May 9, 2017    5 minute read

Brexit: What Next for UK Financial Services?

Part I    May 9, 2017    5 minute read

Brexit: What Next for UK Financial Services?

The United Kingdom’s decision to leave the European Union could be described as taking a leap into the dark in an unchartered territory, with dawn still quite far away. Whilst Brexit is inherently political, this five-part article takes a comprehensive look at its consequences for the economy and financial markets.

£200bn The UK financial services industry’s annual revenue

According to research by Oliver Wyman, the UK financial services industry produces annual revenues of approximately £200bn, and contributes approximately £60-67bn in taxes each year. The UK financial services industry, combined with the related professional services sector, are significant contributors to the UK economy. But they have evolved into an interdependent and interconnected ecosystem. Brexit’s effects therefore have a broader impact than just on cross-border business with the EU.

Context

The UK is yet to leave the EU, however, the prospect of leaving and the resulting uncertainty appear to have cost the UK economy. The cost of this uncertainty is discussed further in the next chapter of this article. Although opportunities may arise from this uncertainty, the economic consequences of Brexit are dependent on the policies adopted by the UK.

Findings from a number of researches suggest that Brexit will result in lower trade volumes for the UK due to reduced integration with the EU, and ultimately may cost the UK economy more than is gained from saving the contributions to the EU budget. One estimate of this cost is 3% of GDP by 2020.

However, putting this in perspective, the cost of the 2008 global financial crisis to the UK was more than 10% of GDP, according to research by the Bank of England. Although, the referendum result has created some uncertainty, it also presents an opportunity for the UK to define new trading terms, similar to the recently completed trade agreement between the EU and Canada, the Comprehensive Economic and Trade Agreement (CETA).

CETA sets a useful precedent for the UK to define its own unilateral trade agreement, perhaps called ‘’BRETA’’ – British Economic Trade Agreement. The findings suggest that it is in most nations’ collective interest to agree to a mutually beneficial trade deal with the UK. The below quotes from the contributors to this article summarise the expected impact of Brexit.

Initial Impact

Although markets initially responded quite negatively to the UK referendum result, with the pound falling to a 30-year low against the dollar, they have since levelled off and started to recover. Additionally, it is possible that the results of the US election in November 2016 may have positively impacted the pound’s value. The Brexit result has destabilised the status quo, but seemingly without changing much yet – although the uncertainty initially appeared to have been costly to the British economy as illustrated in Figure 1.

However, within a few weeks per Figure 2 below, the markets had rapidly recovered and the FTSE 100 is now higher than before the referendum.

The Background to the UK Joining the EU

The UK, ‘divorcing’ the EU after 43 years, was usually the more unwilling partner in the relationship. Whilst it wasn’t necessarily a match made in heaven, it is not clear whether the UK will be better off outside the marriage. An analysis of the UK economy since 1945 provides a useful context with regards to why the UK joined the EU in the first place, which helps to reach a complete assessment of the motive and potential impact of Brexit.

The UK Economy since 1945

Research by Christopher Gandrud analyses how the UK economy was impacted after joining the EU. Between most of 1945 – 1973, the UK economy was often described as the ‘sick man of Europe’, due to its relatively weak economic performance compared to other European countries. This narrative started to change from 1973 upon joining the European Economic Community (EEC), an early version of what is now known as the EU.

The EEC progressively sought investor-friendly and pro-market policies, such as the Single European Act of 1986, leading to the formation of the European single market. Permitting free trade and labour movement led to increased returns from investing in the UK.

Whilst some of the increase in investments in the 1980s could be attributable to EEC membership, however, there were a number of initiatives by the ruling government from the late 1970s, such as trade union legislation, which may have also played a significant role.

A number of international companies increased their investment in the UK. The increased investment during this period seemed common across the large EU economies as seen in Figure 3.

Contrastingly, in the same period investment in the United States, which was not part of the EEC, did not increase as much, suggesting an effect attributable to the creation of the European single market. Whilst the narrow Brexit vote may not return the UK to a similarly weak economic environment to its pre-1979 state, the key to a successful Brexit negotiation will be to agree a deal that will maintain the current level of prosperity. See Insert A for the timeline of events leading to the EU referendum.

 

Stay tuned for the second chapter of Peace Ani’s overview of Brexit’s impact on UK financial services, published tomorrow.

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