Ecomonics: Let the City loose in Europe
The Square Mile could dominate the new markets opened up by EMU, says Graham Bishop
Sunday 30 March 1997
The Bank of England is orchestrating preparations via its quarterly report and the inauguration of a "Joint EMU Forum". The London Investment Banking Association has already published several reports on aspects of conversion and is co-operating closely with the British Bankers Association and the Association for Payment Clearing Services.
Meanwhile, organisations such as the London International Financial Futures Exchange are examining the implications for their own products. And, at the Bank's instigation, the Gilt Edged Market Makers Association has reviewed the potential effects on the operation of gilts, whether Britain is in or out.
Yet all these preparations relate to the City's wholesale markets. The retail banks seem unwilling to make large investments to convert their mass market operations, without a clearer idea of Britain's position.
In 12 of the other 14 member states, there are active project groups co-ordinating preparations in the public sector. Typically, these groups work closely with the private sector, especially the banking community. In Britain there appear to be no significant public sector preparations. This could become a key impediment to joining EMU in the "first wave"; after the next general election it may be too late to catch up with the other governments' 18-month headstart.
The European Commission is mainly fulfilling a co-ordinating role because detailed preparations, in the name of "subsidiarity", fall to the individual states. However, where the commission has been convinced of the need for legislation, it has been prepared to use its power.
Its recent proposals for two regulations on the legal framework for the euro are an excellent example of the commission's response to private sector concerns. To ensure that the fears of market participants were met, it held wide-ranging and frequent consultations on the texts. Britain's legal and financial communities have been heavily involved, to ensure that the City's position is fully protected.
It is thus particularly unfortunate that the British government has not managed to agree to these regulations. That this is preventing the creation of the necessary legal framework, throughout the EU, is causing concern among many City institutions.
Whether Britain is in or out of EMU will have a bearing on the pace of private sector preparations.
What if Britain is out? The key issue would be whether "they" discriminate against "us". As yet there is no definitive answer. The heated debates between Britain and its partners over access to "Target", the post-EMU cross-border payments system, show the kind of problems that lie ahead. In fact the highly technical arrangements for Target will not affect the City a great deal.
What was ominous, however, was the apparent statement of principle on the part of the obviously "Ins" that "Out" central banks should not expect equal treatment.
The European Monetary Institute's initial blueprint for the European Central Bank was published in January. Many important questions have been left to the ECB to decide, such as whether there should be minimum reserve requirements, and the terms of access to Target. Assuming that the pound is out, Britain will be excluded from these decisions. It is abundantly clear, and understandable, that the central bank will conduct its money market operations - the engine of any financial system - inside the euro area. London-based dealers should be able to use subsidiaries within that area. But they could be vulnerable to regulatory changes that impede their access. Given a world of highly mobile capital and star performers, slight shifts in technical regulations may affect wafer-thin profit margins enough to push firms into moving.
What if Britain is in? The table shows the scale of the world's main bond and equity markets. In total, EU government bond markets are significantly bigger than their US counterpart.
However, dollar-denominated markets, overall, are 25 per cent larger than those of Europe. This reflects both the fact that securities markets in America play a greater role in extending credit to corporations and public bodies, and the securitisation of residential mortgages. The role of the US dollar as a world reserve currency also makes a difference: nearly 8 per cent of all dollar bonds are the classic Eurobonds that London started issuing in the 1960s.
This opens an intriguing prospect for London's capital markets.
If the American trend towards extending credit via the securities markets rather than the banking system spread to the EU, and the euro became a reserve currency to rival the US dollar, euro-denominated bond markets could double in size. The existing European markets would inevitably, when denominated in one currency, capture a share of the dollar's reserve currency role.
The City, with its sophisticated array of financial products and its depth of talent, should be able to capture a substantial share of the euro market. That would be a prize indeed for Britain joining EMU. British participation would allow the City to deploy its well-known strengths and to build on its pre-eminence in Europe.
This would benefit not merely Britain but also, through providing improved terms of finance, the entire European economy.
Graham Bishop is adviser on European affairs at Salomon Brothers International. The views expressed are his own. This article is extracted from an essay published in 'Britain and EMU: The case for joining', a pamphlet published by the Centre for European Reform. Telephone 0171 233 1199.
Financial market size in trillions of ecu
Currency Total of publicly Tradeable govt Equities***
issued bonds* bonds**
EU combined 5.5 2.2 4.5
UK sterling 0.4 0.3 1.0
US dollar 7.0 1.7 4.5
Japanese yen 3.0 1.0 1.4
*End 1995. **Fixed rate over one year life remaining. ***Based on the proportion of market capitalisation available to investors.
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