This is the fourth chapter of a five-part series covering the impact of Brexit on financial services in the UK. Click here for Part III.
The impact of Brexit on the various sectors of the financial services industry relative to each other, as derived from interviews with industry experts, is illustrated below:
The consistent theme from the interviews with industry experts are set out below:
Disintegration: Europe’s integrated financial markets have been good for jobs and growth across the continent in the past, and will be good for jobs and growth in the future due to greater efficiency. For example,
- The integrated financial market is more efficient, as French farmers, German car manufacturers and Italian fashion designers can secure funding more easily.
- It also contributes to EU citizens receiving better returns on their savings from the increased access to a wider range of products.
Ecosystem effects: In essence, within the ecosystem a number of related activities may lose the benefits of scale from being part of the ecosystem if the UK leaves the EU, and these activities may also leave the UK. See insert D for details of the ecosystem dynamic effects.
The net impact of Brexit on financial services in the UK is currently unclear for a number of reasons. For example, the range of potential deals that could be agreed between the UK and the EU are still largely unknown. The UK’s potential options are further discussed in the next article. However, the sectors that have thrived since the formation of the Single market are Euro foreign currency trading; investment banking; insurance; and cross-border securities according to the article by Jenkins and Agnew. This is further discussed below for the specified sectors.
The specialty insurance market Lloyd’s of London contributes 20 percent of the UK financial services GDP, employing 48,000 people. The research suggests that some business could shift to other insurance centres. Although this applies broadly, the London-dominated marine market could be most impacted. Research by Jenkins and Agnew found that London currently covers a third of the global marine insurance market worth $18bn, 40 per cent of which is EU related. Writing business across the EU from London keeps prices low because having ‘to set up local operations across the EU will lead to potential cost increases’.
“To think we can still maintain the same access to the Single market as well as control of the UK Borders is naïve.” Dr. Richard Ward, Former CEO, Lloyd’s of London
Contrastingly, 40% of the UK’s top insurers believe that Brexit will have limited impact on their business, with 10% stating that Brexit may have a positive impact according to a report by Ernst and Young. According to Inga Beale (CEO, Lloyd’s of London), London can still maintain its leading position in specialist insurance and reinsurance by adapting to the new landscape in a post Brexit environment.
“Lloyd’s will establish a European Insurance company in an EU member state.” Hayley Spink, Brexit Programme Director, Lloyd’s of London
Investment banking: Invested insurance premiums The impact of the referendum results on market movements with regards to currency and investments have been dependent on individual firm’s strategic investment policy and allocation, and it is therefore inconclusive whether it has had a negative or positive impact so far. Some insurers have benefited where their investment managers have used a contrarian investment strategy.
Brexit is a challenge for UK based international banks, as a ‘ruletaker’, if it is to remain equivalent, with no say over regulatory changes, according to BBA Chief Executive Anthony Browne. A number of US banks who have set up offices in the UK in order to service their EU clients may now need to plan for the required restructuring if the UK loses access to the single market. A successful bilateral market access underpins growth for both the UK and the rest of Europe
The Dog That Didn’t Bark
Immediately following the referendum result banks expected a sharp tightening in financial conditions, but the financial index didn’t fall as expected. There was minimal impact and it seemed the markets experienced a loosening of financial conditions instead of a tightening, possibly due to the Bank of England and Bank of Japan both using QE following the Brexit result.
“In some cases Brexit was like ‘the dog that didn’t bark’, as the cost of borrowing didn’t rise as expected and growth didn’t slow”. Jacob Nell, Chief UK Economist, Morgan Stanley
However in the long run London’s position as one of the leading currency trading hub could be significantly impacted by Brexit. Research by Jenkins and Agnew found that according to Michael Sherwood, joint head of Goldman Sachs’ European operations until 22 Nov 2016, revenues increased by up to 60% following a pick-up in business in Europe, as a result of the single currency in 1999. Prior to this, most of the banks including Goldman Sachs had fragmented trading operations across Europe. Investment banks benefit from the ability to ‘passport’ around the EU from the UK without needing to set up local operations. This benefit could be jeopardised by Brexit:
“In the event of a hard Brexit, banks will need to have a balance sheet within the EU against which trades can be booked in order to continue to serve EU clients and attract EU business for financial services”. Jacob Nell, Chief UK Economist, Morgan Stanley
Foreign currency (Forex) trading
Over the last century, although London has dominated currency trading globally, the creation of the EU single market and euro in 1999 accelerated trading. Experts claim that the future of euro trading in London is uncertain. For example, in the past the EU’s highest court ruled against an attempt by the ECB to force the ‘clearing and settlement of euro-based transactions into the Eurozone’, but with Brexit such a ruling is unlikely, according to Jenkins and Agnew.
Asset management has benefitted from cross-border financial services since the formation of the Single market. For example, Ucits, a cross-border product has grown and benefitted the UK. Research by Jenkins and Agnew found that since 2011 net Ucits assets held between the UK, Ireland and Luxembourg have doubled due to cross-border sales. Following Brexit the UK may lose its share of the Ucits business worth more than €1tn in 2015 to countries located within the EU. According to economist Richard Portes , for businesses where passporting is important, much of the business may be forced into the Eurozone. However, on the other hand, asset managers who do not trade cross-border securities appear to not be impacted by Brexit.
Key considerations for financial institutions are regulatory and capital requirements, given the pending and recently implemented Regulatory Reform following the global financial crisis of 2008. From the research, it appears that there are no immediate changes in these respects, although there might be some small technical changes to some specific elements.
There are numerous viewpoints about the equivalence concept, whereby if a country is deemed to have equivalent regulatory standards, then under the ‘equivalence regime’, they may be able to provide financial services to EU customers. In this scenario the UK becomes a ‘rule taker’ rather than ‘rule maker’. So in effect, the UK may be worse off than remaining in the EU. However, as the UK is a large financial hub, the BOE and Treasury are likely to insist on having some control according to the paper by HM Treasury. Therefore, equivalence will be an inadequate substitute due to:
- narrower range of services
- rule taker and not rule maker
- BOE will insist on making rules
Stay tuned for the fifth chapter of Peace Ani’s overview of Brexit’s impact on financial services in the UK, published tomorrow.