One of Germany’s most senior banking regulators has warned London that it is likely to lose its role as "the gateway to Europe" for vital financial services.
Dr Andreas Dombret, executive board member for the German central bank, the Bundesbank, said that even if banking rules were "equivalent" between the UK and the rest of the European Union, that was "miles away from access to the single market".
Mr Dombret’s comments were made at a private meeting of German businesses and banks organised by Boston Consulting Group in Frankfurt earlier this week.
They give a clear - and rare - insight into Germany’s approach as Britain starts the process of leaving the European Union.
And that approach is hawkish. "The current model of using London as a gateway to Europe is likely to end," Mr Dombret said at the closed-door event. Mr Dombret made it clear that he did not support a "confrontational approach" to future relations between the UK’s substantial financial services sector and the EU. But he argued there was "intense uncertainty" about how the Brexit negotiations would progress and significant hurdles to overcome.
The Bundesbank executive, who is responsible for banking and financial supervision, said he was concerned that the trend towards internationally agreed standards was under pressure.
And that Britain might try to become the "Singapore of Europe" following Brexit, by cutting taxes and relaxing financial regulations to encourage banks and businesses to invest in the UK.
’Race to the bottom’
"Brexit fits into a certain trend we are seeing towards renationalisation," he said.
"I strongly believe that this negatively affects the well-being of us all. We should therefore invest all our efforts in containing these trends. This holds for the private sector as well as for supervisors and policymakers in the EU and the UK.
"Some voices are calling for deregulation after Brexit," he continued. "One such example is the ’financial centre strategy’ that is being discussed as a fallback option for the City of London. Parts of this recipe are low corporate taxes and loose financial regulation. We should not forget that strictly supervised and well-capitalised financial systems are the most successful ones in the long run. The EU will not engage in a regulatory race to the bottom."
At present, London operates as the financial services capital for the EU. More than a third of all wholesale banking between larger businesses, governments and pension funds takes place in Britain.
Nearly 80% of all foreign exchange transactions in the EU are carried out in the UK.
The business is valued in trillions of pounds, with billions of pounds being traded every day to insure companies, for example, against interest rate changes, currency fluctuations and inflation risk. If there were significant changes to the present free-trading relationship between Britain and the EU, that could have a major impact on the value of the financial services to the UK and on the one million people employed in the sector.
Mr Dombret said it would also have an impact on German businesses which use London as a source of funding.
Some banks are hoping that, with the government looking to fully leave the single market, an "equivalence regime" can be agreed where the UK and the EU recognise each other’s regulatory standards.
That would allow cross-border transactions to continue with few regulatory hurdles.
But Mr Dombret said that equivalence had "major drawbacks" and was not an "ideal substitute".
"I am very sceptical about whether equivalence decisions offer a sound footing for banks’ long-term location decisions," he said.
"Nevertheless, I also expect many UK-based market participants to move at least some business units to the EU in order to hedge against all possible outcomes of the negotiations. I am very sceptical about whether equivalence decisions offer a sound footing for banks’ long-term location decisions," he said. "Equivalence is miles away from single market access". Equivalence decisions are reversible, so banks would be forced to adjust to a new environment in the event that supervisory frameworks are no longer deemed equivalent.
"These lead to the overall conclusion that equivalence decisions are no ideal substitute for passporting [which allows banks in one EU country to operate in another as part of the single market]."
Whatever the arrangements, Mr Dombret said that a "transition period" would ease the pressure of change and reduce what he described as the "earnings risk".
"Let me say that I expect London to remain an important financial centre," Mr Dombret told the audience.
"Nevertheless, I also expect many UK-based market participants to move at least some business units to the EU in order to hedge against all possible outcomes of the negotiations."
One of the biggest EU-focused businesses in the UK is euro-denominated clearing - insurance products called derivatives, which allow companies to protect themselves from movements in currencies, interest rates and inflation.
Three-quarters of the multi-trillion-pounds-a-day market is executed in London and a recent report from the accountancy firm EY estimated that nearly 83,000 jobs could be lost in Britain over the next seven years if clearing has to move to an EU member state following Brexit.
Mr Dombret said it was difficult to see how euro-clearing could remain in London, as it depended on the "acceptance of the European Court of Justice" as the arbiter of the thousands of legal contracts signed between counter-parties, many of which last for years.
Britain has made it clear that it does not want to be bound by ECJ judgements once it has left the EU. "I see strong arguments for having the bulk of the clearing business inside the euro area," Mr Dombret said.