The unprecedented financial sanctions imposed on Russia after its invasion of Ukraine have not had quite the devastating impact on the Russian economy that some predicted. But they are still expected to lead to a lasting shift in the international financial order.
The freezing of Russia’s foreign exchange reserves and the exclusion of key Russian banks from the SWIFT messaging network has sent a clear message to other countries — if you fear that one day you will be subject to US sanctions, you might consider reducing your dependence on the Western financial system.
Much of the commentary on this prospect has focused on the threat to the global dominance of the US dollar. But it could also have profound implications for international trade in financial services. As the world’s biggest exporter of financial services, the City of London should be particularly concerned.
It is hard to know how significant the shift will prove in practice. But some leading financial figures see it as a game changer. “The weaponisation of financial services is a very, very big deal,” Jane Fraser, chief executive of Citigroup, told the recent Milken Institute Global Conference. “Every client I talk to around the world is talking about it.”
She said that clients in emerging markets “don’t trust the Western financial order to put all their eggs in that basket”. As a result there will be a move to alternative venues and emerging economies will look to accelerate the development of their own capital markets, said Fraser.
That will clearly pose a challenge to the likes of Citigroup. It could be an even bigger threat to the City.
About a quarter of the UK’s financial services exports go to markets in Asia, the Middle East and Latin America. A third goes to the US and another third to the EU. The City’s Brexit supporters have argued that growth prospects in countries such as China, India and the Gulf would more than make up for any loss of exports to the EU. But those are precisely the countries that are now worrying about their dependence on the Western financial system.
The scope for increased cross-border financial services sales into emerging economies already looked limited, according to trade experts. National regulators have become increasingly reluctant to allow more activity to take place outside their own jurisdiction.
If countries now focus on developing their domestic capability, as Fraser suggests, selling services from the UK will become even more difficult. Sales by UK firms through local operations may be more resilient, but these are less economically beneficial to the UK than cross-border sales.
Moreover, countries seeking to become less dependent on the Western financial system will presumably be less interested in investing in the City. Inward investment in financial and professional services has been a great success story for the economy in recent years, with the UK attracting 114 projects worth £1.1bn in 2021, coming second only to the US.
Many experts predict the Ukraine war will accelerate a process of deglobalisation as countries and businesses seek to reduce their dependence on far-flung supply chains in areas of high geopolitical risk. One possible outcome is the fragmentation of the global system into a number of regional blocs including the US, the EU and Greater China.
In financial services, this possibility is highlighted by the pressure for the break-up of HSBC. Chinese insurer Ping An, the bank’s largest shareholder with a 9% stake, is reported to be calling for HSBC to be split into its Asian and Western interests, which would make the businesses less vulnerable to future sanctions from either side.
If the world does fracture into blocs, with reduced trade between them, it would make Brexit even more unfortunate for the City. Within the EU, the City was the undisputed financial centre of one of those blocs. Now those in the EU trying to grab City business can cite recent events and argue, however spuriously, that the bloc needs to reduce its dependence on a financial centre over which it has no control to ensure greater security and resilience.
All of which underlines the importance of the UK’s financial services trade with the US. In the first nine months of 2021, strong growth in US sales increased UK financial services exports to non-EU countries by 5% while exports to the EU slumped by 16% compared with the 2017-20 average, according to the UK Trade Policy Observatory at the University of Sussex.
Three years ago, Boris Johnson talked of improving access to US financial services markets for UK companies. But now the prospect of anything significant happening any time soon looks extremely remote. In line with the global mood, President Biden has embraced much of the economic nationalism of his predecessor, Donald Trump. The City will be hoping that Biden’s new Buy American drive does not extend to bond underwriting.
To contact the author of this story with feedback or news, email David Wighton