A big unknown in the UK referendum debate is the impact this will have on the City of London as the financial capital for Europe. There are three reasons that impact could be negative. The UK referendum debate and European reform negotiations are going to lessen British influence in the design of Europe’s capital union; they are going to eliminate any incentive for Britain to sign up to Europe’s banking union; and they raise the spectre that the UK government will find itself outside of future decisions about the shape of European financial regulation (and perhaps even without the support of the European Court of Justice inside the internal market).

The first two points apply whatever the outcome of the referendum and primarily during the referendum campaign. The prospect of exclusion applies primarily in the case where the British people vote to leave the European Union (EU). A string of public opinion polls suggest this is unlikely to happen. Nevertheless, the risk is greater than zero and so even the prospect will weigh on decision-making in the world’s largest financial institutions. And that is in addition to the ongoing tensions between the British government and the financial community over the bank levy, the future status of non-domiciled tax residents, and the post-crisis regulatory environment. The bottom line is that the EU referendum campaign is making a difficult situation worse.

Let’s start with the capital union project. This is an effort led by the European Commission to help wean the European internal market off its excessive reliance on bank financing. The result should be a boon to equity, bond, and securitization markets across Europe as firms look to alternatives for bank finance and as banks look for ways to refresh their asset portfolios. For this to work, however, it is not enough that firms have access to alternative credit markets; it is also important that savers (or investors) be able to take advantage of the increasing diversity of financial products and the opening up of new demand for credit across countries. Regulation will play a vital role in all aspects of this process – if for no other reason than to avoid the excesses that most policymakers believe caused the financial crisis in the United States. Hence the question is whether the emerging European regulatory framework will resemble or differ from regulations already in place in Europe’s most advanced capital markets, notably the UK.

There are any number of reasons why other European governments would want to push for a different regulatory framework from that prevailing in the UK as part of the capital markets union. Some of these have to do with suspicion that the Anglo-Saxons are too prone to take on excessive risk and too little inclined to protect retail investors. Others have to do with the fact that accessing international credit is a competitive process and simply uploading UK regulatory norms while making other countries adapt would only reinforce Britain’s first mover advantage. This is the usual stuff of European politics. What the referendum debate adds is a sense of resentment that the UK government is trying to gain added leverage in addition to the many assets it brings to the table as an established global leader in finance. Perversely, this makes it easier for negotiators to dismiss UK bargaining positions on specific regulatory issues as being disingenuous or excessive. Why should they have to make concession to the British in this area in addition to having to open up difficult negotiations over basic European competences?

The concern about banking union applies more within the UK than in the rest of the European Union. The British government has made it clear that it does not want to be part of the European banking union project – with its single supervisory mechanism, common resolution authority, pooled resolution financing, and all the rest. There are good reasons for the UK government to insist on this exclusion at the present. But many of those are specific to the present configuration of European financial markets and the current state of financial market disintegration. As the European economy recovers and banks begin doing more business across national borders, the influence of Europe’s banking union on business headquartered within the UK is going to increase. So will the power of European resolution authorities in the event that there is some kind of renewed turmoil. These are all reasons why an initial UK rejection of a European banking union could – and should – soften into a more cooperative relationship within the British national interest. The referendum debate makes such a softening of attitudes hard to imagine. If anything, the rejection of any extension of powers to ‘Brussels’ on both side of the referendum campaign makes future participation in a European banking union even more unlikely.

The prospect that the British people could vote against membership in the EU complicates matters further. Were that to happen, the hard won concessions about decision-making over financial market regulations within the European Banking Authority would be at risk and the logic of making rules within the European banking union would be more compelling. Such rules would pay scant regard to the competitive position of UK-based banks and the cost of their adjustment to a new regulatory framework. The argument here is not that Europeans would use the rules to put British banks at a disadvantage; rather it is that they would be indifferent to British concerns because UK interests would not be represented at the table. A similar logic applies to the European Court of Justice (ECJ). The ECJ would not suddenly turn on the UK if the British were to opt out of the European Union, but it would have little reason to insist on protecting Britain’s place within the international European market. In other words, the ECJ’s recent decision to allow for euro-denominated clearing outside the euro area could be a risk.

None of this spells an immediate end to Britain’s financial leadership. The capital markets union is still slow to gain momentum and the banking union has yet to face a serious test. It may yet be that both European initiatives prove inadequate. And, again, the British people are very likely to vote to stay in the EU. Nevertheless, these issues will weigh on investment decisions. The capital markets union has a game-changing potential; the banking union has already altered the competitive landscape; and the prospect of British exclusion from future European decision making constitutes a significant risks. Taken together these factors are altering how finance views Britain and they are sure to have an impact on Britain’s financial competitiveness. We just don’t know how big that impact will be yet.

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