Should we bet on Brexit?

By John Gubert

As the UK moves to its momentous vote on staying in or leaving the EU on 23rd June, we have to ask what a vote to leave, the famous Brexit option, would mean for the industry.

Nobody can be sure of the process that will be adopted to unravel the links between the UK and the rest of the EU. We do know that it will take time to resolve. We can guess that it will be fractious given the destructive power of a Brexit on the stability of the EU. And we can be certain that the UK financial sector will suffer as a result of Brexit, if only because it is the UK’s most effective exporter.

Will the perception of the City of London as a global market place change? Will uncertainty during exit negotiations cause shifts in business allocations? And how will Brexit impact on City employment?

It is clear that, as far as the global market place is concerned, the UK financial sector has three fundamental attributes. It is a gateway to international opportunity, with the success of London based Renminbi clearing or foreign exchange activity being cases of point. It is a gateway to Europe and Brexit will wreak havoc with that attribute, as EU regulation, without UK arguments, will become ever more parochial and require activities to be executed within the EU. UK firms may well not suffer as they can move activity into the EU and it is highly probable that this will occur at an early stage after any Brexit decision if only to avoid the uncertainty that negotiations would bring. Finally, it is unclear how the global nature of the financial markets’ labour force will be affected. US and other non EU nationals have little trouble getting to the UK for senior jobs, but the market for EU personnel is much broader than that and contributes to the global ethos of the UK’s financial markets. If the requisite talent is barred or feels unwelcome, the impact on the City could be dramatic. Some would add English language and UK law to the list of attributes, but, in reality, English has become the global international banking language irrespective of location and UK law can be used from any jurisdiction. Although the UK is a great place to do business, language, law or even the memory of the Empire hold little sway in global markets.

At a business level for our securities markets, there are several issues. It is likely that the clearing sector will be the most hit as ESMA and the EU would undoubtedly pressure firms to operate within their realm of authority. The UK would also be outside any liquidity support arrangements on the Euro to an even greater extent than it is today through its maintenance of the pound.

There is an unknown in respect of the treatment of UCIT and AIFM funds. Under the current regulatory framework, UK based funds can be distributed, albeit with some hurdles in many countries, across Europe. They have also found competitive value in leveraging these two brands, from a risk and control angle, when selling globally. There is provision for compliant funds from outside the EU to have the same rights as UCIT or AIFM funds but the question is how smooth a transition could be arranged, whether a period of uncertainty will lead to client demand for funds to be re-domiciled to Luxembourg or Dublin and how this will impact global branding.  

At an entity level, there are issues of critical mass. If some activity needs to be migrated into continental Europe for regulatory or commercial reasons, how will organisations structure their business in the UK? Several may well shift their European headquarters to alternative locations and this would detract from the UK’s value. Repeated news of banks or other financial entities’ exits of functions, and especially the mind of management, will be psychologically damaging to the sector. Added to this is the potential disruptive impact of any new Scottish referendum, which, although likely to be of benefit to London’s financial centre, would be a huge distraction for those firms with operations north of the border.

There remains a question over global headquarters as well. The UK excluding Europe may not be the most attractive environment. Regulation of financial services in a standalone UK may be tighter and more intrusive than currently, for the UK has been one of the more bullish voices on many aspects of regulation in Europe. There will be no reduction in the controls over systemically important institutions. There will be no easing of the calls for ring-fencing of banking activities. And the Basel capital rules will be strictly applied. Politics most likely also dictates, albeit irrespective of the Brexit vote, that disclosures are increased and that fiscal rules of residence become more onerous. Sound risk management is an attraction but the relative cost of operating in one or another regulatory environment will be a driver, in an ever more mobile global market place. The choice in Europe will be between London, Paris or Frankfurt, with the latter two benefitting from their improving regulatory cultures. Globally, the challenge will be from those centres or, more likely,   New York, Hong Kong or Singapore, where so much global business is sourced. And we need to accept, in the event of Brexit, that London will no longer be an influencer or best practitioner, from a business operation and regulatory perspective, across the EU markets. And those who believe we will easily source new markets for our financial sector should talk with those, like me in my HSBC days, who have tried to gain entry for specific services in markets such as China or India. The reality is that it is harder to gain entry for services than for goods and the timeline, often dependent on the ability of local providers to supply those same services domestically, is measured in decades rather than years! And getting beneficial trade treaties is not going to be simple, given the increasingly protectionist voices in the US and elsewhere.

Some may welcome a Brexit that leads to a shrinkage of the UK financial sector and reduces its risks for the public purse. Such shrinkage would, of course, have a serious impact on the UK tax take and require government services to be further reduced or other taxes to be raised. The cost of operating in London would also undoubtedly decline with Brexit with a likely fall in our industry’s exorbitant wage bill, if there is excess capacity, and a decline in the pound’s value if the various economists are to be believed. But any decline in the pounds’ value would most likely be in turbulent markets and that makes hedging difficult and therefore costs of operation more uncertain.

Many in the City support Brexit. Maybe it will not be as difficult a proposition as I have suggested. But looking at it, with the benefit of having worked and prospered through forty years of growing businesses in Europe and across the world, I personally would maintain the status quo and look to grow our franchises further as the financial markets’ gateway to Europe, the key financial services centre of the region and a major conduit for the continent of Europe and others to global financial markets.