By: Hteik Tin Min Paing, Rachele Foo
Research Head: Mrunali Doshi
Editor: Sakshi Sanganeria
Illustration by Ka Ling Abstract This article discusses the short-term and long-term impacts of Brexit on the UK’s financial sector. Amidst the uncertainties involved in the negotiation process between the UK and the EU which was given a deadline until the end of 2020, this article looks into each possible scenario and gives insights on the outcomes, challenges and opportunities.
On 31st January 2020, the UK officially left the EU. Since the first voting in 2016, Brexit has caused a great amount of uncertainty in the UK. Even now, the uncertainty continues. 1. Overview of the financial sector in the UK The financial sector in the UK contributes significantly to the economy. In 2018, the sector generated £132 billion making up 6.9% of the UK’s total economic output (Rhodes,2019). Furthermore, financial services is also the UK’s largest service export which generated£60 billion in 2017, with 43% of these exports going to the EU (Rhodes,2019). This also shows the importance of the free trade between the UK and other EU states to the financial sector. This sector provides 1.1 million jobs which makes up 3.1% of total jobs in the UK(Rhodes,2019). Out of the 1.1 million, around 7.5% of the workers are from the EU (Jones,2018). 2. Loss of Passport Rights The largest problem that Brexit could bring to the financial sector would be the loss of passporting rights. Currently, financial companies located in the UK be it local or foreign, have passporting rights which allow firms to trade freely across the European Economic Area (EEA). Until 31 Dec 2020, which is the end of the transition period, firms will still enjoy passporting rights (Bank of England, 2020). However, what will happen after that is still uncertain. About 5,500 firms in the UK currently have passporting rights (Arnold,2016). It is estimated that if the UK does not manage to secure passporting rights or any equivalent, 20% of revenues in capital markets and investment banking will be lost (Arnold,2016). Furthermore, without passporting rights, the UK loses its attractiveness as a financial centre. Firms based in the UK would have to set up subsidiaries in other EEA states to get a license and if other states could serve the same purpose as the UK, the firms could simply move their operations there. Some banks have already started and completed their move which led to a transfer of jobs from the UK to the other states. For example, the Bank of America had already completed its move from London to Dublin and would move up to 400 jobs to the EU (Reuters,2018). According to a Reuters survey, there could very possibly loss of 10,000 financial jobs in the UK in the next few years (MacAskill, Jessop & Cohn, 2017). Additionally, trade between the UK and the EU, which made up 43% of financial services exports, will fall. When the UK joined the EU, it led to the openness of trade increasing from 40% to 55%(Campos and Coricelli, 2015). Hence with the loss of passporting rights, the openness of trade will decline- leading to a fall in export revenue of financial services.
There is also likely to be a fall in Foreign Direct Investment (FDI) to the UK. As the financial services sector is one of the biggest recipients of the FDI to the UK, with a fall in FDI in general, the financial sector will definitely suffer too. It is estimated that with EU membership, FDI would increase by 25%-30% (Campos and Coricelli, 2015). Hence, with the loss of the benefits of the membership, mainly passporting rights, it is predicted that Brexit would lead to a fall in FDI by 22% (Dhingra et al, 2016). With lower investment, the financial sector would definitely face lower growth. Furthermore, with the shrinking of the financial sector in the UK, the sector might suffer from the loss of talents. With companies creating more job opportunities in other EU states, as well as the likelihood of slowing growth in the financial sector, job prospects in UK’s financial sector willfall. Additionally with the new immigration rules, to obtain a visa to work in the UK, many conditions must be met. This could make the process more complicated and certain highly skilled individuals who might not meet the requirements due to certain situations would not be able to work in the UK. This could make non UK citizens, especially those from the EU which made up 7.5% of the sector, to find jobs in the EU or elsewhere. Hence, Brexit could lead to the financial sector in the UK losing its importance as growth declines and talents move elsewhere. 3. Long Term Vantage The EU is one of the largest financial markets for UK’s financial services providers. In 2018 alone, total financial services exported to the EU stood at 26.1 billion pounds while the financial services imported from EU was at merely 6.1 billion pounds (Ward, 2018). The overall size of the EU market contributes to the UK around 41% of total financial services exports in 2018 ("UK Trade in Numbers", 2020). Once the largest single market for the UK, it has a higher bargaining power and is now in a position to challenge the UK’s financial hub which will have some long-lasting impacts on the UK’s financial sector. 4. Limited Access to the EU’s Financial Markets Businesses will no longer be the same as usual since the UK was given a deadline until the end of 2020 to prepare for the departure from EEA (European Economic Area) which will revoke the passporting rights for the UK’s financial institutes. In order for the UK to continue its passporting rights to get continuous access to the single market, it has a few options to choose from. However, each option only creates more unfavourable terms for the UK and the prospect of gaining access to the single market remains low. Firstly, the UK could opt for an option called the European Free Trade Association (EFTA) which is also known as Norway model. Being a member of EFTA grants the rights to join EEA again which will continue the passporting rights for the UK’s financial sector. However,
the option is impossible for the UK as it will have to allow free movement of people for all the 30 members of EEA as one of the conditions to be a member of the EEA (Carswell, 2018). Alternative best shot for the UK is to go for the equivalence regime in which the UK will bear the responsibility to prove that the UK’s financial regulations are at the standard of equivalence with Brussels’. However, it is impossible for a third country outside the EU to be granted such a right. Therefore, the equivalence will most likely be a selective equivalence such as the UK’s clearing houses or only a short-term equivalence. In both cases, the EU will no longer be the land of the single market for the UK’s financial institutes. 5. Future of London Stock Exchange As the UK government tries to close the deal on the equivalence, chances are that if the agreement is only for selective financial institutes, both sides will preserve the right to come out of agreement with only 30 days’ notice. This would be painful for the London Stock Exchange as it requires three months’ notice from its clients to terminate the contract ("Rules of the London Stock Exchange", 2019). If the equivalence right were to be extended to other financial sectors, every financial institute and business under those sectors will bear the brunt of it. That means less and less companies listing on London Stock Exchange due to the probability of imminent contract termination which will leave them unprepared if it happens. 6. Capital Raising and Liquidity for the UK’s Businesses in the Long-run On the other hand, if the equivalence regime is granted for a short period of time, there will be further problems for businesses in the UK that are looking to raise capital on Stock Exchange. One case example could be taken from what happened to Switzerland’s equivalence rights with the EU in 2019. As the Swiss government agreed to the rulings from Luxembourg judges which demanded that the EU citizens in Switzerland be given labour market benefits, both countries found themselves unable to progress further to extend the equivalence regime and as a result brought the agreement to an end (Khan, 2019). This further stresses the issue of unpredictable political agreements which arise from the equivalence regime, and lead to repercussions, if one side fails to oblige. One long-term effect of it would be the businesses having lesser options to raise capital, which in turn will affect their liquidity and the economy of the UK as a whole. 7. Paris- The Next Financial Hub of Europe? After London, the next largest financial sector of Europe is Paris with around 180,000 employees. Given that the road ahead for the UK and the EU is complex and unpredictable, the EU now has the opportunity to build up the next financial hub for Europe. Businesses are enticed to move out of London and into one of the EU countries as setting up a financial unit in the EU will automatically grant the right to operate in the rest of the member countries..
Since the announcement of the UK leaving the EU, JPMorgan has purchased another building in Paris which could house up to 450 employees to avoid any potential disruption related to Euro trading operations due to Brexit in future. Likewise, Bank of America opened another trading floor in Paris and HSBC moved 1000 jobs to Paris from London. Apart from the investment banks preparing themselves to prevent any undesirable outcomes from post- Brexit negotiation, one most significant blows to the UK was the shift of European Banking Authority (EBA) from London to Paris in 2019 which gave Paris an advantage invying for the throne (Coppola, 2019). President Emmanuel Macron of Paris has a plan to cut corporate tax to 25% in 2022 and completely remove wealth tax on financial assets in order to attract more financial institutes from London. As of FY 1 January 2020, the corporate tax stands at 28% for the first 500,000 profit before tax and 31% afterwards. The first cut of 1.5% is expected to happen in January next year and another 1.5% in 2022 ("France: Corporate tax provisions enacted in Finance Law for 2020", 2020). All in all, Paris is in a very good position to become the next financial hub of Europe- and it is starting by setting more favourable tax regimes for corporations. 8. Future Outlook The most likely outcome will be that Britain will not be able to close any deal that is as efficient as EEA. The single market rights will be granted only for either specific sectors of the financial industry or for a specific amount of time. Challenges and limitations come with each option and it is in the UK’s interest to get the most favourable deal out of the negotiation for its financial sector. On the other hand, the threats coming from France to take the throne of Europe's financial hub will give the EU a better bargaining position, and therefore, the UK needs to focus on strengthening its financial sectors more than ever. Furthermore, as the businesses have become more digitalised, the reliance on physical contact to provide financial services has become minimised, and therefore, potential threats from Hongkong, Singapore and New York should also be expected. However, every challenge comes with an opportunity and it is now in the UK’s best interest to build good financial diplomacy with foreign markets like Hong Kong and Singapore by influencing financial regulation and supervision at the international level- as it has previously done so with the EU through Treasury officials (Boleat, 2018).
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