forward is therefore clear: the City needs to capitalize on its position at the periphery of Europe, but as a bridge between Asia and the US. This is happening already: in September, China endorsed the City's move to push the first offshore renminbi trading centre, a move which is progressing and likely to take shape next year.
London has inherent benefits. The New York Times' recent article on US traders rising at 2am to get ahead of European markets underscored the need for a base in this time zone. "London has the advantage of language, time zone and the depth of the financial and support services you can get here and I don't expect that to change very soon," argues Jan Putnis, a regulatory lawyer at Slaughter & May.
There are already calls for a reorientation of the City away from the EU. “We can go back to as it was in history, being a financial-services centre to the world, including places with which we’ve got historical ties: the Americas, Asia, Africa and bits of Europe,” Terry Smith told Bloomberg this morning.
Reorientation may leave the City smaller, however. Emerging and Asian markets are becoming more self-sufficient and will have less need of international capital in future: PricewaterhouseCoopers argues that China will overtake London and New York to become the preferred location for raising capital by 2025.
The future City therefore seems diminished, but secure as an important international hybrid. If the UK remains a member of the EU, but outside a Eurozone-focused transaction tax, so much the better. The real danger to the City will come if the UK's broader problems catch up with it, prompting the pound to plummet or the imposition of a more punitive popular levy on the financial services industry than we have already. In that situation, the threat from the EU could seem inconsequential.