Guy Faulconbridge reporting from Reuters in London did an interesting piece today regarding the United Kingdom’s and particularly the City of London’s influence on FX markets should a ‘Brexit’ become a reality in the future. He states in the article that, “If there is a symbol of British ambivalence to Europe then it may be the euro itself.” The piece suggests gathering anecdotal reports from famed investor Jim Rogers that London’s dominance of the $5.3 USD trillion-a-day FX market could wane if Britain left the European Union. The key word being could…
Britain’s Euro-skeptics have for a long time resisted replacing pounds with euros. Nevertheless, FX traders in the City of London now buy and sell more than twice as many euros then the whole 19-member euro zone and more dollars than the United States.
As industry players know, London has been the undisputed king of the Forex for a long time, but some investors fear that if British voters decide to leave the EU, the City would eventually lose its top position, especially in euro trading.
“If the UK left the European Union, London’s dominance of foreign exchange including euro trading would gradually decline and then end as the flows moved to Asia and other European capitals,” US investor Jim Rogers, who co-founded the Quantum Fund in 1973 with George Soros, told Reuters.
“London’s dominance of the foreign exchange market evolved historically but evolution will continue in other places if the UK leaves. It would be foolish to leave the EU, but politicians have done foolish things since the beginning of time,” Mr. Rogers concluded.
Twelve years after Rogers left Quantum in 1980, Soros used the fund to bet successfully that sterling was overvalued against the Deutsche Mark, culminating in Britain’s biggest financial humiliation since the sterling crisis of 1976. (famously known as when George Soros “broke the Bank of England”).
On so called ‘Black Wednesday’, September 16, 1992, Prime Minister John Major was forced to pull sterling out of the European Exchange Rate Mechanism (ERM), which had been intended to reduce exchange rate fluctuations ahead of monetary union. (see chart below).
Fast forward to current times, the London elite are debating about post-imperial Britain’s place in Europe and whether it might not be worth striking out alone. The impact of the euro on the UK falls across Prime Minister David Cameron’s attempt to renegotiate Britain’s relationship with Europe, then hold a referendum on membership by the end of 2017.
London as the ‘King of Forex’
– London accounts for 41% of global FX turnover, more than double the nearest competitor, New York.
– According to the Bank for International Settlements; London’s closest European competitors are Switzerland and Paris, which each take about 3% of global FX turnover.
– London wasn’t always king of Forex: The dominance of the pound sterling in the British empire meant that before 1914, London played second fiddle in FX to Paris, Vienna, Berlin and New York.
– London became center for global dollar trading after WW2, it benefited from America’s and the greenback’s rise. The growth of international banking during the 1950s and 1960s put it in pole position to benefit from the FX trading boom when floating exchange rates were adopted in the early 1970s.
– Since UK exchange controls were scrapped in 1979, London has thrived as a center for everything from FX and bonds to derivatives and fund management, making it the largest net exporter of financial services in the world.
– Though the euro’s introduction reduced the number of currencies traded in Europe, London emerged as the global center for the most traded currency pair, EUR/USD.
“If Britain left the EU, that trade is gone,” said one senior European diplomat, waving his hand. “The first thing Berlin and Paris would do is to sit down and say: ‘How do we bring that business back?’”
Not So Fast
– London offers the deepest pool of capital in the time zone between Asia and the United States, and London time is often quoted in international business settings.
– London’s trading cables and infrastructure, combined with institutional inertia and the flash of the City of London, mean that any shift of Forex flow to main continent after a so-called “Brexit” would be gradual.
“The wires that make the trading of FX electronic are all in London and so a quick move from the UK to Europe would require infrastructure spending,” said Robert Savage, the CEO of CC Track Solutions, a New York-based hedge fund with US$100 million under management.
However, Mr. Savage still sees FX trading moving away from London and Europe if Britain leaves the EU.
“The volume of business in FX is likely to shift from the EU and UK to the US and Asia,” Savage said. “Big picture, the flow of capital is the driver of FX markets and the Asian centres are on the rise.”
Mr. Faulconbridge of Reuters reports that Britain’s allies say leaving the world’s biggest trading bloc would be foolhardy, leaving London’s financial powerhouse subject to rules it would no longer influence and turning it into an insignificant offshore ‘Treasure Island’.
Euro-Skeptics
– Opponents of the EU say London would thrive outside. They note that doomsters cried wolf in the 1990s, warning that London would wither as a financial center if Britain didn’t dump sterling and join the euro.
– The five-year euro zone debt crisis and Greece’s near bankruptcy are evidence of a flawed monetary union that is doomed unless it integrates more deeply, a step that would consign Britain to the sidelines.
“We, almost alone among the non-euro members, have no commitment to join the single currency — and no realistic prospect of wanting to do so,” that most powerful minister, George Osborne, told London financiers last month.
Euro zone rules and British interests
– The government’s worry is that Britain may eventually be one of the only EU members outside the euro. It can already be outvoted on regulatory issues by the euro zone if all 19 members vote together as a bloc, which they rarely do.
– The risk was underlined by an attempt by the European Central Bank to force clearing houses for major euro assets to relocate from London to the euro zone.
– Britain challenged the ECB, and the EU’s Luxembourg-based General Court ruled in March that the central bank did not have the ‘competence’ to impose such a requirement. Things might look different if Britain were no longer an EU member.
How long Britain can sustain its balancing act of profiting from euro trading while staying out of the currency may depend on the outcome of the 2017 referendum. The referendum on whether the United Kingdom and Gibraltar should remain a member of the European Union (EU) is planned to take place before the end of 2017.
To view the entirety of the Reuters piece, click here.