Brexit and the risk of fragmentation of EU financial services

26 February 2018

In recent weeks several economic and financial commentators on both sides of the Channel have raised concerns that the UK’s decision to leave the EU could result in fragmentation of the European market for financial services, leading to higher costs for British and European consumers.

Andrew Bailey, Chief Executive of the UK’s Financial Conduct Authority (FCA), warned in a recent speech that “fragmented markets reduce diversification and transparency, thereby increasing risk”. On the international stage, David Lipton, First Deputy Managing Director of the IMF, also warned that fragmentation of banking and capital markets “would prove costly”.

Our latest study, Impact of Loss of Mutual Market Access in Financial Services across the EU27 and UK, provides a quantitative appraisal of the costs of fragmentation with a Europe-wide focus. In this report, we use our in-house Computable General Equilibrium (CGE) macroeconomic model to evaluate the benefits and costs for the UK and different groupings of the EU27 states in the case where no market access agreement is reached as the UK exits the EU.

It is important to note the scope and limitations of our study. First of all, we focus on the economic impact through more restrictions in financial services cross-border activity: our analysis is agnostic to any agreement that may or may not be reached in other industry sectors, which may in turn have knock-on impacts in the financial services sector as well. Secondly, the “mutual loss of market access” scenario we consider is close to the more restrictive (albeit orderly) end of the spectrum of plausible future trade arrangements. We assume delegation of portfolio management in the asset management industry and existing international third country access arrangements will remain, but our results should be treated as a “hard Brexit” estimate.  It is not our central estimate of the ongoing Brexit negotiation, which could result in an arrangement somewhere between a disruptive and disorderly exit and the current single market regime. Indeed the way of limiting detrimental economic impacts is to secure a negotiated outcome.

Finally, we do not take into account any new international agreements that the UK, or EU27, may enter into with countries in the rest of world.

The analysis concludes that there are ‘no winners’ from the change in trading between the UK and EU. We find that the EU27 gain from relocation of financial services activities, but they also experience downsides in terms of the economic impact of fragmented markets, loss in productivity and reduced efficiency which results in higher costs of financial services to EU27 consumers and businesses. While no single location appears to have gained the majority of proposed relocations, Frankfurt, Dublin, Luxembourg, Paris, Brussels and Madrid have all been selected as new or expanded bases for EU27 activity.

From the UK perspective, mutual loss of market access between the UK and the EU27 will require some UK-based financial institutions to move and/or replicate some of their functions in the EU27. As a result, before taking into account any other potential agreements with the rest of the world, the UK is likely to lose financial services employment and related economic activity to the EU. The whole of the EU, including the UK, will also suffer from a less efficient financial services system with fragmentation of capital, liquidity and risk.

Our analysis suggests the UK will be negatively impacted, with a Gross Value Added (GVA) impact of -1.3% (or €27.2bn in 2016 values) per annum impact by 2030. The economic impact for the EU27 is also negative. For the EU27, the annual GVA impact is -0.3% (or €33.0bn in 2016 values) by 2030. Even for our group of smaller financial services-focussed states with proportionally more to gain from Brexit - Ireland, Luxembourg, Cyprus and Malta - they are also more negatively impacted from the fragmentation of EU financial markets and therefore do not gain in overall terms.

For the existing EU28, we estimate is that there would be a negative economic impact of -0.45% (or €60.2bn in 2016 values).  In conclusion, our analysis points to a clear economic rationale for an agreement on mutual market access between the financial services industries of the UK and EU27 after Brexit.


Andrew Gray

Andrew Gray | Head of Brexit for Financial Services
Profile | Email | +44 (0)20 7804 3431

Nick Forrest

Nick Forrest | Director
Profile | Email | +44 (0)20 7804 5695




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