London’s Bridge is Falling Down

New York & London. Two cities of monumental financial power that hyper-accelerated the global meltdown. Home of the rogue traders, the mysterious derivatives, mega-funds, the trader-cowboys and the largest financial centers on earth. And two symbols of financial excess that have drawn the ire of the rest of the world for obvious reasons. Among two major currencies on earth, neither the British pound sterling nor the dollar is faring particularly well. Deficits are soaring, and the powerful and well-funded lobbyists are using their massive war chests to resist any wholesale rewriting of financial regulations that might restrain a repeat of the recent past. The UK has at least taken steps to tax the excess bonuses payable and paid to financial players at all levels, this after much the same rescue effort (as mounted by the U.S.) by the British government.

I’ve trashed my own nation’s ungrateful and insensitive financial institutions, but it is equally interesting to examine the mounting pressures in England to reign in a financial market gone wild. The stage is set for a showdown – you see the UK has another master to serve and cannot simply set the financial rules for itself. As a member of the European Union, even though it has elected to retain its own currency at the expense of using the Euro and thereby has sidestepped some of the regulatory issues, Britain must accept the overall financial regulations imposed within the EU. And the Continent is bubbling and broiling with hostility for the London market.

First, it is important to recognize the scope and impact of the London-based financial markets. 70% of Europe’s major financial transactions flow through London at some level or another. The December 28^th TheDeal.com” “About 80% of EU hedge fund activity is managed from London, as is 60% of EU[‘s large private equity funds]. Yet Britain's rivals would like nothing more than to see the City cut down to size… Now that London, New York and the offshore islands that host their fund industries have shown that barely regulated ‘Anglo-Saxon’ capitalism can destroy wealth as well as create it, a tightly regulated, socially responsible European capitalism is seen as the superior model.”

There has always been hostility, rivalry if you will, between two particular segments of the European marketplace, nations with profoundly different national sensibilities: England and France. The Brits see an over-regulated, socialist menace across the Channel, and the French see boorish bullies ready to use money to force their way in the world. To France, this moment represents an opportunity for a little comeuppance. The fact that the new EU commissioner for the internal European market is a Frenchman, Michel Barnier, with regulation on his mind suggests that the UK is in for a battle, you’ll excuse the expression, royal. The Brits took their eye off the ball, emphasized other priorities of involvement in the EU, and let this clearly anti-UK regulator into a job that will impact the London financial markets like no other.

The press for regulation was already steaming through the EU parliament. “The Alternative Investment Fund Managers’ Directive, now passing through the EU's legislative process, with parallel discussions in the European Parliament and among the 27 member states, seeks to regulate EU-based managers of hedge, private equity and venture funds that are either domiciled or marketed within the EU. The directive demands greater transparency and disclosure, independent valuation of assets and regulatory oversight of fundraising outside the manager's home country… Unfairly, in the eyes of [private equity] players, it excludes sovereign wealth funds [funds that are managed by national governments], family endowments, individual billionaires and non-EU alternative funds, if the latter do not market to investors in Europe. All of these players will be able to invest in EU assets at a lower cost than their regulated brethren. Yet -- as Dubai has shown -- sovereign funds could themselves pose systemic risks to the world economy… The commission estimates the legislation would catch about 30% of hedge fund managers, managing almost 90% of the assets of EU-domiciled funds. It will also affect about half of PE and other fund managers.” TheDeal.com

While this new wave of regulatory frenzy will impact anyone with a European presence, and that embraces American funds as well, the clear target is the London market, traders who are covered on every transaction simply because of their location. Will they move to other countries – very difficult and inconvenient, follow the directives while squealing down the line, or rail in other less-than-supportive ways? British banks are barely able to contain their envy at their U.S. counterparts who have managed to sabotage the most serious efforts of regulation in the States with highly effective lobbyists and even more effective campaign dollars. But wait, it gets worse.

According to the January 8^th Wall Street Journal, "Big Deficits Cloud Britain's Future" as their national deficit looks as if it will consume a staggering $280 billion, representing approximately 12.5% of their Gross Domestic Product. Hey, we're not doing too well either in this department, but at least we are better off with a deficit that represents only 9.4% of our GDP (the wider European Union is at 6.9% of GDP). Bottom line: even as the U.K.'s financial sector is pushed down by the EU regulators, there isn't going to be much in the way of new local government spending to pick up the slack; they won't have the money. As the U.S., Japan, France and Germany saw a tiny movement of growth at the end of 2009, Britain contracted still, "making it the last of the Group of 20 developed nations to leave the recession." (WSJ)

For London, the writing is on the wall: “In the new EU configuration, the free-trading, free-market nations seem to have lost the economic portfolios to more corporatist and mercantilist rivals. British Prime Minister Gordon Brown wanted to make a mark in foreign and security policy but likely made a huge strategic error in failing to push for an economic job for the U.K. As a result, Britain will shout angrily from outside the euro currency zone -- and continue to shoot itself in the foot every time it reminds Europe of the importance of British financial services. Private equity losses are just collateral damage.” Will New York be the last mainstream refuge in the Western World for the rogue trader? Time will tell.

I’m Peter Dekom, and “s@%t” happens.