Mr. George looks at the prospects for the City of London - in or out of EMU
Speech by the Governor of the Bank of England, Mr. E.A.J.George, at the Royal Institute of International
Affairs Conference in London, on 24/10/97.
Prospects for the City -- in or out of EMU
Mr. Chairman, you have asked me to speak specifically about "the prospects for the
City - or out of EMU". You -- very kindly in recent circumstances -- did not ask me to discuss the wider
pros and cons, either of the project as a whole, or of UK membership. But perhaps I might nevertheless
begin by making a more general point.
Perfectly reasonable people can legitimately disagree about EMU, both in principle and
about the appropriate timing and pace of monetary integration. On the project as a whole, most analysts
would acknowledge that there are real potential benefits, but that there are also real risks to be set against
them; and most would acknowledge that those risks will increase if the politics of EMU are allowed to
run ahead of the economics, so that countries are allowed, or even encouraged, to participate, without
first having achieved genuine, and sustainable, economic convergence -- in substance and not just some
technical accounting form. On the question of British membership the new Labour Government has
spoken of 'formidable obstacles' to this country joining EMU in the first wave. But one thing is clear:
everyone, in or out, has an unambiguous interest, if EMU does go ahead, in doing everything we can to
make it a success. And it is equally clear that those countries that participate in Monetary Union have a
similar unambiguous interest in the economic prosperity of countries remaining, at least for the time
being, on the outside.
Larry Summers, the Deputy Secretary of the US Treasury, writing about EMU in the
Financial Times on Wednesday, said:
"The US is well served when Europe is vibrant economically and working to open its
markets and strengthen its ties with the global economy."
He might have been speaking for all of us here in Europe, in or out, recognising that we
have a mutual, and reciprocal, self-interest in each other's economic well-being. So my general point is
this. Whatever the outcome on EMU, it is vitally important that we continue to maintain, and strengthen,
positive and constructive relationships throughout the European Union area -- and indeed beyond -- in
our national and collective interests.
For the UK, in particular, if we were to opt out of the first wave, that certainly means that
during our EU Presidency, over the critical first half of next year, we must -- as I am quite confident we
will -- do everything we possibly can to ensure that the procedures leading up to the historic decisions
run smoothly and that the decisions themselves are timely and, hopefully, harmonious. But beyond that it
certainly means, too, that "outs", or potential "pre-ins", should not attempt to exploit any
perceived -- and certainly short-term -- advantage from the additional policy freedoms they might have
on the outside, but should, for example, persist in macro-economic, fiscal and monetary, discipline in
parallel with the EMU countries. But it also means that the "in" countries, for their part, have an identical
self-interest in maintaining an open and constructive relationship with the "outs"/"pre-ins". Otherwise we
would all be cutting off our nose to spite our face.
I make this general point, Mr. Chairman, because this context seems to me to be relevant
to any assessment of the economic prospect, of the economy as a whole or of any particular sector,
within or without the euro-area. In the rest of my remarks I assume that, in or out, we will be operating
within a constructive, co-operative, environment throughout the EU, for the powerful reason that that is
in everyone's interest.
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Against that background let me turn to the prospects for the City.
I will, in fact, concentrate on the case in which the UK does not participate in EMU in
the first wave, because in the alternative case, the UK in scenario, while there may be uncertainty about
the overall macro-economic implications, there is little reason to suppose that there would be any adverse
implications for the City in particular. The only possible disadvantage I see would result from the
imposition of onerous regulatory or financial burdens -- for example onerous minimum reserve
requirements -- which might act to distort activity within the financial sector and/or drive it outside the
euro-area altogether.
So what then are the prospects for the City if the UK is, initially, out?
The current strengths of the City -- as a uniquely international, rather than simply a
national or regional European financial centre -- will be familiar to you. They include a vast, critical mass
of markets and financial services in commercial and investment banking, securities and derivatives
activity, investment and fund management, insurance and commodities and so on, involving an
extraordinary concentration of the strongest financial businesses from all around the world. To give just
one example, uniquely among the major countries we have more banks which are incorporated abroad
operating in the City than domestic banks, and over half of the total deposits of the UK banking system
is denominated in foreign currencies, worth over £1 trillion -- that's a one and twelve
noughts -- notwithstanding the current strength of sterling.
The particular strengths that have contributed to this massive concentration of
international business are many and various. They include: the English language; the convenient time
zone; the ready availability of the relevant trading and other financial skills as well as professional
support services -- in law, accountancy, tax, property, communications and so on. They include effective
infrastructure. And they include importantly, too, an adaptive regulatory framework which has in fact
been remarkably successful in maintaining confidence in financial institutions and markets without
stifling innovation and risk-taking. All of these factors -- and no doubt others -- help to explain why
some 600,000 people are estimated to be employed in finance and other business services in Greater
London -- a number which I believe is roughly equal to the total population of Frankfurt.
Now you will have noticed that none of these factors has anything to do with the
question of the national currency used either here in the UK or in Continental Europe.
The main impact of the advent of the euro on financial activity, as I see it, is that it will
encourage the development of broader and deeper and more liquid markets, in financial instruments of all
kinds, where they are currently fragmented because they are denominated in the various individual
national European currencies. The City of London thrives on liquid markets regardless of the
currency -- and it will thrive on the euro, whether the UK is "in" or "out". Measured in these terms the
introduction of the euro represents an opportunity for London rather than a threat. I have no doubt
whatever that there will be a vigorous euro-euro market in London, come what may, just as there is a
vigorous market in euro-DM or euro-francs as well as euro-$ and euro-yen at present. The reality is that
the location of financial activity does not depend upon the local currency. It will continue to be carried on
wherever it can most conveniently, efficiently and profitably be carried on. And the fact that
foreign-owned institutions -- from Europe itself and from around the world -- continue to build their
presence here, despite the near universal assumption that the UK will not in fact participate in EMU from
the beginning, suggests that they share this perception.
I would hope that the rest of Europe would positively welcome the contribution that the
City can, and I am confident will, make to the development of markets and other financial activity in the
euro, because it is in their interest too. International or intra-regional trade and investment activity is not,
at the macro-economic level, a zero-sum game. It is a positive sum game. And this is true of financial,
just as much as of any other kind of economic activity. The prosperity of the City -- whether the UK is
"in" or "out" -- is simply a particular case of the general point which I made at the outset. I welcome the
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prospect of increasing financial activity in Frankfurt, Paris, Milan or Amsterdam or wherever because it
will result in increased activity here too in London. And the converse is equally true. It is in this sense
that the City is a major European, not simply a national asset.
Now some people may argue that "offshore" markets in national or regional currencies
complicate the conduct of national or regional monetary policy, with the implication that national or
regional currencies should somehow be confined to their national or regional space. I must confess that
this view seems to ignore the fact that it has in practice over the past twenty or thirty years proved
perfectly possible for monetary policy to be conducted successfully despite the existence of the
euro-markets. And I do not see how one could realistically expect to contain the use of a major currency,
which the euro will certainly be, within territorial borders in any event.
But as I have made clear, the UK's interest -- "in" or "out" -- lies unambiguously in
doing all that we can to ensure that the single currency succeeds. And in this context we would, of
course, co-operate with the ECB in any way we could, to avoid potential disturbance to European
monetary policy, were it shown to exist.
Mr Chairman, London does not hold its pre-eminent position as Europe's major financial
centre as of right. We must continue to earn it. If we are to take advantage -- "in" or "out" -- of the
opportunity that the euro will bring, then we must be technically well prepared.
We will be.
There is increasing evidence that financial institutions in the UK are now taking the steps
necessary to ensure that they are ready for the introduction of the euro, whether or not the UK joins
EMU. In the early summer, we invited a representative sample of firms to confirm whether their
preparations were on track. The response we received was broadly reassuring, though some of their
preparations are dependent on decisions about the euro markets which have yet to be taken, as I shall
explain in a moment. But the key point is that the urgency of the need to prepare is now widely
recognised.
The Bank of England is playing a substantive role in the preparations in two
complementary ways. Through our very active participation in the work of the EMI, we aim to make sure
that the design of EMU, at least so far as the operations of the ECB are concerned, is capable of being
delivered in a technical sense. That is the test that we have applied, for example, to the work of the EMI
on the implementation of monetary policy and on the so-called changeover scenario. John Townend
talked about this yesterday.
Our other role is to co-ordinate the preparations for the introduction of the euro in the
City of London, to the extent that co-ordination is required. The Bank's role in helping the financial
sector to prepare for the euro was recognised and reconfirmed by the Chancellor this summer when he
launched his complementary initiative to begin preparing the business community for the euro. In
addition to making our own internal preparations at the Bank, we play a co-ordinating role in the
financial community in three main ways:
First, our job is to ensure that the necessary infrastructure is developed in the UK to
allow anyone who wishes to do so to use the euro in wholesale payments and across the financial markets
in London from the first day of EMU.
Second, we aim to promote discussion between the EMI, national central banks and
market participants across Europe about practical issues on which the market is seeking a degree of
co-ordination.
And third, we provide information: for example, through our quarterly series of editions
on Practical Issues Arising from the Introduction of the Euro, which is distributed to around 32,000
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recipients across the City and beyond, including 4,000 directly abroad. And following the successful
symposium we held early this year, we are planning to hold a further symposium, next January at the
Bank, on London as the international financial centre for the euro. Our theme will be: 'London will be
ready'.
I shall now turn to the steps that we are taking to ensure that London will be ready for the
euro, whether the UK is "in" or "out".
(i) Payments and settlement infrastructure for the euro
First of all, the payments and settlement infrastructure. We are constructing payments
arrangements in euro in London which we intend to be at least as efficient and cheap as anywhere else in
Europe, even if the UK stays "out". In the UK, the real-time gross settlement system which came into
operation in the spring of last year is being developed so that it will operate in euro. If the UK joins, the
UK sterling system will effectively become a euro system. And, in case the UK is "out", a parallel euro
system is under construction to sit alongside the sterling system: it will enable the members of CHAPS
to process euro payments as a foreign currency within the UK and across borders within the EU, through
its link to the pan-European RTGS system -- TARGET -- which is being developed.
The idea behind TARGET is to link together in euro the national RTGS systems of EU
Member States so that large-value payments can be made or received between Member States throughout
the EU area, with finality in real time, in exactly the same way as they can at present be made and
received within Member States with national RTGS systems denominated in their own national
currencies. One of the main purposes of TARGET is to support closer European economic and financial
integration by reducing the risks in pan-European payments -- just as national RTGS systems reduce the
risk in national payment systems. The other main purpose of TARGET is to integrate the euro money
market so as to ensure that the same short term euro interest rate -- determined by the single monetary
policy of the ECB -- prevails throughout the euro area. TARGET is a project which we strongly support.
It has been agreed that all EU Member States may connect their national RTGS systems
to TARGET, whether or not they join EMU. The main policy issue outstanding concerns the terms on
which the European Central Bank will grant intraday credit to the "outs". We see no monetary -- or
other -- grounds for any discrimination against the "outs". If intraday liquidity to the "outs" were to be
restricted the effect would be to increase the cost of using TARGET, and to damage the efficiency of the
system for both "ins" and "outs". That would simply divert euro payments to alternative mechanisms,
including correspondent banking and the EBA's net end-of-day settlement system. It would be unlikely
significantly to deter the international use of the euro -- if that were the objective -- any more than lack of
direct access to national RTGS systems deters the international use of the dollar or yen or Deutsche Mark
now. Its main impact would be to make intra-European payments less secure. We would regret that.
Besides payments systems, the preparation of securities settlement systems for the
introduction of the euro is a complex task in its own right. One of the reasons for this is that there are
different approaches to securities settlement between different Member States and financial institutions.
Another is that different approaches may be required to meet issuers' requirements for re-denomination.
Even in one market in one country, the introduction of major changes in securities settlement systems
can lead to teething problems, both in the central IT infrastructure and for individual institutions as they
learn how to apply the changes. Yet in the case of EMU, a number of Member States will switch to the
euro more or less simultaneously at the start. That carries considerable risks of confusion and error,
unless there is an extensive programme across Europe to explain the changes required in detail first. This
is not of course, a particular problem for the UK.
(ii) Market framework for the use of the euro
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The second important aspect of preparation is the development of a comprehensive
market framework for the use of the euro in London. The euro regulations help to provide the legal part
of the framework as I understand you discussed yesterday.
To make sure that the euro market in London, as elsewhere in Europe, is as deep and
liquid as possible, we also need to harmonise market conventions on new issues of securities in the euro
money and bond markets, and conventions in the foreign exchange markets. Market associations now
agree on the basis on which conventions in these markets should be harmonised, and the Bank has
encouraged their initiative. The problem has been to see how EU-wide decisions will be taken.
Harmonised practices may develop spontaneously in the markets, but there is no guarantee of this. So it
is very helpful that the EMI Council decided with our encouragement in September to 'welcome and
support' harmonised market conventions on the basis proposed by the market associations. We also
welcome the EMI Council's decision in September to prepare for the computation by the ESCB of an
effective overnight reference rate for the euro area.
There remains however a good deal to be done everywhere -- in co-ordinating price
sources, for example, as methods of redenomination. But in all of these respects London is well up with
the game.
Conclusion
Mr. Chairman, it is sometimes suggested that a perceived threat to its activity if we were
"out" will cause the City to press for early UK membership of EMU, and that this will be an important
factor in the Government's decision. I am bound to say that I see very little sign of this. Certainly there
are those in the City who advocate our early participation, but there are equally those who are more
hesitant -- just as opinions are divided elsewhere within the country. But for the most part, my
impression is that City attitudes to EMU, whether for or against, reflect a broader assessment of the
respective pros and cons for the country as a whole rather than strong views about the implications for
the City in particular. On the whole I find that City opinion is relatively optimistic about its future
prospects, "in" or "out". And, provided we do indeed operate within a co-operative framework, and
provided we are indeed well prepared, the City has good reason to be optimistic.