The decision by the majority of the British population to vote in favour of leaving the EU immediately resulted in S&P’s removal of the UK’s Triple-A credit rating, a 13% fall in the FTSE 250 index and a sharp fall in the value of the pound. Despite these disconcerting statistics, the UK has responded strongly now that the shock has started to subside.
The Purchasing Managers Index (PMI), an indicator of business confidence, rose 5.6% in August, while the FTSE 250 now resides above its pre-Brexit level. Even the IMF, who predicted a financial crash in the wake of Brexit, has admitted its forecasting to be incorrect and predict the UK will be the fasting growing G7 nation this year. However, while these facts give the UK a degree of cautious optimism, a wave of challenges still face the city of London.
One of the most significant issues is passporting, which currently enables UK banks, hedge funds, asset management firms, insurance companies and financial services firms to operate across the EU from their headquarters in London. The issue of passporting will be an integral component of the trade negotiations which will follow Theresa May’s invoking of Article 50 in March 2017.
The City Of London’s Opinion
The city currently exports over £20bn of financial services, equivalent to 1.2% of GDP, to the EU. Many pre-empted that Brexit would jeopardise and disrupt these trade links and consequently it was no surprise to see many City of London firms heavily rooted in the Remain camp. Citigroup and Morgan Stanley each donated £250,000 to the Remain campaign in the lead up to the referendum, while many City of London firms including Goldman and JP Morgan have warned of restructuring in the event of Brexit.
A report conducted by KMPG concluded that “76% of British CEOs are considering moving their headquarters or some of their operations outside the UK as a result of the decision to leave the EU.”
Therefore for an industry which employs 1.1 million people, represents 10% of UK Government tax revenue and accounts for 7.5% of total Great British income, it is imperative to work to allay the fears of the industry and strongly represent their interests in post Article 50 trade negotiations.
The Norwegian Model
A plethora of potential trade agreement models has been proposed in the wake of Brexit, including the Norwegian, Swiss and Turkish models. The Norwegian model permits membership of both the EEA and the EFTA, granting it access to the lucrative single market but also the right to negotiate on the world stage as a member of the World Trade Organisation (WTO).
However, one of the grievances of the Leave campaign was the UK’s significant £9bn net contribution to the EU, and Norway’s annual cost of almost €500m does little to solve this concern. Perhaps most significantly, Norway has had to accept free movement of labour, a significant political tool used by the Leave campaign.
In total, the Norwegian model sees the continuation of two of the Leave campaign’s strongest grievances: the free movement of labour and significant net contributions to the EU. Critically, in the event that the UK decided to go with the Norwegian model, it would have no control over the policy which it would have to abide by.
The Swiss model is similar to the Norwegian Model with its EFTA membership but does not possess EEA rights. The model operates a series of bespoke free trade agreements but crucially involves market access fees and the free movement of labour. It is for these reasons, which drove the rhetoric of the Leave campaign, that the Swiss Model may not satisfy the desires of the UK electorate.
Boris Johnson’s preferred Canadian Model has some strengths. It satisfies Brexit profiteers’ demand for control of the UK borders, sovereignty and the removal of the perceived “£350 million” the Leave campaign claimed the UK lost to the European Union a week.
However, Britain may not be afforded the luxury of being so selective with free trade agreements, particularly for the UK financial services industry which is a great strength of the UK economy. Angela Merkel has stated that “access to the single market is inextricably linked with acceptance of the four freedoms” and that any attempt by the UK to gain access to the single market without accepting free movement would “throw into question the entire EU system.”
Win Some, Lose Some
This view is echoed by Bank of France Governor Villeroy de Galhau who has stated that unless Britain has single market access and accepts its conditions, it will ultimately lose its right to passporting.
Many European financial centres, including Paris, Amsterdam and Madrid, are using this uncertainty as an opportunity to promote their cases in the event of firms deciding to relocate from London, creating a conflict of interest for post Article 50 negotiations.
There is, therefore, a clear divide, with the Brexiters’ demand for border control, sovereignty, and removal of financial contributions running contrary to the need for single market access, economic prosperity and passporting for the UK financial services firms. Compromise is almost inevitable.
No Need For Robin Hood
Despite the need for passporting, the UK’s decision to leave the European Union has distanced the City of London from the threat of Robin Hood Taxation and increasing EU regulation. The Robin Hood tax proposes a tax on the trade of multiple asset classes and targets voluminous trading.
The concept of Robin Hood Taxation was passed by the European Parliament in December 2012, and there is talk of implementation in 2016 once the final details have been determined. While the Brexit vote will give UK policy makers the sovereignty to protect the city of London from the harmful proposal, it is also important for the future of the City of London that passporting is secured.
The Two Ways Forward
There are two key strategies which can ultimately acquire it for the UK. The first is equivalence: the synchronisation of UK law with EU regulations which would enable the city to retain its access to the single market.
While it represents a slight compromise of sovereignty, it would grant the UK financial services access to the single market which it craves. Ultimately trade negotiations will take an expected 24 months after Article 50 is invoked in March 2017, but equivalence gained for the UK financial services sector would be an excellent result from a currently uncertain landscape.
Second, the UK could look to assess and utilise legal technicalities. Articles 46 and 47 of MIFIR (Markets in Financial Instruments Regulation) allow passporting to be extended to non-EU firms and most importantly the city of London. MIFID II, due to be implemented in 2018 will also potentially give UK businesses back door access to the single market.
However, it is important to take away from this article that regardless of the outcome of the trade negotiations, the strength of the city of London lies not just in its access to the single market, but a number of highly significant other factors which have secured its status as the financial epicentre of Europe.
The skillset of London’s finance professionals, infrastructure, technology, systems, language, relatively favourable UK policy making and its status as the home of Greenwich Mean Time (GMT) mean London will always form an integral part of global economics and financial services.