Speech by Ian Plenderleith, Executive
Director, Bank of England
At a conference organised by the
International Center for Monetary and Banking Studies on The International
Monetary System after the Decision on EMU in Geneva on Friday 7 November
1997
London as a Financial Centre After EMU
I am very grateful for the invitation to speak at this distinguished conference.
I am asked to address my remarks to the outlook for financial centres after EMU, and I shall speak principally about the London financial centre. But in doing so, I want to make clear that I focus mainly on London not out of any sense of any chauvinism, nor because the British are in some way incurably Anglo-centric, but because London is the principal financial centre for the European time zone as a whole and, as importantly, is par excellence an international financial centre - the location for market participants and financial institutions from all round the world. So in looking at the impact of EMU on the London markets, I hope to be able to illuminate ways in which EMU will affect the development of the international financial system as a whole.
It is precisely because London is an international financial centre that we have for some time recognised that EMU, and the birth of the euro, would have a significant impact on the wholesale financial markets in London, whether or not the UK was in EMU at the start. And until very recently, that proviso - "whether or not the UK was in EMU at the start" - had to govern our planning and preparations for the euro. But in the UK Government's statement on EMU last week, we now have a very clear account of UK policy in relation to the monetary union, and I would like to begin by reminding you of the main conclusions of that statement.
The Government's conclusions on EMU
The Government's conclusions, as the Chancellor of the Exchequer set them out in his statement to Parliament on 27 October , began by addressing three issues of principle. It concluded first that, in principle, a successful single currency within a single European market would be of benefit to Europe and to Britain. Second, to share a common monetary policy with other Member States represents a major pooling of economic sovereignty; but, while this constitutional issue is a factor in the decision, it is not in the Government's judgment an overriding one. Rather it signifies that in order for EMU to be right for Britain the economic benefit should be clear and unambiguous. If, in the end, a single currency is successful, and the economic case is clear and unambiguous, then the Government believes Britain should be part of it. There is a third issue of principle, namely popular consent, which the Government has reiterated will be tested through a referendum.
The UK Treasury has published its assessment of five economic tests that define whether a clear and unambiguous case can be made for the UK to join EMU. These are: whether there can be sustainable convergence between Britain and the economies of a single currency; whether there is sufficient flexibility to cope with economic change; the effect on investment; the impact on the UK's financial services industry; and whether it is good for employment.
Applying these five economic tests leads the Government to the following clear conclusions. British membership of a single currency in 1999 could not meet the tests, so that joining at the start of EMU is not in the country's economic interests. The Government will therefore be notifying our European partners, in accordance with the Maastricht Treaty, that we will not seek membership of the single currency on 1 January 1999. The Chancellor emphasised that there is no need - legally, formally or politically - to renounce our option to join for the period between 1 January 1999 and the end of the current Parliament; nor would it be sensible to do so. But he concluded that, barring some fundamental and unforeseen change in economic circumstances, making a decision during this Parliament to join is not realistic. It is therefore sensible for business and the country to plan on the basis that, in this Parliament, the Government does not propose to enter a single currency.
However, the Government has said that if a single currency works and is successful, Britain should join it. The Government believes that we should therefore begin now to prepare ourselves so that, should the economic tests be met, a decision to join a successful single currency can be made early in the next Parliament. In order to facilitate this, both the Government and business must prepare intensively, so the Government will:
- first, commence work on the detailed transition arrangements for the possible introduction of the euro in Britain, including the introduction of notes and coin, should we wish to enter;
- second, step up the work on what business should do now, to prepare for the introduction of the euro in 1999;
- and third, work with business on what Government must do to prepare for EMU, should it decide to join in the next Parliament.
To help with the essential preparations, the Chancellor has invited the Governor of the Bank of England and the heads of the two main bodies representing industry and commerce, and two other Ministers, to join him on a Standing Committee to lead the preparations for EMU.
The Governor has welcomed the Chancellor's statement on EMU , particularly the timetable set for possible UK membership and the prior conditions which will need to be met, as providing a much firmer basis on which business can now plan. The Bank will continue to work closely with the Government in preparing the country for the single currency.
Preparations for the euro in the UK markets
In the UK wholesale financial markets, practical preparations are in fact already well advanced.
We at the Bank of England have now for nearly two years been helping prepare the UK financial markets for the euro. We do this because, even though the UK will not be in at the start, it is plain that banks and financial institutions in the UK, in their wholesale business for their corporate and institutional customers, in the UK and overseas, will want to be able to offer the full range of financial facilities in the euro from the outset. They will want to be able to offer their customers deposits and foreign exchange facilities in the euro, lending and borrowing in the euro, hedging and collateral in the euro and financing and settlement facilities. The London markets will need to be able to operate in euro from the outset across the full range of their wholesale activities, and practical preparations are now well advanced to achieve that by January 1999.
The Bank of England's part in this extensive process of market-wide preparation, besides equipping ourselves internally for operations in the euro, is a co-ordinating one, 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 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 a quarterly publication on Practical Issues Arising from the Introduction of the Euro, which is distributed to around 32,000 recipients, including 4,000 directly overseas. The next edition will appear shortly, neatly timed for people's Christmas reading, and I confidently expect it to be on the best sellers' list for the festive season. 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.
This exercise - to prepare the UK markets for wholesale activity in the euro by January 1999 - has now gathered substantial momentum. Let me touch on a few of the main priorities being pursued:
First, market participants agree on the need to be able to trade in London the full range of euro-denominated instruments.
Secondly, they also agree on the need for appropriate payments mechanisms in London to carry out transactions in euro both between parties within the UK and cross-border to and from the UK.
Thirdly, efficient, cost-effective mechanisms for settling transactions in euro-denominated securities also need to be made available in London.
Fourthly, there is agreement on the desirability of harmonised market conventions for the issuing and trading of euro-denominated instruments.
Fifthly, there is agreement on the need for as sound a legal basis as possible for euro transactions, to provide legal certainty and to ensure continuity of contract.
Sixthly, there are tax and accounting issues to be addressed, related to the introduction of the euro.
There is work going on in each of these areas, and good progress on many of them. For example, on market conventions, with the Bank of England's assistance, the main international market associations, together with the two international central securities depositories (Euroclear and CEDEL), have agreed on the harmonised approach they would like to see adopted for the issuing and trading of financial instruments in the euro money, bond and foreign exchange markets. That is, essentially:
- in the euro money markets, a day count for interest calculation of "actual over 360"; spot (ie two-day) settlement; and business days to be based on when TARGET is open (ie every working day in the year except Christmas Day and New Year's Day).
- in the euro-bond markets, a day count of "actual over actual"; quotations in decimals rather than fractions; TARGET business days; three-day cross-border settlement for internationally-traded bonds; but no standardisation for annual or semi-annual coupon frequency.
- and in the foreign exchange market, spot settlement; quotations in the form of one euro for x units of foreign exchange; and central bank publication of daily closing reference rates.
The EMI has very helpfully said that it "welcomes and supports" the market associations' initiative. But to ensure that these market conventions will be applied in the market-place, continuing efforts are needed by all those involved - market associations and the authorities - to promulgate as widely as possible the desired approach in order to ensure that harmonisation becomes a reality. We will certainly be playing our part in this process.
Detailed planning of this kind is also taking place in the infrastructure and clearing systems of all the main markets in the UK; and internally within market participants' own firms. Let me give you one example - the payments system, which lies at the heart of the UK's preparations for the euro. The UK's sterling Real-Time Gross Settlement (RTGS) system is being developed to accommodate the euro, so that from the beginning of 1999 euro wholesale payments may be made in a safe, efficient and cost-effective way as sterling payments can now, even though the UK will not be a participant in the monetary union at the outset. That development remains on schedule, and it is encouraging that the UK system (CHAPS) has had expressions of interest recently from a number of overseas banks wishing to join.
The UK euro system - CHAPS euro - will allow payments to be made both between parties within the UK and cross-border from and to the UK through its link to TARGET. Using the knowledge and expertise we have acquired through developing and operating by far the largest RTGS system in Europe - with average daily volumes of some 70,000 payments, worth some £150 bn - we are contributing a great deal to the technical development of TARGET. Because it extends the benefits of RTGS systems, in reducing the risk in payments, for the first time cross-border, it is a project we wholeheartedly support.
But we also want to see TARGET as efficient and effective as possible, so that it becomes the payment system of first choice for banks, in order to maximise its benefits in reducing systemic risk. We have to recognise that TARGET will be competing with alternative euro payments mechanisms, including correspondent banking and the European Banking Association's net end-of-day settlement systems. Consistently with this view, we believe that it is essential that payments be able to flow freely throughout the TARGET system.
Why do we devote this effort for preparing for the euro? The reason is very straightforward. London's pre-eminent position as an international financial centre rests on the fact that it provides broad and liquid markets for the full range of internationally-traded currencies and for the vast array of different instruments and facilities denominated in them. The euro will undoubtedly become a major internationally-traded currency, and it is therefore certain that it will be traded extensively in the London markets. The euro thus represents an opportunity, rather than a threat, for the London markets, and it is important that the London markets prepare in good time the systems and infrastructure needed to take advantage of this opportunity.
London as a financial centre after EMU
The reason why we are convinced that the euro represents a major opportunity for the London markets relates essentially to the strengths that the London markets have displayed over the years:
- London is a global financial centre rather than just a European centre, with much of its business generated around the world, not just within Europe.
- London has always thrived on financial innovation, and has a strong track record of capitalising on new opportunities.
- The euro may very well bring greater financial activity to the main Continental financial markets. But expansion in these markets is not, on past experience, a zero sum game: it is likely to lead to more, not less, activity in London since London is the major interface with the rest of the world in the European time zone.
- The economics of financial market activity point to concentration, to gain economies of scale and facilitate better management control. That is why many firms have been moving their operations, and even headquarters, to London as the preferred financial centre. Uncertainty about UK participation in the single currency has been with us for some time. But undeterred by that uncertainty, firms have continued to concentrate their trading activities in London.
- London has an unrivalled range of markets and ancillary services; and an associated deep skill base; and an unbureaucratic approach to financial regulation, which has been developed working with the grain of the market.
All these advantages and more help to explain why there are more people working in financial services in the City of London - over 600,000 - than there are in the entire population of Frankfurt and its surrounding region!
None of this gives any grounds for complacency: the financial services industry is an intensely competitive business. But importantly, if we can harness the strengths of the London markets to the opportunity presented by the euro, I believe that will be an important contribution to the success of the single currency. Of course, London will benefit. But London is not just a UK financial centre. It is a European financial centre, and by providing competitive trading facilities in the euro London can help provide better facilities for business and industry across the whole single market and bring more business into Europe from the rest of the world.
Opportunities in euro for market participants
I have talked so far principally about the steps the authorities are taking to help prepare the London markets for the euro. But of course, at the end of the day, the authorities can only facilitate: the real challenge in seizing the opportunities presented by the single currency has to be met by market participants themselves. Let me touch on three areas where the advent of the euro is likely to usher in significant changes - but, I believe, positive changes, offering new business opportunities - for financial market participants.
First, in the bond markets , monetary union will serve to unify the various national government bond markets of the EMU participants, and the already substantial ECU bond market, into a single market in a single currency with multiple national government issuers. Currency risk will be removed, at a stroke. This does not, of course, mean that all government bonds of the different national issuers will trade at the same price: differences will still remain in trading structures and liquidity, in perceptions of sovereign risk and the scale of supply by different governments, and in investors' basic preferences. But the different national government bonds will tend to trade on essentially the same yield curve, with the focus of the market being concentrated, even more so than at present, on spread relationships.
This of course raises the interesting question - spread over what? Who will provide the benchmark issues? Moreover, the intensified focus on spread may produce two further results. First, there will be even greater incentives than at present for national governments, who will remain responsible for their own debt management, to converge in their techniques for issuing and marketing their debt. It will be interesting to see whether this will generate greater co-ordination amongst debt management authorities in managing their debt programmes, including, for example, their auction timetables.
A second effect in this area flowing from the concentration on spreads may be greater interest in developing a diversified, deeper corporate bond market in euro, as has long been present in the US, but much less so in other countries. If this happens, it could be a considerable boon to corporate borrowers as a whole because it would extend the range of financing opportunities open to them.
A second area where financial market activity in the euro is likely to generate new opportunities is in the short-dated money markets . Foreign exchange traders do clearly face some contraction in their activity, as an inevitable consequence of currency unification. But I do not expect to see too many destitute foreign exchangers miserably wandering the streets in search of charity or menial employment because of course, as trading amongst the EMU currencies disappears, new international trading is developing in a range of currencies of leading emerging market economies. But more importantly, the advent of the euro will usher in potentially much deeper markets than exist in the individual national centres at present in a range of different money market instruments - short-dated government and/or central bank paper, commercial bills, CDs, inter-bank deposits, commercial paper, repos, interest-rate futures, swaps, FRAs, options and a miscellany of tailor-made variants on these basic products. Markets in these products are of very varying depth and liquidity, where they exist at all, in the individual local-currency markets of the countries likely to participate in EMU. But all of these instruments are, as it happens, traded in London in the main international currencies; and with the advent of the euro, all of them will also, for the first time, be traded in the major European currency. This represents a tremendous business opportunity for banks and financial institutions with the capacity to trade these instruments and to harness them to the needs of their customers.
But there is a third impact on financial markets from the euro that is essentially a necessary prerequisite that must be fulfilled if the benefits from integration of the bond and money markets that I have identified are to be achieved. This is that the new single-currency, euro, markets develop trading practices and standards of conduct , and the necessary infrastructure, that will genuinely facilitate integration. In terms of infrastructure, for example, real-time, same-day wholesale payments are essential to tie together money market activity conducted in different centres in the same instrument in the single currency; and similarly, linkages may also need to be considered between different settlement systems. Common trading practices, and market conventions, will also need to be developed. The lead here lies in many cases with market participants themselves, and with the systems they have developed to serve their trading needs. But it is a process we are very familiar with in London, where we have sought when necessary to encourage just such common initiatives in order to enhance the effectiveness of international trading activity in London. And with an eye on EMU, we have encouraged trading activity in the ECU, particularly in the money markets: hence, for example, the regular programme of monthly auctions for UK government ECU treasury bills, and the quarterly auctions of UK government three-year ECU notes, which have been running for some years. Because of the international flavour of our markets, and because we are conscious that these markets will want to trade the full range of euro instruments in London, we will continue to support initiatives aimed at achieving the necessary market structure where we feel we can make a contribution.
I have tried in these remarks to set out some of the ways in which I believe EMU will open up new opportunities for the financial markets. I believe this will be particularly so for the international markets in London. We intend to be ready to take full advantage of these opportunities, right from the outset in January 1999, even though the UK will not participate in EMU at that stage. The reason for this is very simply: London is the major European financial market, and we think that extending its activity to include financial services in euro is a significant contribution we in the UK can make from the outset to the success of the monetary union and of the single European market as a whole.
