Generation Brexit


The aim of the Generation Brexit blog is give voice to British and European millennials in the Brexit debate.

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Whither finance? Why Brexit might have a silver lining for the economy

Posted by Roch Dunin-Wąsowicz (Admin) Mar 19, 2018

The UK is leaving the single market. What are the ramifications for the world’s foremost financial capital? However severe, they also hold the promise of shrinking and placing under greater regulatory control a burdensome financial sector that exists at the expense of the real economy. Dominik A. Leusder, Domenick Baumgarten and Georgina Sideri-Papagianni argue that in such respect Brexit might have a silver lining for the economy.

The many banks in the City of London use their British subsidiaries as a ‘passport’ to the wholesale banking of the EU27. The prospect of Brexit – however hard or soft – has dealt this arrangement a fatal blow. The passport now has an expiration date. Banks interested in business with other member states will have to conform to the same ‘equivalence standards faced by non-EU banks. As a result, prominent banks to reconsider London as their hub, setting their sights on Paris, Frankfurt and Dublin.

What’s the bottom line for the City? The example of CCPs

Meanwhile, the government has been engaged in a protracted legal battle with the European Commission and the ECB over an obscure feature of financial market infrastructure. The conflict revolves around the location of so-called central counterparties (CCPs). These ‘clearinghouses act as intermediaries for the highly lucrative trade in derivatives, financial contracts linked to the fluctuation in the price of an underlying asset. Since most of these contracts are denominated in Euros however. Since the ECB issues the currency it has been keen on gaining supervisory oversight over the clearing business. In 2012 it proposed a location policy, which sought to relocate clearinghouses that handled more than 5% of euro-denominated derivatives into the eurozone. Despite losing a subsequent court case, eurozone regulators have not relented. On June 13 of this year the European Commission published a proposal refining the supervisory requirements for CCPs.            

The relocation of euro-clearing is a good example of the challenges facing the UK financial sector. It alone might cost banks an estimated £63 billion pound while depriving London of 83,000 jobs. The overall slimming down of the City after Brexit might also cut into £28.8 billion it generates annually in taxes. The City’s financial sector contributes to 3 percent of the United Kingdom’s GDP and 13 percent of London’s output.

The up-side: becoming more European?

While the short-term effects might be undeniably negative, there may be some perks. For one, the risks associated with highly centralized CCPs are real and the cause of acute concern. The liabilities – $1 billion of outstanding positions every night – are the implicitly backed by the UK taxpayer and the possibility of these clearing houses going belly up would seriously undermine the fiscal position of the sovereign, which in turn endangers the solvency of banks holding British bonds. More generally, he relocation of a large part of the financial industry to the EU, with stricter regulations and a wider risk sharing between the Member States will dramatically reduce the impact of future financial crisis for all – including the United Kingdom. Besides that, it is not entirely clear how the financial industry benefits the UK economy beyond taxes. Traditionally, UK banks have focused on their profitable wholesale business rather than financing the real economy (mortgage lending being the only exception in what Lord Turner has described as a ‘socially useless’ industry). Yet that is what any healthy financial system should do: channel savings into productive investments in the real economy while providing insurance and consumption smoothing. Rather than being a risk-generating entity, autonomous to the rest of society, finance should be something boring utility.

Lastly, should the burdensome financial sector depart it would perhaps force the British economy to diversify into manufacturing and non-financial services. Ideally, it would become more like its more diversified EU trading partners. One of the great ironies of Brexit, then, is that the British economy might have to become more European.

This post represents the views of the author(s) and not those of the Generation Brexit blog, nor the LSE.

Dominik A. Leusder, Domenick Baumgarten and Georgina Sideri-Papagianni are MSc Students in Political Economy of Europe at the LSE European Institute. 

This post was edited on Mar 22, 2018 by Roch Dunin-Wąsowicz

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Comments (2)

Isaac Clark says... 11 months ago

This is an incredibly interesting blog article and raises some interesting points, could you further explain the role of CCPs

Peace Ani says... 2 months ago

This is a very interesting blog with some prescient conjectures.

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