How dramatic is the effect of BREXIT going to be on the financial services industry? Whether we get the hard or soft variety is almost irrelevant as the fine line, commercially, between the two appears marginal. A more critical risk is the danger that the global environment pushes Europe, ex the UK, into an Armageddon option; namely destructive protectionism – something that in the heady days before the Trump era appeared almost impossible.
The nirvana style relationship sought by the UK government is, simply speaking, freedom of trade and services without freedom of movement of people, payment of EU dues or the primacy of EU law. That extreme option, effectively a single market without constraints, is not going to happen. BREXIT, for the remaining members of the EU, if only for political reasons, needs to be less attractive than membership of the EU club. And financial services, the UK’s gold standard industry, will be at the fore of that vision. On the other hand, as long as politics is not allowed to prevail over economic common sense, a transitional arrangement and a soft landing across the financial sector should be viewed as being to the benefit of all. And that remains the more likely, if still uncertain, option.
At a corporate level, most of the major financial institutions have adequate footholds within the EU to be able to migrate impacted services to a new location. Policy decisions on such migrations will be initiated fairly promptly, although the end to end process will take time. Elsewhere, migration of functions to the EU is likely to be more gradual and challenging, including a need for potential corporate restructuring and reassessment of firms’ business models and objectives. Perversely we may see meaningful repatriation of business to the US if there is more than expected EU intransigence around the openness of their future business model, thereby making London based regional entities less attractive to operate.
Take the most politically charged area of all, namely clearing. If the EU wishes to place politics as supreme and over rule economic common sense, then all EU institutions will be mandated to only clear EU instruments through EU based and regulated entities. If the liquidity of markets is taken into account, ESMA or EBA may well decide to levy a cost in terms of capital, for EU institutions, were they to use non EU clearing houses, to reflect the absence of direct control over such entities. However, equivalence could possibly come to play in such cases. Each party to a transaction, be they EU or non EU based, will make their choice of preferred clearer. A major driver will be their CCP membership profile and their net collateral position and business structure. And there will be a further impact if their clearing house of choice has a link into an appropriate EU based clearer. There is no binary solution. The outcome will be dependent on cost, efficiency and control and that will also dictate the impact on market liquidity.
I cannot see the EU promoting an environment which effectively culls the sources of liquidity to its financial institutions, many of whom are fragile. The UK is likely to continue to adopt Basle guidelines in the fullest manner, for that has always been Bank of England policy, and that should allay any regulatory fears that UK based banks could prove unreliable sources of liquidity. I do not see a huge amount of retail lending out of remote entities across the EU. As in insurance, most non EU headquartered retail distributors have opted to create retail entities in their countries of operation or in a continental hub, although many will need to look to establish EU holding companies where hitherto they have had branches. The question is how many will stay and how many, in such an environment, will decide the business case, with the added costs of incorporation, does not work.