Protestors hold banners in Parliament Square during a 'March for Europe' demonstration against Britain's decision to leave the European Union, central London, on Saturday. Picture: REUTERS/NEIL HALL
Protestors hold banners in Parliament Square during a 'March for Europe' demonstration against Britain's decision to leave the European Union, central London. File Picture: REUTERS/NEIL HALL

AFTER the initial drama of the result of Britain’s EU referendum, an uneasy calm has settled over the City of London. Markets have drifted even as an existential question hangs in the air. Might London’s financial firms end up drifting to a new home on the continent too?

The risk arises from passporting, a regulatory provision that allows financial firms licensed in one EU state to provide services across the bloc. Lacking a passport after Brexit, City firms would need country-by-country approval for each service they sell on the continent, substantially raising costs. Alternatively, they could relocate and operate with a continental licence but this, too, would be costly. Either way, firms in Europe can ill afford the shock of higher costs and reduced access to London’s capital markets.

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This outcome could be avoided by granting the UK full access to the EU single market, while at the same time placing restrictions on movement of labour. But labour mobility is one of the four freedoms of the EU, fundamental to the functioning of the single market. If the UK can cherry-pick its freedoms, what is to stop Eurosceptics across Europe demanding the same?

Whichever way that question is answered, London need not give up its position as Europe’s financial centre, which would be to the detriment of both parties. Rather, and as contradictory as it sounds, the UK should consider joining the EU’s banking union (membership of which is open to countries that are not part of the eurozone), even as it withdraws from the bloc.

UK membership of the banking union could allow passporting to continue while giving ultimate regulatory power to the European Banking Authority and the Single Supervisory Mechanism. This would answer Europe’s substantive policy concern about London: that if it is to prevent or manage crises, a core part of its financial sector cannot be located beyond the EU’s jurisdictional reach. For Britain, there is further assurance of oversight and voice given that banking regulations are increasingly made at forums that are global not European. Were it to join the banking union, the UK would participate in the European Banking Authority and the Single Supervisory Mechanism. The UK Prudential Regulation Authority would guide day-to-day oversight of London businesses.

At the same time, the UK could allow free movement of labour in financial services, even if there was a political imperative in Britain to control labour movement more broadly. With a limited exemption from such controls, financial firms would be free to hire EU nationals, while EU countries could be confident that their fate was not left entirely to foreign nationals.

Whether the two sides can come to an understanding is uncertain. The UK will worry that the EU’s focus may be more on preserving the euro than on financial stability per se. Europeans will want to know how the two sides’ differing approaches to the separation of investment and retail banking can be reconciled. Given the stakes, a rapprochement on such issues is not out of the question, especially with reasonable transition periods to work out the complexities.

While there will be a temptation on the continent to shift the EU’s financial centre of gravity, this is a perilous option. A London-am-Main or sur-Seine would take at least a decade to build, time Europe does not have.

The last thing the EU needs is a fragmented capital market to match its fragmented banking system. A co-operative solution with London, based on a banking union, seems better for all sides than leaving the outcome to the complex bargaining that will accompany the Brexit negotiations.

Moghadam is vice-chairman for sovereigns and official institutions at Morgan Stanley.

© Financial Times 2016