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As Brexit sinks in…

As the impact of Brexit starts to sink in, John Gubert looks at some of the key concerns firms need to face up to.

Forty eight hours have now passed since the UK electorate voted to leave the EU. In that time, the pound and stock markets have fallen sharply, rating agencies have started the downgrade process, a motor company with operations on both sides of the Channel has already indicated plans to move some production out of the UK and financial firms have advised employees of proposals to move activities to continental Europe. Perversely, there is no clear indication of the plans and process for Brexit and the UK is to have a new Prime Minister and government.

But some things are becoming clearer. The EU will not give the UK an easy ride. There are two reasons for that. The first is to ensure that there is no belief among the 27 countries remaining that there is some pot of gold at the end of an exit rainbow. The second is that Article 50 is about exiting the EU and not negotiating trade and access terms. These are seen by the EU officials as two distinct processes and, although they may be allowed to overlap, there is every indication that they will not be run in parallel.

This is critical for the financial sector for it highlights an increased risk from Brexit. The likelihood is that access to the single market will only be granted, if at all, after the UK has left the EU. Thus there is a high risk that there will be no equivalence for UK funds or special arrangements for various functions at the point the UK leaves the EU.

It is worth considering how trade negotiations take place. They are not dissimilar to standard negotiations. The UK imports a range of goods, from raw materials or agriproducts through to manufactured goods and services. Exports are dominated by services but include manufactured goods, some dependent on EU based supply chains, as well as agriproducts and some “sophisticated” raw materials such as specialised steels.

We import more cars than we export. The EU would thus in theory be agreeable to a zero tariff on cars as it is in their interest. But the agreement is needed from all 27 member states and that will mean that cars will not be dealt in isolation but will be linked either to other goods or to political values such as freedom of movement or budget contributions. The UK may wish to tie a benefit to the EU such as car exports to a benefit for the UK such as access to financial markets. Thus the negotiations are complex and not on a product by product basis whilst requiring unanimous agreement across all EU nations. This is why the trade deals take so much time and why there is a high risk that a UK trade deal will not be completed by the time the UK leaves the EU.

The EU could prolong the exit period but, as it would only be for the benefit of the UK, this appears unlikely. And threats by some to adopt legislation to allow the UK to take back, for example, control of its borders prior to an exit deal being agreed would not only perhaps breach international law but would also be a red rag to a bull and harm the UK in the longer term.

So what is likely to occur? In 2016 very little. But I expect two major developments in 2017. We will see the migration of functions that need to be operated within the EU. Few will wait for the UK to be granted equivalence under EU rules because, assuming we must exit by end 2018, if the commentary from Europe is to be believed, firms need to give themselves time to handle the migration in a prudent manner. I also believe that Brexit will be a catalyst for the migration of other headcount from the UK. Some of this headcount will be tied directly to functions that are migrated. A good part, though, will be linked to cost management, through offshoring or back office consolidation. Paradoxically, the UK’s quite open market means that origination and production for its domestic market can easily be sourced from overseas and that will add to the migratory pressures.

It is important to see the process in context. The UK will remain a major centre for financial activity. It will though not be the centre of almost automatic choice for the EU region.   The UK will remain a power for post trade administration as that is driven by the scale of the wallet for local market opportunity. The UK will continue to operate within much of the EU regulatory framework, although this will be run, one has to assume, from the UK regulatory body.

The UK budget will be impacted. Whether it is by a lack of growth in revenues or by a reduction in absolute fiscal revenues is hard to say. But the financial sector contributes £60-65 billion of tax revenues per annum or 11-12% of the total. I would estimate that each 1,000 lost jobs would reduce this by around £50 million in income tax receipts alone. And one other critical element should not be forgotten. 30% of all income tax in the UK is paid by the top 1% of the population. If you analyse the divides in the vote, one sector has been hit hard. The skilled, highly educated young professional. Let us only hope that Brexit does not lead to a brain drain of these people for they are critical to the nation’s future and to the funding of its public services.

Of course it is not the end of the world! But it is the start of a process whereby London is no longer the automatic and instinctive choice for EU based or euro denominated activities.