B+2: Revisiting Brexit two weeks on

John Gubert assesses the sentiment towards Brexit two weeks after Britain’s shock decision to leave the EU.
Two weeks on from the UK’s momentous vote to leave the EU and it is amazing how polarised a view is held in different locations across the world.

In the City of London sentiment varies from despair at the damage to the financial system to a bizarre and unexplained belief that there will be no change to EU access models. In continental Europe the view appears to be that the UK will, unless perhaps it accepts the Norwegian model, be treated as a foreign nation. In the US, there is question as to the logical location of impacted and unrelated businesses as US banks consider whether to restructure and migrate activities outside the UK.

Many in Europe believe that equivalence cannot be given to UK fund managers until after the UK has left the EU and once the dust has settled on the post BREXIT legislative programme. In effect they believe that there will be a lack of clarity over regulation in the UK even if initially it is fully compliant with EU rules. In addition, there is a discussion on the location of the mind of management in funds domiciled within the EU and questions whether those who delegate management to entities outside the remit of ESMA should be granted equivalence.

There is also a strong belief that the swap arrangements between the ECB and the Bank of England will not fully survive a BREXIT and thus London will, as it had in the early days of the Euro, a euro liquidity challenge in the event of market disruption. This, in turn, leads to a firm belief across Europe that derivative clearing will relocate to Germany and France from the UK.

And it is only nervousness about the practicality of operating in the traditionally less flexible EU locations that is preventing a flood of relocations, across a broad range of European activities, from London. Many non UK, but EU headquartered, operations are having difficult discussions with their regulators who do not wish major areas of risk activity to come under the UK regulatory regimes which will no longer be allied to the European infrastructures. Many other banks, in areas of heavier employment such as custody, are seeing the review needed of their operations as a catalyst for migration of processes to offshore locations, with the Polish option being favoured as a logical and lower cost EU based solution.

It is unclear how the UK will approach BREXIT. Some would like it to be immediate; others would prefer it to be managed. Given the size of the UK financial services industry and its dominant position within Europe, those who believe in speedy change are treading dangerous and systemically risky ground especially if their often quite xenophobic approach to all EU institutions is manifested through the negotiations. Unfortunately a more reasoned and reflective approach increases uncertainty, and, as that uncertainty touches the ability to do business in certain market segments, it in itself will lead to precautionary shifts of activity to the EU, if only because of the time needed to plan any meaningful business migration.

So what is threatened? First, as the UK is a quite flexible market, the option to outsource UK based activities to EU and other locations is increased as related functions migrate to the EU for regulatory reasons. Although there may be little change in custodial activity, the likelihood is that fund administration will trend towards Europe. Fund management will remain strong in the UK, given the scale of the domestic wallet, but the larger and more geographically diverse managers should see a more even balance across their different locations with Western EU capitals benefiting to the detriment of London. London will become a minor market for the Euro with liquidity being the key driver, and there appears no reason, given the depth and experience of other centres, for swap and other derivative clearing in Euros, and perhaps other denominations, to move from London. And, as I have mentioned in earlier blogs, it is inevitable that the mind of management will move away from the historical centre of automatic choice in London when looking at launching new products or entering new spaces.

If that is the downside, where is the upside to the Brexit decision? Some political figures believe that a downsizing of the UK financial sector is in the interest of the economy given the cost of the last crisis to the public purse. That is perhaps understandable but the likelihood is that fiscal revenues will be lost faster than they can be replaced for early estimates suggest that the UK financial sector contribution could shrink by up to 10-20% as a result of relocation of activities, the impact on savings and other financial activity of a downswing in the economy and the cost of restructuring. So far, no country has offered to open its borders to UK financial institutions as a result of the referendum and so the idea that there is a pot of gold at the end of that illusory rainbow is farfetched to say the least.

There is a growing mood of protectionism across the world, manifested again by the EU decision to look for national approvals of each member state rather than the EU parliament for the Canadian trade deal. There is an increasing belief across the EU that BREXIT precedes trade deals and the CEE countries especially do not seem ready to budge on their greatest export to the UK, people under that freedom of movement. There is a fear that BREXIT has destabilised the Eurozone and that has led to a hardening of attitudes towards the UK, and is concerning as the EU is still the target for around half our own exports.

It seems impossible to find a solution that will work for all sides. Or is there somewhere a golden bullet that the different protagonists will produce as the final hours tick by?