Brexit and financial services: The cost to Europe
17 October 2016
As the immediate turmoil of the EU Referendum eases and attention turns to negotiations to leave the EU, the implications for financial services across Europe are a priority.
Much has been said about the potential damage to the UK financial services industry - the potential loss of so-called passporting rights by firms based in the UK threatens the City of London’s future as a regional financial centre. But it is equally important to consider the impact on the FS industry outside of the UK? Can the rest of the world safely watch from a distance, and wait for the outcome? As detailed in our latest industry report, we don’t think it can, because an integrated UK FS industry has clear mutual benefits to both the EU and the UK.
So what’s at stake for the entire European economy? Yes, the UK FS sector could lose access to Europe as a result of Brexit but equally, Europe could lose access to its de facto financial centre with all its production and distribution capability and the access it provides to the global financial system – and that’s hugely significant. In the wake of the global financial crisis we hardly need reminding how interdependent the health of the financial system and wider economy are. In Europe, both are now in a fragile state: The growth outlook for the EU and Eurozone for the medium term have fallen, and Europe’s financial institutions failed to break even in 20151.
What’s the issue? In a nutshell, as a result of 40 odd years of market evolution and integrated regulatory reform, the UK - the City of London in particular - has emerged as Europe’s financial centre to the extent that, in 2015, the net export/import of financial services between the UK and the 27 remaining EU States amounted to €31.2bn. The UK also acts as a crucial conduit for Europe’s governments, businesses and citizens to access the global financial system including deep pools of investable wealth in places like China. By implication, the rest of the EU today relies heavily on the financial services production and distribution capacity that’s currently based in the UK. Also, given the specialised and competitive nature of the industry today there are also gross trade flows in the other direction, from EU27 based firms to customers in the UK. Stopping or curtailing that trade flow essentially means that, if its recipients are to continue receiving its benefits, the associated production capacity needs to move. This is unlike other categories of trade such as cars or computer software where the main issue is the existence or otherwise of trade tariffs which change price levels. In the case of financial services - to generalise - the issue is whether the trade is permissible at all.
It’s true, of course, that the financial services capacity that exists in the UK – insofar as it caters to European needs - could be replicated or relocated elsewhere in Europe, but that’s an expensive, time-consuming and potentially highly disruptive exercise. Given the state of the underlying economy, and the challenges already being faced by financial firms right across Europe, this disruption could hardly come at a more awkward time ... for the industry, for the economy, and for all Europeans.
So, whatever the future holds for the overall trading relationship between the UK and EU, there is, we believe, a strong economic and indeed political case for all 28 members states to reach an agreement that minimises the service disruption, uncertainty, cost and risk to Europe’s people, businesses and public bodies of shifting and dispersing financial services capacity from the UK to elsewhere in Europe. If there is to be a partial relocation of financial services capacity from London to other European centres, transitional arrangements will need to be agreed to enable firms, suppliers, supervisors and others to undertake this in an efficient and orderly way; to maintain service continuity and value for clients; to invest in new technologies to improve efficiency and customer service; and to maintain a clear path to see through other critical public-interest reforms of the industry. That rebalancing could a decade or more to complete.
This won’t be easy, but it will be much more manageable if everyone is clear on the nature and extent their mutual economic and societal interests in this regard. To date, understandably, much of the FS industry’s focus has been on the potential impacts on industry – firms have a clear obligation to protect the interests of their shareholders. A lot of it has also been aimed at lobbying the UK government, to help ensure that the UK’s vital interest in its FS sector is given the right priority. But as the industry across Europe now considers how best it can inform the wider negotiation – among all current 28 members states - we believe the focus must now shift to what is at stake right across Europe, not just for industry, but also for the businesses, public bodies and private citizens that depend on it … as customers (business and personal), employees, suppliers and investors. We, as a global professional services firm, are contributing to this effort.
Building on work that we did prior to the referendum which focused on the UK economic impacts, we’ve begun a study to assess the direct and indirect implications for Europe’s economy of curbing FS trade flow between the UK and the rest of Europe and between Europe and the rest of the world. These implications could include the economic drag of uncertainty through the negotiation period; capacity adjustment costs; reduced ongoing growth in the FS industry together with multiplier effects into the wider economy; disruption in the supply of finance and related services to the real economy (a new credit crunch, in other words), and the loss of productivity and efficiency arising from the partial fragmentation and dispersal of Europe’s current regional and global financial services centre.
The mutual stakes in this for all Europeans need to take centre stage in the forthcoming negotiations.
1. In 2015, European domiciled ‘Global Systemically important Financial Institutions’ (G-SIFIs) together delivered a return on equity of about 6.5 percentage points below their average cost of equity, implying an economic loss of about $85bn in the year.