The trend towards relocating some financial activities to the European Union (EU) is undeniable, even if it has remained circumscribed up until now.
This trend was inevitable. Indeed, once the United Kingdom chose to leave the single market, it also gave up freely providing services within that market – in other words, in order to access most customers (individuals or businesses) located in the EU, it became necessary to operate from a legal entity located there. The reason is simple: it flows from just how the single market was designed in the 1990s (at the urging of the British in particular!). The underlying concept was clearly to establish that all would be subject to the same regulations (European directives or regulations) and to the same judge who interprets these regulations (the Court of Justice of the European Union (CJEU)), to which today should be added the coordinated financial supervision through European agencies (European Banking Authority (EBA), European Insurance and Occupational Pensions Authority (EIOPA), and European Securities and Markets Authority (ESMA)). However, the UK has clearly decided to withdraw from this legal universe.
Relocation presents a clear advantage in terms of monetary policy and supervision of financial players. Indeed, one of the paradoxes of the situation created by the single market was that the main financial center of the euro was located in London, beyond the jurisdiction of the European Central Bank (ECB) concerning both its monetary function and banking supervision. Therefore, if an accident had occurred in the London euro market, the ECB would have been faced with a formidable dilemma – either provide liquidity blindly, having to trust the British authorities absolutely, or refuse, at the risk of setting off a much more serious crisis. The return of a substantial part of the euro market to the universe of the ECB's jurisdiction thus corrects a potentially dangerous anomaly1.
THE ACTIVITIES CONCERNED
What was the extent of relocation made necessary by the exit from the single market? The United Kingdom long denied the need for any relocation, arguing that there could be an agreement on the recognition of regulatory equivalence – which the European Commission very quickly and rightly analyzed as a proposal for the EU to give up its financial sovereignty.
Another discussion concerned the types of activities involved. The relationship with the final customer, a key element of freely providing services, was quickly identified as having to be carried out in EU territory. But how far back in the value chain was it necessary to go? With the act of selling the financial product or service, bookkeeping naturally followed, and quite naturally all operations to control operations and risks. A more difficult discussion arose over downstream operations, which are carried out at least in part between professionals. This concerned in particular the management of positions for market operations, for which there was a strong propensity on the part of operators to demand the possibility of back-to-back operations (the hedging and management of positions created by sales and purchases made by European entities being done in London). Similarly, for insurance, reinsuring in London the commitments generated by European contracts; or for asset management, delegating to London-based teams the actual management function of mutual funds registered, sold, and managed administratively in the EU.
However, two types of problems arose on these issues. The first was the difference of views between European countries. For example, Luxembourg, which is very capable of registering mutual funds and managing them administratively, felt that it was relatively ill-equipped to attract financial management teams: it therefore had an interest in ensuring that delegating continue. On the other hand, a country like France, with a strong asset management industry, wanted to reduce the possibilities of delegating in order to attract new teams to the Paris financial market. But many countries long hesitated on which doctrine to adopt. Some thought it would be easier to attract business, even in a limited way, by being rather lax about the extent of the transfers required.
The second problem arose from the fact that delegation is widely practiced universally for reasons of efficiency. But as a general rule, business transfers that are linked to delegating balance out pretty well. Thus, it did not seem very realistic to systematically ask all operators to spread the management of assets in little-used currencies over two management teams on the European continent, whereas it did seem logical to require that euro-denominated assets be managed within the EU. This would have been logical even for mutual funds sold to clients in the rest of the world, which the United Kingdom finds difficult to accept. In the same way, the back-to-back system seems to be an acceptable solution when operating in a currency that is not widely traded in the EU. However, it seemed to be excluded for the euro and the other EU currencies, and even for the dollar, for which a sizeable market could easily be established, with operations finally being settled in New York.
The European doctrine has gradually become clearer, thanks in part to the ECB, which has made it clear that it wants the entire value chain to be located within the EU so that it can monitor and audit it. In any case, this applies to euro transactions. The ECB has, however, given operators several years to make these transfers, for example by allowing back-to-back transactions with a time limit. In the field of insurance and asset management, after much jaw-boning to convince a majority of countries, and with the help of the European Commission, the same type of doctrine was finally established. But actual implementation by the regulators of the different countries still leaves a lot to be desired. It should be noted that in France the doctrine of the Financial Markets Authority (AMF) and that of the Prudential Control and Resolution Authority (ACPR) are fully aligned. One could even say that they preceded the establishment of the European doctrine.
The overall size of relocations is difficult to assess, either in terms of asset values or in terms of the number of employees involved; especially as these figures continue to change for several reasons:
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first, many of the firms in question have been given time to complete all the transfers, whether by the ECB or by the various national authorities;
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secondly, the pressure from the authorities to make transfers that were not specified at the outset has tended to increase;
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finally, financial operators are looking for efficiency. Having initially fulfilled the regulatory requirements in order to be able to continue to operate in the EU and serve their clients there, they are now beginning to look at how to optimize their organization, and in a number of cases this involves an additional transfer to their European entities.
In the spring of 2021, the New Financial think tank (Friis Hamre and Wright, 2021) estimated on the basis of surveys conducted since 2019 that 440 firms had already been affected, while acknowledging that this total certainly missed some firms, and that the real figure was most likely significantly greater than 500. It also estimated the transfer of bank balance sheets at £900 billion, i.e. roughly 10% of the total banking system located in the United Kingdom. It is even more difficult to estimate the general impact in terms of jobs. New Financial said it had identified 7,400 relocated jobs, but focused on only a small number of firms. Moreover, this number is still very much in flux – while asset transfers are essentially done all at once, for example on bank books, job relocations are ongoing and gradual.
WHICH FINANCIAL CENTERS HAVE BENEFITED?
When we look at the number of firms that have augmented their presence in the various financial centers, we find three groups: Dublin, Paris, and Luxembourg, with a hundred or more companies involved; Frankfurt and Amsterdam, with around 50 or 60; and finally Madrid, Brussels, and Stockholm, with a small number of recorded moves.
Of course, the size of these moves varies considerably from one firm to the next, but there is no one financial center that emerges as clearly dominant, and for now Brexit has resulted in a multipolar scene, in which a small number of financial centers have managed to attract a significant amount of business. It should also be noted that many of these players, especially the largest, have chosen to spread the transferred business between several centers, and have occasionally played on the separation between a legal hub (a subsidiary) and one or more branches that have received business and staff, sometimes to a much greater extent than the subsidiary.
The various financial centers in question generally appear to be fairly specialized. Dublin, for example, has received a third of the asset managers who relocated part of their activities, as well as a few commercial bank legal entities; Frankfurt has been the main destination for banking legal entities (60% of the moves recorded to this city); and two thirds of the moves to Amsterdam have involved trading platforms or brokers.
Within this panorama, Paris appears to occupy a special place. Its financial center has been able to capitalize on a favorable initial position in several respects: it was already the largest financial center in the European Union, apart from the United Kingdom; it was the only one where all financial activities could be found (for example, it was the only place where a few trading rooms could still be found at French banks and even at a handful of foreign banks); it had some very powerful overall major players in banking as well as in insurance and asset management; the strength of its asset management industry was recognized; and finally, it had weathered the crises unscathed, and its regulators benefitted from a solid reputation. In addition, the city's corporate client base was unrivaled by any other European city, and Paris was also very well endowed in the legal and accounting professions, with the active presence of many international firms. In other words, Paris was the only complete financial ecosystem, the only one that replicated London's financial center on a smaller scale2.
The relocation movement that has been making its way to Paris has indeed included all branches of the financial industry. A quick, non-exhaustive survey counts around 30 banks, 2 insurance companies, 20 or so asset managers, 10 or so fintechs, several market platforms (equities, foreign exchange), a commodity derivatives trader, and around 15 brokers. Among the most recent moves, it is possible to chalk up 2 large hedge fund managers, who on the European continent had been present only in London, and who bring with them important liquidity because quite different from the rest of the buyside, i.e. from the clients of the investment banks' trading rooms. Finally, the concentration in Paris of repo clearing contracts within LCH-Clearnet (as well as the development of credit default swaps (CDS) on European sovereign risks) has strengthened the ecosystem for interest rate management.
In terms of personnel, it is possible to identify around 3,300 people having moved by the end of 2021, and project roughly 4,300 by the end of 2022, given the intentions expressed by the main players. However, these figures are certainly lower than the reality, because a certain number of business transfers fly under the supervisors' radar, for example when they concern the branch of a legal entity established in another country of the European Union. It has not been possible to identify all the moves that have been made or are planned.
The other feature of Paris has been that it has won the battle for market operations. Admittedly, only a limited number of subsidiaries have been set up in Paris for this purpose: there are more in Frankfurt, and some have been established in Dublin or Amsterdam, even though several subsidiaries for these dealer-broker activities are present in Paris, including a very large American bank. But most of the institutions that use a legal hub located in another country have set up a branch in Paris where, for all practical purposes the only (or sometimes the main) trading room is located. In other words, while certain administrative and accounting functions have been divided between various centers, trading activities and the majority of salespeople are located in Paris. Several banks, particularly American banks, who had planned to divide up their market business between Paris and Frankfurt, giving more weight to the latter, have gradually modified the planned division, and in fact now tend to concentrate most of these activities in Paris. But in this business, the tendency to concentrate everything in a single center is very strong, as we have seen historically in London, in particular because it is easier to recruit talent that way. Barring an accident, it is therefore likely that this business will be concentrated mainly in Paris.
THE STRENGTHS AND WEAKNESSES OF THE PARIS FINANCIAL CENTER
The biggest strength of Paris is its talent pool. Even before Brexit, Paris had the largest talent pool in the EU financial industry outside the United Kingdom. Secondly, when we look at the nationalities represented in the City, we find the French to be the most numerous, immediately following the British. For one thing, this means that a significant number of people, when faced with the need to come and work in the EU, will prefer Paris over another city. But it also means that every year France is capable of supplying a new generation of experts able and eager to work in the finance industry. France's strength is particularly noticeable in high value-added activities, such as financial market professions and management, for example, and it is well known that the French quants greatly dominate financial activities.
The second strength lies in the attractiveness of the city of Paris. Endowed with a very positive image for the quality of life it provides, the only city of a size comparable to London among the European centers, the city of light offers, for example, employment opportunities in many other professions for the spouses or partners of financial sector employees. Its fairly central location in Europe, its airport with direct connections to numerous cities in Europe and the world, and the quick and easy connection to London by Eurostar, are so many advantages from both a professional and personal point of view. Added to that is the tax system for expatriates, which, although it does not offer the employer any advantages, has proven to be a good tool for convincing employees3. Indeed, particularly in high value-added professions, where there is a hunt for talent, the preference expressed by individuals is often crucial. Companies do not want to risk losing some of this talent to competitors who have chosen a different location.
A third strength lies in Paris' reputation. Its regulators (the ACPR and the AMF) are considered to be both rigorous and credible as well as responsive and flexible when justified. They benefit from a very good reputation among their foreign counterparts (and thus among home country supervisors). The English language, which is often essential in certain professions, is widely used in the financial sector, including among supervisors, and is therefore no longer an obstacle. Paris has succeeded in setting up active working groups that cooperate with the Treasury Department, the Banque de France, and the AMF, whether it be in the legal field (the Legal High Committee for Financial Markets of Paris) or in many other areas (under the aegis of Paris-Europlace or the various industry federations). Paris has shown that it is active in areas that are expected to become increasingly important in the coming years, such as green finance.
Finally, it should be noted that the attractiveness of Paris would have been nil without the emblematic reforms carried out at the beginning of the previous presidential term concerning labor law and taxation. Almost all companies made quite clear that these reforms were a prerequisite for their investment decision and that any rollback would immediately induce them to reconsider their choice. Labor law reform in France, even if it doesn't provide the same flexibility as in the United Kingdom or Ireland, is generally considered to ensure management conditions that are fairly comparable to those of the best continental European countries. On the personal tax side, the abolition of the wealth tax was felt to be an absolute prerequisite4. On the corporate tax side, two favorable factors have played a role – the commitment to lower the corporate tax rate towards the European average, which has been kept; and the commitment to gradually lower production taxes.
Concerning handicaps for Paris, the primary issue is the cost of labor for the employer. In professions where the salary paid by the employer is often the same for the same position regardless of the country in question, the difference in payroll taxes can quickly reach levels that weigh on location choices.
The first factor concerns the level of payroll taxes. France is the European country where payroll taxes are by far the highest, especially for skilled jobs5, and in particular for highly skilled jobs, due over the years to the substantial raising of the salary ceiling to which healthcare insurance taxes are applied, and the compulsory nature of supplementary pension contributions. These are two issues that set France apart from almost all other countries. As an example, the additional cost compared to Germany is around 30% for the average expatriate employee. A reform was introduced in 2019 to allow expatriates who may be covered by another retirement system, either foreign or private, to opt out of joining the French retirement system, but this rather restrictive reform, which has only temporary effects for a given employee, and can cover only a fraction of staff, has not yet been widely used.
The second element concerns production taxes, which are known to severely penalize all economic activities on French soil and are probably the main explanation for the country's deindustrialization6. This negative factor has been aggravated in the financial sector by the salary tax, which is almost unique in the world7. Despite a reform effort undertaken in 2016 and 2018, it continues to weigh very heavily, without any serious justification for its existence8. In the Paris region, there is also another factor, the transportation payment, which is also totally disconnected from the real cost of transportation for the employees concerned, since it is proportional to the level of wages. Far from being trivial, this levy represents about 5% of the total payroll.
A third problem is education. Well understood by successive governments since the United Kingdom's decision on Brexit, the need created by the influx of children who are following foreign or international educational curriculums has led to the creation and extension of several international secondary schools, fortunately complemented by the creation of a European school thanks to the arrival of the European Banking Authority in Paris. Unfortunately, the actions that have been taken have not been felt to be commensurate with the challenges and needs. First, because this extension of the supply is being made rather slowly, undoubtedly delayed by a ministry for which it is not a priority. Secondly, because in a certain number of cases, the demand is for instruction given mainly in a foreign language (most often English), which may lead to a secondary school diploma other than the French baccalaureate (the “international baccalaureate” issued in Switzerland, for example). However, instruction mainly in a foreign language can only be provided by private schools, and it seems obvious that the administration is putting the brakes on plans to rapidly extend their number. Moreover, the possibility of graduating from a school program in France with a diploma other than the French baccalaureate, which used to exist, no longer exists. This situation is quite worrying, as it may lead a number of employees to change their location choices as their children grow older.
Finally, a more difficult factor to appreciate is France's reputation for legal and fiscal instability, and consequently the perceived risk that the conditions which had governed the choice of a location may be challenged, or even upended every time there is a change of political majority.
These different factors – both positive and negative – partly explain what the Paris financial center has gained or lost with Brexit. When employees, such as traders, have had a genuine possibility to apply pressure to their employers, the choice of Paris has been facilitated; when this has not been the case, as for back office activities or administrative functions, other locations have often been preferred. Moreover, fear of legal and fiscal instability, or simply the fact that certain significant location decisions were taken before the implementation of labor and tax reforms, which were considered by decision-makers as absolute prerequisites, led in a sizeable number of cases to the leading legal structure in the EU being located in another country, even if subsequently the French branch of this entity received a significant, or even very dominant, share of the business and jobs, particularly the highly skilled jobs.
All told, the calculation can be made today that Dublin has probably received the largest number of legal entities; that Frankfurt probably holds first place in terms of banking assets transferred (the “books”)9; and that Paris holds first place in terms of staff transferred or recruited after Brexit.
However, the reorganization of the financial industry in Europe triggered by Brexit is far from over. After the initial phase prompted by regulatory obligations and the desire to be able to continue serving their European clients, financial firms are beginning to look at what would be the best organization in terms of efficiency. Efforts to strengthen the attractiveness of the Paris financial market, and more generally that of the “France” site, thus deserve to be pursued.
(October 4, 2022)