Following the UK’s vote to leave the European Union, in the financial services sector it was rapidly recognized that Brexit is as much a problem for the European financial system as it is for the UK and it represents a test of the resilience of the global financial system. Since the financial system is intimately integrated into — and fundamental to — the operation of the real economy, Britain’s exit from the EU presents challenges to the whole developed world. It is in everyone’s interest that these are resolved effectively.
For Eurozone members to tackle the serious economic challenges they face, and promote the growth and jobs agenda across the continent, there must be a strong, efficient financial services infrastructure. This is essential to facilitate and broker inward investment into debt and equity markets, underpin trade both within the eurozone and with its external partners, originate and distribute credit, provide risk management and risk transfer solutions and ensure secure and reliable payments, clearing and settlement systems.
As the acknowledged European leader, to what extent can the UK finance industry continue to provide such services to the real economy in Europe after Brexit? There are some signs that European political leaders are realizing that parochial disputes over particular components of the financial services sector need to give way to a rational debate over the best ways to achieve common economic and social objectives.
For example, the European Commission’s proposal for Capital Markets Union (CMU) is designed to make capital more mobile across the EU, and could be one of the key ways that some of the Union’s structural problems can begin to be addressed. If it now stalls, there is a chance of a shortage of both debt and equity financing for European business, depressing opportunities for jobs and economic growth. It would be to mutual advantage if a post-Brexit settlement took account of the skills London can provide for the benefit of Europe and the wider economy.
One of the key issues to be resolved in any negotiation about the terms of Brexit is the extent to which existing passporting rights for UK financial services firms can be retained or replicated after a British exit. Passporting gives a firm authorized in one country of the European Economic Area (EEA) the right to set up an establishment or open a branch in any other EEA state, or to provide cross-border services. If the UK were to leave the EU without remaining a member of the EEA, these passporting rights would automatically lapse. If the exit negotiations fail to allow a comparable alternative, the impact could be significant — although the details will depend on a firm’s particular business model.
From the point of view of the real economy, Europe will continue to need a critical mass of relevant talent and expertise to support access to capital markets, wholesale funding markets and asset management services, and it is indisputable that much of this expertise currently rests in London.
The debate over the Commission’s regulatory initiatives has been unfairly colored for many years by the belief that Brussels over-regulates, that the UK gold-plates these already costly regulations, and that leaving the EU would allow massive simplification. In fact, most regulation is uncontentious and beneficial, aimed at consumer protection, product safety or generally accepted social goals. In the financial services sector, development of the regulatory regime has played a key role—although admittedly not perfect — in promoting financial stability in the aftermath of the global financial crisis. Ultimately, much financial regulation introduced during the last few years was not only welcome, but developed with significant UK input.
It is possible that the European Central Bank will seek to reopen the issue of whether London should retain its primary role in euro clearing. Since the referendum, there has been a revival of the argument that euro clearing needs to take place inside the Eurozone to ensure effective oversight and regulation.
Once again, this is an issue of capability, economies of scale, cost and efficiency. The jobs and growth agenda, and the health of the real economy, have nothing to gain from deliberate fragmentation and transfer of existing centres of expertise.
As senior executives in financial services firms struggle to determine the potential impacts of Brexit, the reality is that the next couple of years will be uncertain. It is unlikely that definitive decisions on many crucial issues will emerge before the end of the process. In the meantime, much can and should be done.
First, firms need to identify people with relevant expertise, to monitor, understand and interpret developments as they emerge. Second, they need to review and ensure they understand their own business models against a Brexit background. When these analyses are complete, firms will have a firmer foundation to enable them to respond effectively to the outcome of the negotiations.
Brexit may cause complications. But like any major change, it will also bring opportunities and benefits to the best-prepared.