The case for Brexit: a fallacy that will put the UK financial services sector at risk

Brexit could offer the political independence and sovereignty that many Britons desire. Economic growth in the European Union (EU) has stagnated, which has in turn fuelled London mayor Boris Johnson’s view that the EU has been responsible for undermining the corresponding rate of UK growth, harming the country’sonce unrivalled position of strength on the world stage.

The pro-Brexit advocates’ argument is that the EU is becoming increasingly overwhelmed by a sea of eurozone interests, which have eroded the region’s pure economic foundations and moulded it into a highly charged political entity. So, why would we want to continue to be part of the bureaucracy of a union, which has become highly politicised and join what seems to be the eventuality of a United States of Europe?

Attracting US and Asian banks…

London is unique. It has an established banking infrastructure, highly regarded by its client-base across the world. In particular, it is within a time zone that offers access to both Asian and US markets, while also providing a platform for international banks to access the European market.

Britain’s membership of the EU offers free access to the markets of all 28 member states, a privilege referred to as ‘passporting’. The relative importance of this facility is highlighted in the most recent data published by the Office for National Statistics (ONS), which shows that the UK’s financial sector exported £20.2bn (US$29.2bn/€25.9bn) of its services to the EU in 2014, approximately 41% of the UK’s financial services export total of £49.2bn. Put simply, the EU is the largest trading partner for banks based in the UK.

The alternative…

The European single market, and its 500m-strong population, is highly prized by international banks. However, in the event of a Brexit the UK would have to negotiate a trade agreement with the EU to maintain access for UK-based banks. This could come in the form of an European Economic Area (EEA) agreement, as already applied to Norway, Iceland and Lichtenstein. Such an agreement would not remove some of the deeply unpopular political features of EU membership, such as the free movement of people, or avoid the UK’s obligation to contribute to EU budgets.

Alternatively, the UK could create bilateral accords to access the single market, as achieved by Switzerland. That said, a highly politicised negotiation could increase the bureaucracy that so many wish to avoid as it could take years – maybe even a decade – to negotiate.

The regulatory fallacy…

Some argue that Brexit could cause a swift repeal of unfavourable rules, such as the bonus cap on the financial services sector imposed by the Capital Requirements Directive (CRD IV). However, the prospect of repealing all EU regulation is a fallacy.
The UK is independently committed to the majority of rules which form EU regulations, because these are developed as part of a globally-coordinated effort directed by the Basel Committee on Banking Supervision (BCBS). Therefore, Brexit would only weaken the UK’s position in Europe as regulatory equivalence will need to be maintained, but the UK would surrender its influence over EU policymaking.

The threat of relocation…

UK-based banks may be faced with little choice but to relocate parts of their organisations to maintain access to EU markets. For example, under the terms of the Markets in Financial Instruments Directive (MiFID II), EU members can require non-EU firms to establish a branch within their jurisdiction before allowing them to provide services to clients.

The establishment of such subsidiaries would increase costs to firms at a time where cost savings are imperative in order to remain competitive. In turn, this would potentially incentivise firms to relocate the entirety of their business functions in order to avoid the additional costs of operating across two trade zones within Europe.

Frankfurt and Paris have been suggested as future competitors to London as financial services hubs. How credible these locations might be is not totally clear; London has a long-established track record at being in the forefront of financial services. In an ever more volatile eurozone facing deflationary pressure to what extent would France – with its lowered credit rating – and Germany – with its vast bailout contributions – be better positioned than London to act as the European financial hub for foreign enterprise? History and reputation work in the UK’s favour. The EU cannot replicate this overnight.

On balance…

Based on face value, Brexit could cast Britain into what some might see as a utopian state – the perceived composition of which would be founded on independence and national sovereignty in their purest conceptions. In reality however, this utopian “victory” could reduce London’s stature and reputation as a global financial services hub to a chapter in history.

These concerns are echoed by the most respected figures in the industry; most recently espoused by the Bank of England’s (BoE) governor, Mark Carney, who has warned that Brexit represents the biggest domestic risk to the economy.

Brexit will also set a dangerous precedent that could trigger other member states to consider their positions as part of the EU. To deter other would-be leavers, the EU will not wish to make UK post-Brexit trade negotiations a tempting prospect. Both historically and at present the UK has benefitted from its relationship with the EU. A vote to leave the EU would put the country’s trade surplus in financial services (valued at £16.5bn in 2014*) at risk, a highly valuable and much envied element of the UK economy.

*Calculated by the most recent (2014) ‘Trade in services by type of service’ data contained in ‘The Pink Book 2015’ published by the ONS.

The regulatory services practice of Crossbridge contributed to the content of this article.

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