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Brexit expected effects on EU’s capital/financial sector

Eugene Eteris, European Studies Faculty, RSU, BC International Editor, Copenhagen, 20.09.2016.Print version
EU’s supranational administration concerning extensive economic integration requires more active oversight in capital and financial sectors. The British “City of London” is a renowned world financial leader being an efficient financial actor in both the UK and EU’s economy. However, Brexit can damage that position argued some experts, acknowledging an impending tragedy.

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...    






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