In June 2016, British citizens participated in a referendum with regard to leaving the European Union (EU). The vote proved to be a close call, but ultimately, the public decided to leave the EU. This decision has had major political, economic, and financial consequences for the UK. Firstly, the vote was held amidst political turbulence in the country, thus the results of the vote made the political scene even more complicated. Secondly, businesses in the UK had to brace themselves for economic and financial consequences - leaving the EU would mean that companies would have to work in an environment of uncertainty and higher risks. It would also mean that businesses would have to comply with new regulations and deal with the issue of market access. As the UK now leaves the EU, a cloud still hangs over the future of the financial sector and what lies ahead. The overarching question of whether London will remain as the major finance hub of Europe lingers in the air. Is the Financial sector geared for a ‘Hard’ Brexit?
Before the referendum, most researchers believed that the impact of Brexit on the UK financial sector would be moderate. Post-Brexit this view has now changed, many people believe the UK is set for a ‘hard’ Brexit. The economic effect on UK businesses will be more significant mainly for two reason; firstly, the UK will have to renegotiate trade deals with almost all of its trade partners, including the EU and the rest of the world. Such negotiations could result in clauses that are not favourable for UK businesses. Secondly, the decision to leave the EU will almost certainly have a negative impact on the UK Gross Domestic Product (GDP). Leaving the EU may mean that domestic demand for goods and services will slow down, driving corporate profits down together with decreased Foreign Direct Investment. This could potentially mean that UK businesses affiliated with foreign companies are likely to face funding cuts. According to estimates, within the first 5 years, Brexit could lead to a 37% decline in FDI inflows into the UK. Fig 1 – UK domestics and UK overseas earners relative price from 2013 to 2018.
The possibility that the UK will no longer have access to the European single market requires large banks with strong investment banking divisions to move some of their operations to other EU Member States in order to continue to gain market access across the EU. One of the most important constituents that contributed to the success of the City of London in attracting global banks such as Goldman Sachs, Deutsche Bank or Societe Generale after the liberalization in 1986 was passporting rights, basically allowing financial institutions to operate in a single location within the EU and then sell their products and services in all EU countries. In total, nearly 70,000 employees of London’s global banks depend on the freedom of movement of services within the EU, one of the four freedoms set out in the EU treaties. As a consequence of Brexit, there could be a potential decrease in the number of employees from the EU countries in the UK financial industry. Out of the 360,000 London City employees, 78% are British and 11% are from the EU.
The insurance industry may also face the impact of a ‘hard’ Brexit. Lloyd’s of London may lose out to Asian competitors, as it will no longer be able to offer unlimited access to Europe. Furthermore, once the UK leaves the EU it will no longer be subject to EU directives and regulation, including Solvency II. The UK will implement its own equivalent regimes however the possibility for regulatory divergence is likely in the longer term. Although at the point of withdrawal the UK has indicated it will not be looking to make major changes to the regulatory landscape, the possibility remains that firms operating in the UK and EU could be subject to two distinct regulatory regimes, lending to a greater compliance burden over time. Also the Forex market, the world’s largest and concentrated in London (43% share), could suffer as a result of losing access to the European market as most euro transactions are made in London, but the ECB wants to move clearing houses to within the EU.
Businesses are having to adopt new strategiesBusiness leaders in the UK have begun to develop strategies that would help them in negating the harmful effects that Brexit may pose. For a number of decades, London has been considered a hub for financial services. However, this position is already under threat with companies such as Barclays, HSBC, and Royal Bank of Scotland having already initiated relocation plans. These companies are wary of the economic conditions that will prevail in the UK after Brexit. According to estimates, the UK’s largest financial services firms have already committed over £1.3 billion worth of relocation funds. In addition, these firms are investing over £2.6 billion in order to build new headquarters outside of the UK and have announced over 1,500 job cuts. Overall, across industries, it is estimated that nearly £1.2 trillion worth of assets is being moved from the UK to mainland Europe.
The United Kingdom EU membership referendum was inevitable when David Cameron won the 2015 general election, having promised such a vote during his campaign. Coincidentally, 2015 was the year when branchless challenger banks such as Monzo and Revolut were founded. While the direction of the banking industry was established six years ago, the combination of Brexit and now COVID-19 has quickened the drive for older financial institutions to transform their business and operating models, because it’s clear: the future is digital. Technology is enabling fintechs to enter the banking market, and thrive. Experts predict traditional banks will have to partner with tech organisations to keep pace with developments. A study of 200 UK and European banking executives found that in the wake of the coronavirus pandemic over three-quarters (78%) of banks have been forced to change their future banking strategy. Some 72% of those surveyed are planning to grow the number of in-branch digital services, and two-thirds will invest more in digital banking and services. Companies such as everis lay at the forefront of helping financial institutions to digitally transform, offering bespoke consultancy and tailor-made solutions.
Although these next upcoming months will provide more robust answers to the changes the UK financial sector will face with respect to Brexit, there is an underlying thought that the transition will not be as smooth as businesses would have hoped for. Alterations to trade agreements, regulatory policies, free-market access and taxation will indeed be some of the issues financial firms are faced with. Having said that, many of the larger firms have taken actionable measures in preparation of Brexit, though the future will tell if enough has been done. In this article I explored the potential impacts of a ‘hard’ Brexit, it is however also important to take into consideration of a ‘softer’ outcome where UK businesses may not have to face hefty changes. Next week, in my follow-up article, I aim to explore how a ‘soft’ Brexit scenario might present lesser challenges to firms operating in the UK.