Looking at the hard numbers: what Brexit means for financial services
14 April 2016
By Simon Hunt
What would the UK leaving the EU mean for the financial services (FS) sector? There’s been a lot of speculation about how the UK, an important European financial services hub, would fare outside the EU but over the past few weeks we’ve been busy calculating the potential impact of Brexit in numbers. According to our analysis for The CityUK, under both of the possible exit scenarios, the value of its activity would be lower in 2030 than if the UK remained in the EU.
While we do not believe that big business should be telling people how to vote, it should be helping to provide impartial information into the debate and that's what we have been aiming to do with our work with the CityUK and others.
Our calculations show that leaving the EU could put up to 100,000 FS jobs at risk by 2020. Brexit could also reduce the contribution the FS sector makes to the UK economy over the same period by almost 10% – or £12 billion – compared to a ‘remain’ vote and business as usual.
These are the headline findings of our new report, Leaving the EU: Implications for the UK financial services sector, commissioned by TheCityUK. It follows on from our earlier report for the CBI on the potential impact of Brexit for the UK economy as a whole.
Leaving the EU, however, would be a process rather than an act, which makes the precise impact difficult to calculate and quantify. We don’t yet know what a Brexit would look like in practice, but in the report we analyse the potential impact on financial services between the referendum date and 2030 based on two possible exit scenarios.
Under the first Brexit scenario, ‘FTA’, the UK negotiates a Free Trade Agreement with the EU based on tariff-free trade in goods, but not services. Under the second, ‘WTO’, the UK trades with the EU on the World Trade Organisation’s Most Favoured Nation basis. In neither case would the UK be bound by the ‘four freedoms’ of the EU but one of the biggest differences between the two scenarios lies in immigration – under the FTA scenario we’ve assumed the Government would be able to relax immigration rules for highly-skilled migrants from EU and non-EU countries.
What’s clear, though, is that under both scenarios, the FS sector grows more slowly than if the UK remains within the EU. The sector as a whole would decline by between 5.7% and 9.5% by 2020 compared with the status quo. In 2015 values this means a reduction of around £7bn to £12bn by 2020, although the impact would moderate over time. We also estimated a fall in UK FS employment of between 70,000 and 100,000 jobs by 2020 compared to the status quo. The market would adjust over the longer term but by 2030 we estimate there would still be between 10,000 and 30,000 fewer jobs in the sector.
The report also demonstrates that the impact of Brexit on the FS sector would be notably greater than the impact on the UK economy as a whole – according to our CBI report, UK GDP would fall by between 3.1% and 5.5% over the same period.
So why would FS suffer more? We looked closely at all the potential direct and indirect impacts that could be felt if the UK votes to leave the EU. Some would have a negligible effect on the sector – FS regulation, for example, isn’t likely to change significantly in the event of Brexit – but two stood out as having a big potential effect:
- Uncertainty, particularly while the terms of an exit agreement were being negotiated. The increase in uncertainty is likely to result in higher risk premia on sterling financial assets, including for financial corporates. For example, the spread on UK investment grade financial corporate debt has widened by 40 basis points (bps) relative to European corporate bonds between January 2016 and February 2016. This could result in a short term deterioration in banks' funding costs.
- Trade. The status of the UK sector as a major FS hub relies on firms’ access to European markets. The sector has a £20 billion surplus in trade with the EU. The passporting regime, which allows banks and investment companies authorised in an EEA state to provide services to clients in other EEA states without the need for further authorisation, could potentially disappear if the UK leaves the EU. This increases barriers to trade in financial services.
Our report also explains that uncertainty and less access to European markets might, over the medium term, persuade international firms to relocate activities that particularly relate to serving EU customers which could further impact both the sector and the UK economy as a whole.
The UK FS sector is very successful and we are not suggesting that it will disappear overnight. However, our findings indicate that an erosion of the UK's position as the number one financial services hub in the world could be an outcome of Brexit. This could have significant implications for not only the sector but the economy as a whole. Of course, modelling comes with in-built uncertainty, so our estimates can only be an indication of the broad direction of Brexit and the size of the potential impact. That said under all the scenarios modelled uncertainty exists in the event of an exit and that appears unlikely to be good for the economy.
You can read the results for yourself at http://pwc.to/1SAj9QM.