Analytics, Banks, Business in Europe, Financial Services, Modern EU
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Friday, 29.03.2024, 11:10
Brexit expected effects on EU’s capital/financial sector
London’s
financial sector is a huge generator of tax receipts for the government’s
budget. Thus, according to the City of London Corporation, the City paid last
year in the 1st quarter over £ 66.5 billion in tax. Besides, the
City provided revenue and profits for innumerable non-financial businesses
facilitating much easier access to capital for many UK companies.
In the “Capital
flight: the City will decline outside the EU and Britons will be the poorer for
it”, September 2016 edition of “Prospect Magazine”) Nicolas Veron underlines
that the City benefited greatly from the EU’s membership; in particularly, in achieving
the UK’s “current dominant position in international finances”; Reference from:
http://www.prospectmagazine.co.uk/features/capital-flight-london-economy-brexit-business
Taking advantage
In general,
argued N. Veron, the City has benefited greatly from participation in the EU
single market. The UK achieved its current dominant position in international
finance in three phases: the process, actually started in the 1970s with the
development of international currency markets; a sharpened competitive edge in
the 1980s thanks to the de-regulatory “big bang” of the Thatcher era; and in
the 1990s and 2000s, a centralisation of most of Europe’s wholesale financial
activity thanks to the aggressive dismantling of national barriers by EU
legislation on investment services, financial instruments, fund management,
accounting standards, market infrastructure, and much more. Crucially, the
structure of the EU single market allowed non-EU financial firms, including big
US financial companies, to conduct most or all of their European business from
a single London’s location, which allowed for significant cost savings. On most
measures of wholesale financial activity, London’s share of the EU financial
market rose sharply after the early-1990s, typically to three-quarters or more,
while the other contenders such as Frankfurt or Milan or Paris all shrank to
single-digit percentages, sais Mr. Veron.
These
benefits might disappear as soon as the UK leaves both the EU and the European single
market. The UK would have to find a “market substitute” somewhere in the US,
Canada or Japan.
“In some
market segments, argues Mr. Veron, bilateral agreements with the EU may allow
for something like “Switzerland-minus”: Switzerland is not a member of the EEA
and has its own sovereign framework for financial regulation. It has agreements
with the EU that grant its firms some access to the single market. But not
coincidentally, much of the large Swiss banks’ services to EU clients are
provided through their London affiliates, rather than directly from Zurich.
The impact
on the City from being outside of the single market is a matter of speculation,
given the complete absence of precedents. According to Mr. Veron, “the
optimistic view is that only a limited share of the City’s business, perhaps
somewhere between 15- 25% of its activities, will need to remain inside the
single market and thus will move outside the UK, with the rest unaffected by
Brexit; it would be a significant blow, but far from a fatal one”.
This view,
however, downplays the risk-management and cost advantages of keeping all parts
of a business in one single entity. In the current system, the UK affiliates of
large international financial firms internalise a vast array of transactions,
exposures, and market segments, which would be split if a significant subset
had to move to a separate jurisdiction. For at least some of these firms, it
might be preferable to move the bulk of the business, rather than suffer the
consequences of fragmentation. The financial services that move onto the
continent may drag a much larger volume of activities along making the whole network
extremely complicated.
EMEA’s region after Brexit
The City
has thrived in recent decades because it was the best place to do financial
business in Europe, the Middle East and Africa (EMEA). Post-Brexit, the loss of
the EU-single market membership will become a clear disadvantage in comparison
to EMEA financial centers inside the EU.
British
firms, e.g. Barclays or Aviva may endeavor to keep as much of their business as
possible in the home country, Mr. Veron argues. But non-domestic ones, whether
from America, Asia, or the EU itself, will get out of the UK if there are
better business conditions elsewhere (e.g. in Amsterdam, Brussels, Dublin,
Frankfurt, Luxembourg, Madrid, Milan, Paris, Stockholm, Vienna, etc.)
Given the
enormous opportunity, these cities and the respective states will compete hard
to facilitate their positions in terms of attractiveness for financial service
activities. It may be that Frankfurt and Paris will be winners in this contest.
But there are enough places in the EU with top marks in cultural vibrancy,
physical infrastructure, English proficiency, independent judiciary, and other
key factors, so that it is likely that at least one and possibly even several
(in a first phase) will emerge good enough to become, as London has been so
far, the best place to do financial business in EMEA.
Attitudes
of regulators may further tip the balance, argues Mr. Veron: in the EU,
national and euro-area authorities never “discriminated” against UK-based firms
neither from the European Commission nor from the Court of Justice. Such “protections”
will erode after Brexit.
Besides, the
US authorities’ attitude may change as well. In recent decades, the US
government has been “rather accommodative” in their relations with their UK’s counterparts:
the US firms got access to the vast EU market through UK. When this connection disappears, the US firms
will most probably rely on the trade clause in the TTIP agreement.
Most
probably, writes Mr. Veron the UK would remain the largest financial centre in
EMEA’s region for the foreseeable future: it is currently so dominant that it
will presumably take a very long time for any of its regional competitors to
surpass it.
However,
warns Mr. Veron, the City is likely to decline in absolute size and in relative
terms as global financial activity would keep expanding. The EU’s efforts
towards further cross-border integration would facilitate the process through
the EU financial sectors’ initiatives like Capital Markets Union and the Banking
Union.
The future
of London outside of the EU single market seems bleak: together with the
growing financial activity in other parts of the world (e.g. in Asia) other major
financial centers may emerge, including the European one. That will push aside
the City to the fourth place globally: after EU, Asia and the US.
Two different paths
The UK government
(if Scotland secedes, an English one) can do two things to improve the City’s
prospects; two different paths may be pursued at different times, or perhaps
even simultaneously, in the years to come, argues N. Veron. The first strategy,
called “near-remain,” is to stay as close as possible to the single market, by
emulating most EU rules and maintaining close cooperation between UK financial
authorities and their counterparts in the EU.
The second
strategy is of “going alone,” enhancing the difference between the UK and “the
continent” while boosting the City’s competitive edge through more favourable
tax and regulatory treatment, as most off-shore financial centers do.
However, these
two strategies are largely incompatible, says N. Veron: none of them is exactly
a winning one; “near-remain” will never be as good as being in the single
market in terms of mainstream EU financial business; “going alone” implies
focusing on a limited number of niche segments and losing the one-stop-shop
position that the City currently enjoys. Different firms in the City, and
different factions within government, can be expected to advocate either
strategy.
It may be
the case that when the UK policy shifts from one path to another it will fail
to reap the full benefit of either.
Bleak news
The
mentioned scenarios represent “bleak news” for the City providing revenue and profits
for innumerable non-financial businesses and easier access to capital for many
UK companies.
The market
reaction has been rather muted so far, argued N. Veron, adding that “this may
only be because the harsh reality of Brexit has not fully surfaced yet”. And reliable
data about the Brexit impact on investment and/or capital outflows will not be
available until the end of 2016. Moreover, the international financial media,
being largely headquartered in London, have various incentives to focus on “the
bright side” of Brexit.
London-based
financial community may also be biased in its initial judgment because many of
its members voted for Brexit. The rest of the world, including non-European
investors, is critically dependent on two clusters of sources for their own
assessments: London-based international media, and City analysts. The global
information channels may be viewed as temporarily impaired, but this gap cannot
last forever, concluded N. Veron.
The Brexit future
is regarded “terrible news” both for the City, British economy and for Europe
as a whole. The “decline issue” development is difficult to predict, which,
among many other things, is highly dependent on the outcomes of the present financial
crises.
The golden
age of London in the 2000s and early 2010s, a place of blatant excesses but
where everything seemed possible, that made Paris and even New York or San
Francisco feel provincial, a de facto capital of the world, may be wistfully
remembered as a fleeting wonder. It will be sorely missed by many, concluded
Mr. Veron.
However,
the truth is that slightly downgraded City, as a consequence of Brexit, would
not mean diminishing the UK’s economy, though “an impending tragedy” can be acknowledged...