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Political Realignment and Realpolitik in the European Union

29 June 2016 | Philip Ammerman

David Cameron's "last supper" with his European counterparts exposed the underlying political realignment in Europe, with Angela Merkel and other leaders asserting national self-interest in the wake of Brexit. had this to report:

Asked by POLITICO if leaders considered the possibility that the U.K. may opt not to to set the separation process in motion, Merkel responded: “We didn’t discuss the possibility. I don’t consider it possible. The referendum is reality … I assume the [withdrawal] notice will be submitted.”


Dutch Prime Minister Mark Rutte described the referendum outcome as “a fact and we have to deal with this fact.”

Note the German insistence on Brexit, despite the political crisis and buyers remorse so clearly taking place there.

What is occurring now is a massive political realignment within the European Union as leading countries revert to realpolitik and seek to maximise their positioning.

Germany is already the leading macro power in Europe. A British withdrawal consolidates this position. Germany will now be pressing to relocate key financial industry functions from London to Frankfurt and Berlin. At stake are the daily 2 trillion-Euro settlement and repo markets in London, but also the relocation of hundreds of private equity funds, VC firms and other investors. France has exactly the same priorities, for Paris.

I anticipate three policy initiatives from France and Germany:

  1. The Euro clearing / settlement process and ECB repo contracts will be moved into the Eurozone, most likely to Frankfurt, by regulatory decree.

  2. British banks will no longer be passported within the EU, but will have to set up fully-owned and capitalised subsidiaries within the EU, and likely within the Eurozone.

  3. European institutions headquartered in London will be transferred to EU Member States.


Euro Clearing and Repo Business

While registered in an EU Member State, UK banks and other financial institutions dominated the Euro clearance and settlement system. There are approximately € 2 trillion in Euro-denominated derivatives and repo contracts that are settled, cleared and traded in London every day.

This business is now in doubt. The Financial Times expressed this in a June 25th article:

Up to now, most global banks have done business in the EU by setting up regulated businesses in the UK and using their right to “passport” into the rest of the 28-member bloc. London also serves as a major centre for clearing and settling trades involving EU securities.


On Saturday, France’s central bank governor François Villeroy de Galhau made clear that is no longer going to work. “If tomorrow Britain is not part of the single market, the City [of London] cannot keep this European passport, and clearing houses cannot be located in London either,” he said.

This was also clearly stated in a Reuters article on 1 April 2016, long before the Referendum:

According to euro zone central bank officials, the ECB is determined to tackle an anomaly dating from 1999 when Britain opted out of the euro's launch: a dominant share of trading in the currency it issues goes on outside its jurisdiction in London.


Euro zone officials are reluctant to discuss publicly such a sensitive issue - and the risk that London could lose out to rivals Frankfurt and Paris - before the June 23 referendum on a British exit from the European Union.


But Christian Noyer, a former ECB vice president and Bank of France governor, is free to make the case as he no longer holds a high office in the euro zone.


"If Britain left the EU, the euro area authorities could no longer tolerate such a high proportion of financial activities involving their currency taking place abroad," he said.

"It is already very difficult for euro members to accept that our currency is largely traded outside the currency area, beyond the control of the ECB," Noyer wrote in an article for economic think tank OMFIF.


Losing European Institutions

A smaller but equally important competition will be held to see who can take over the European Institutions currently hosted in London.

At stake are the European Banking Authority, headquartered in Canary Warf, and the European Medicines Agency, also headquartered in London.


The Scottish Endgame

Following Brexit, it is highly likely that Scotland will receive a much warmer reception for its own independence Referendum, and EU entry. Why?

  1. Because a Scottish exit from the UK weakens the UK, while confirming the basic attractiveness of the European Union from a realpolitik perspective. This also provides validation to European leaders that the European project remains vital.

  2. Because Scotland has a developed economy and an established legal system which enshrines EU law. The costs and timeline for harmonisation and accession will be limited. Scotland is already a European Union country in nearly all respects.

Until Brexit, it was held impossible that Scotland would join due to a Spanish veto. The idea what that Spain would veto a Scottish EU entry because it did not want the risk of a Catalonian independence and EU entry. It is now highly likely that, following the UK's exit from the European Union, Spain's fears are most simply solved by striking a deal with Scotland that, should Catalonia declare independence and seek to join the EU, Scotland will veto any Catalonian application. This will be an irrevocable condition for Spanish approval.

I therefore believe that it is only a matter of time before Scotland holds a second referendum, becomes independent and joins the European Union as a new Member State.


A Closer European Union

As a result of Brexit, the process of European integration will continue, at least in purely legal and regulatory terms. There have been a large number of articles and opinion that “EU integration is dead”. I do not believe this is so:

  1. Germany, France and other key EU powers now need to accelerate their own decision-making in order to safeguard their domestic political legacy. They will be able to do this without major disruptions, Marine Le Pen and Geert Wilders notwithstanding. Any other referenda on EU Membership are likely to be defeated in Parliament or in the popular vote.

  2. I do believe that further EU expansion will now be on hold, particularly for countries like Turkey or Ukraine. This does not apply to an independent Scotland.

  3. Even in the UK, there are few perceivable and clearly-quantifiable benefits to an EU Exit that are not outweighed by the opportunity costs of exit, or by operating within the existing system.

Much has been made about “punishing” the UK for its Referendum. Sadly, I believe this will take place. We have seen the same attitude by the leading European powers vis-à-vis Ireland, Greece and Cyprus. I fully anticipate seeing the same treatment of the UK, despite the fact that it is a larger country. External observers consistently underestimate the extent to which European powers will go to protect their system.


Political Domination

On a longer timeline, the EU is clearly facing major problems. These include declining national competitiveness and demographic pressure. They also include apparently disastrous educational outcomes, judging by how easy it was to influence “Leave” voters in the British Referendum.

The EU is now clearly driven by a single power, Germany, much as the Delian League was dominated by Athens in from 470 BC onwards.

France and the UK were useful counterweights. Absent radical reform, France appears to be headed for economic stagnation and collapse. And the UK has just left the European Union.

Italy, Spain and Poland are large economies, but face significant internal economic and demographic challenges, or risk becoming economic satellites of Germany.

With Brexit, what we see now is the consolidation and monopolisation of power even further within the European Union. This does not bode well for the future. But it is likely an irreversible process.


Philip Ammerman

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