Many have speculated about the economic impact of the Brexit vote. This article examines the predicted effects of Brexit on the UK’s financial sector, assessing their merits and probability, as well as the possible long-term impact on economic sectors around the globe.
The question is: Is Brexit really a big deal or not?
Unfortunately, it seems that the answer is most likely yes.
A thorough analysis of financial issues and concerns leads to a number of alarming conclusions.
These issues are centered around three key areas: passporting (passporting), regulatory uncertainty, and talent drain.
What is passporting, and why is it important?
The passport process allows any British financial institution (banks, insurance companies, asset management firms) to sell its products and services to the rest of Europe without having to get a license or regulatory approval or establish local subsidiaries.
The passport, along with other factors described below, is a major factor in why many financial institutions choose to establish their headquarters in London.
Recent research estimated that 5,500 UK firms rely on passports in order to do business with the EU. The flows are reciprocal. Over 8,000 companies from the rest of the EU trade with the UK by using passport regulations.
Will passports continue as Brexit approaches? It seems that passporting will not continue.
Only a ” Norwegian Deal ” with the EU would allow Britain to benefit from passporting. This includes membership in the European Economic Area (EEA) and adhering to all of its rules.
A Norwegian-style solution, however, is unlikely because it would force Britain into compromises on the same issues (specifically immigration) that originally led to Brexit.
Is there another way that UK companies can sell to the EU without passports? One solution could be to pursue a ” Swiss Deal ” with the EU.
A solution in the Swiss style also seems unlikely.
Capital Economics explains that “it is unlikely the UK will get a deal as good as Switzerland.” As Capital Economics points out, “it is unlikely that the UK would get a deal with the EU as good as Switzerland’s.”
Even if this model were to be implemented, it would still not be effective. The “Swiss Model” is based on the so-called Third Country Equivalence rules. These allow non-member states to perform many of the same functions as passporting.
Anthony Browne, Chief Executive of the British Bankers’ Association, points out.
The EU’s “equivalence” regime is only a pale shadow of passporting. It covers a limited range of services and can be withdrawn with little or no notice. This will likely mean that the UK has to accept rules over which it does not have any influence.
This could explain why Switzerland’s exports of financial services have been underperforming in the UK over the last 15 years (see Chart 2).
Is there a third choice if both the Norwegian and Swiss models seem to be tough?
Yes, it is possible. This would mean a single Free Trade Agreement similar to what Canada, South Korea, and the EU have negotiated.
These negotiations, however, are lengthy and complex (the Canada-EU negotiation took seven years), and they would result in conditions that were far more restrictive than those currently allowed under passporting rights.
Explains as Jonah Hill did, “Most approaches to accessing the EU market come with the free movement of people. I don’t think that will fly given the importance of immigration in the referendum debate.”
Unfortunately, you cannot cherry-pick in Britain. Either passporting (or quasipassporting), with free movement for labor, is possible or not.
On the Horizon is Regulatory Uncertainty
Uncertainty in regulatory matters is the second issue that’s crucial to Brexit.
It is important to note that regulation has always been a strength of Britain, especially when it comes to determining why London became Europe’s (and, arguably, the world’s) financial capital for two reasons.
The law offers certain advantages in practical matters, such as laws on debt issuance or insolvency.
The British labor laws are more relaxed and friendly to employers than their continental European counterparts. (e.g., In an article published in the Financial Times, an employment lawyer quoted in the report said that “a senior banker who earns $1.5 million could be made redundant in London with a payout $150,000, but in Frankfurt, the cost would be 10 to 15 times higher.”
Brexit has made things more complicated.
First, Britain must replicate or renegotiate over 40 years of EU regulations. It will take time to accomplish this (see Chart 3). Unfortunately, many financial service firms can’t afford to wait for that long.
Despite the timing issue, it’s still not clear whether or not new UK financial regulations will be beneficial to the sector.
Fair enough, this was one of the arguments used by Brexit supporters to support leaving the Union. Brexiters claimed that Britain would be able to enter a new age of deregulation once it was freed from excessive Brussels bureaucracy. This, they argued, would boost the financial industry.