This is the final chapter of a five-part series covering Brexit’s impact on UK financial services. Click here for Part IV.
A critical assessment of the rationale behind the referendum result provides a good basis for understanding the various sectoral impacts and the UK’s options. Whilst the focus of this article has been from an economic perspective, the political impact has been inescapable. Therefore, it is necessary to understand some of the political as well as economic drivers that led to the Brexit result.
For completeness, the various schools of thoughts about the drivers of the referendum result (such as anti-immigration rhetoric) were analysed and there is limited evidence to support the view that immigration has negatively impacted employment – with an unemployment rate currently at less than 5%, the UK has one of the highest employment rates amongst developed economies. Figure 1 indicates that immigration has had a positive impact on GDP and the UK’s standard of living:
Perhaps it is the quality of the employment (which is beyond the scope of this article). It also appears that it’s partly due to the ripple effect from the global financial crisis of 2008. Although parts of the economy have since recovered, there are certain sectors and demographics that remain disaffected from the 2008 bust. Whilst it could be argued that the politicians who were on the ‘Leave’ campaign gave misleading information, the pre-existing disaffection created a greater susceptibility to being misled.
Additionally, although this article is primarily focussed on the impact of Brexit on the UK’s financial services industry (deemed the most vulnerable to the negative outcomes of Brexit), a significant portion of financial services employers voted to ‘Leave’. From interview discussions, their rationale didn’t appear to be driven by anti-immigration or xenophobic sentiments but, rather, a rational assessment of the costs and benefits of EU membership. Some respondents believed that the UK’s voice in the EU is not proportional to its contribution, despite it being a significant contributor to the EU budget. This view is further supported by economist David Miles: “there was a fairly rational cost-benefit analysis that may have gone through the minds of many people who voted to leave”.
The City ‘Brexiteers’
Interestingly, given the potential negative impact of Brexit on the financial services industry, there were a number of Brexit supporters from this industry (although most seem to be from asset management). This is surprising because one of the most tangible successes in EU cross-border services is Ucits funds. Some of the evidence suggests that some asset managers are anti-EU due to the nature of European regulations, such as MiFID 2, which restricts the scope for commission payments, and the newly implemented Alternative Investment Fund Managers Directive (AIFMD), which is seen as costly, onerous and bureaucratic.
The UK’s Options
The UK’s various options are set out and further discussed below.
Soft Brexit: Norwegian Deal (EEA)
A soft Brexit implies continued access to the Single market, but with no control over EU migration, this option is described as ‘Norway minus’ according to economist Jacob Nell. The case of a Norway type agreement suggests that the UK’s net EU budget contributions could be significantly lower if the UK left the EU and joined the EEA according to the report by the Institute for Fiscal Studies. Whilst this option appears to be the least economically damaging, further research suggests this may be an unrealistic option with the decreased scope to influence EU policies, in the capacity as a ‘ruletaker’.
Moderate Brexit: Swiss Deal (EFTA)
Switzerland is part of the European Free Trade Area (EFTA) instead of the EEA, which allows free access to the EU’s manufactured goods market, but with limited access to services. Research by the Institute for Fiscal Studies shows that Switzerland has negotiated a series of deals with the EU for specific sectors, such as Insurance, which still leaves out several financial services. However, the Swiss deal will not be a suitable option for the UK as Swiss banks cannot provide investment banking services to their clients from Switzerland and have relied on having an office in the UK.
Hard Brexit options
The findings suggest that the likelihood of a hard Brexit is between 60 – 70% and this was also further supported when Prime Minister May set securing national control of the border as the priority for the exit negotiations in early October 2016.
The two possible options for a hard Brexit are, i) WTO rules and, ii) Customised UK Trade agreement (“BRETA”).
Hard Brexit Option 1: WTO Rules
In the interim, the UK may default to World Trade Organisation (WTO) rules. The rules include no free movement, no financial contribution, and no obligation to apply EU laws. However, traded goods would still need to adhere to EU standards, with some tariffs in place on other EU trades (WTO, 2016). However, access to services would be restricted as WTO rules have no meaningful provision for financial services (Nell, 2016).
It is important that the UK remains a competitive business location for international banks for more positive jobs and growth prospects. Therefore, it is advisable for the industry and government to make transitional arrangements, so that customers can access financial services before the new UK-EU partnership agreement comes into force.
This option may be costly and disruptive to organisations, thus contributing to a negative impact overall for the UK by displacing some activities from the UK to other jurisdictions (Nell, 2016).
Hard Brexit Option 2: UK Deal (“BRETA”)
The research results indicate a higher likelihood for a ‘Hard Brexit’ or new UK-EU agreement. Businesses are in a unique position as the referendum result means the UK now has the opportunity to define new trading agreements with its trading partners. This has created a potential situation whereby businesses can maximise the opportunities a new trading model will present whilst minimising any negative impacts on their business model and the UK economy.
CETA as a precedent
The EU recently completed a new free trade deal with Canada, called the Comprehensive Economic and Trade Agreement (CETA), where Canada has agreed to better conditions for EU companies compared to companies outside the EU. This Canadian model sets a good precedent for the UK to negotiate similar agreement, which could be called the British Economic Trade Agreement (“BRETA”). CETA appears to be the most comprehensive free trade agreement that the EU has agreed to date, providing tariff and quota free access for significant areas of services with some exceptions for financial services (European Union, 2016). However, a key consideration is that there are no budgetary contributions to the EU, although the degree of Canada’s trade with the EU is likely to be less than the UK, at least from a geographical perspective. For some of these reasons the EU-Canada deal is perhaps not a perfect template for a bespoke British trade model. However, it is noteworthy, as it sets out the range of trade agreements signed by the EU and non-members and the schedule of budget contributions. For example, the EEA countries with the highest access to the single market are required to contribute grants to the poorer parts of the EU. Whilst the contribution to the EU programmes could be substantial, it would be less than the current UK net contributions, according to the studies by NIESR.
Trade Negotiations Timeline
Illustrated below is the projected timeline for the negotiations. Irrespective of which option the UK agrees to, it may take up to ten years to complete according to the Morgan Stanley research.
The impact of Brexit on the UK’s financial services sector will depend on the level of access retained to the EU as well as between the different financial services sectors as supported by the Oliver Wyman research. Several institutions have indicated that the cost of relocation and the inefficiencies resulting from the fragmented operations could lead to scaling back or even closure of parts of the business.
The economic impact of Brexit depends on the policies the UK adopts, lower trade from reduced integration may cost the UK economy more than is gained from reduced contributions to the EU budget according to the research by the Centre for Economic Performance. Although the inescapable political debate is beyond the scope of this research, the UK may come out of this stronger than expected given the current political uncertainties in some of the other European countries, with Italy, France and Germany facing elections in the near future. Additionally, with the increasing disenchantment and anti-establishment rhetoric, there may be other countries exiting the EU after the UK. If that happens, the UK may be in a much stronger position to negotiate and make new trade agreements. It is both in the UK’s and the EU’s best interests to reach a mutually beneficial agreement. In this context, this presents an opportunity for the UK to define a customised ‘’Brit model’’ that satisfies some of the issues that led to the Brexit vote whilst maintaining the economic growth and existing standard of living. Although this may be a challenge depending on who has the upper hand between the UK and the EU.
Finally, most of the evidence suggests that the optimal Brexit scenario will be neither ‘soft’ nor ‘hard’ and as we move towards accepting that Brexit is inevitable, it is advisable that the UK government explore constructive ways to structure what Brexit becomes in order for the UK to develop in a different and better direction than it may have otherwise turned out.