Hedging your Brexit bets
The Prime Minister has negotiated with his 'heart and soul' to stay but London's Mayor campaigns daily in favour of leaving. The director general of the British Chambers of Commerce resigned after being suspended for revealing his support for Brexit at the BCC annual conference. Whereas the Bank of England Governor warns of a City exodus where jobs, business and HQs would flood to Paris or Frankfurt. The IMF and Barack Obama have also waded in for team 'remain'. With a little over two months until the referendum, what does Brexit really mean for one of the UK's biggest exports – financial services.
The UK's financial services sector (including insurance) runs a net trade surplus with the EU exporting approximately £60bn more than it imports. This is a fundamental and differentiating factor to most other elements of the UK economy, such as manufacturing, which run a trade deficit with the EU. In a post Brexit world, a UK net exporter will become a competitor with the EU and exposed to the risk of protectionist policies which promote inter-EU member trading, such as the imposition of tariffs, levies and additional regulation which have the potential to undermine the UK's competitiveness. The regulatory issue is especially pertinent in the financial sector having already invested in compliance with RDR, MIFID, AIFMD, EMIR and capital adequacy rules.
It is, therefore, no secret or surprise that some financial institutions have openly confirmed they are contingency planning for Brexit by considering how to move EU operations headquartered in the UK to an alternative European centre. A business operated in one EU member state has access to the entire EU market under 'passporting' arrangements, which the UK and the City have taken advantage of to date. However, if the UK is no longer in the EU there is no guarantee it will be able to negotiate access to the EU market via an equivalent regime. Even if it could, the UK's ability to influence change going forward is diminished – whether those changes relate to trading within the EU or how the EU trades as a block with the rest of the world.
The lack of influence is compounded for those who believe that the EU has an underlying agenda to undermine London and divert financial markets to Frankfurt, Paris or Dublin. The UK has more than a 25% market share of all EU wholesale banking transactions including over 40% of derivative trading. Also, even though the UK is not in the Euro it accounts for 45% of global trades in Euro foreign exchange markets – a figure that far exceeds any country in the Eurozone. A substantial proportion of these trades involve banks that are regulated by the European Central Bank which has clashed with the UK's dominance in EU wholesale banking from time to time.
For example, the ECB has previously attempted (and failed) to impose a requirement that clearing houses for mainly Euro-related financial products should be located within the Eurozone. This would have required a significant relocation of business away from London. Other examples include plans for a Financial Transactions Tax and a cap on bankers’ bonuses. Similar tensions will continue to arise in the future which raises the question – how exposed is the banking and financial services sector if the UK left the EU?
Currently, the EU guarantees a level playing field which London has been able to exploit via its status as a global financial centre. It has also provided ease of access to the EU as a single market with the UK retaining a seat at the political table to protect the financial sector's interests via a right of veto. This has provided a political, economic and legal platform for financial services firms to invest in the expertise the UK, and the City in particular, has on offer. It is easy to see how the removal of the foundations upon which that platform is built could negatively impact on the banks, lenders, insurers, investment funds and intermediaries already established here in the UK.
The 'remain' arguments bear a startling similarity to the 'no' campaign on Scottish independence i.e. better the devil you know combined with a lack of cogent material available on what a post Brexit world would look like (also coined 'project fear'). However, it does seem to be agreed by both campaigns that Brexit would mean a short term loss of jobs in the UK financial services sector. What is at issue is how deep the cuts would be and whether the exploitation of opportunities in global and emerging markets, unconstrained by Brussels red tape, would outweigh this in the long term. For example, by learning from the Norway and Swiss models, negotiating free trade agreements with the EU and getting the most out of World Trade Organisation membership.
Risks, uncertainty and transitional periods do not build investor confidence, unless you are speculating on the pound losing value in the run up to the referendum or post Brexit – several banks have predicted that the Pound could reach parity with the Euro after Brexit. However, bookmakers (rather than opinion polls) put the odds of Brexit at about one in three or four.