Who stands to win from #Trump and #Brexit?

One would say that both Trump and Brexit are the result of populism, complacency and … to be frank stupidity. But they have more things in common. They both benefit the financial industry. See my two recent articles on Newsweek exploring what this new order means for our banker friends.

What does a hard Brexit mean for the City of London? (read here)

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What does Trump deregulation herald for Wall Street? (read here)

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@iGlinavos

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The City and Brexit: A Primer

passporting

Chapter 1: Passporting

The prospect of Brexit has created a tsunami of information as people try to get to terms with the various consequences of a British exit from the European Union. As a teacher of Banking Law, I realised that while a lot of terms are commonly referenced in the financial press, our students – and the wider public- have little appreciation of what is happening and what the implications are.

I am starting therefore a series of short posts on issues Brexit-related from a non-technical perspective for a non-legal audience. You can view this as a primer on the relationship of the world of business with Brexit.

We start with the City and the perceived threat Brexit poses to Passporting. This post presents what Passporting is, why it is important and how Brexit is likely to affect the operation of financial firms & banks out of the UK and with what consequence. This piece is meant to be informative, not partisan, so I will make an effort to avoid repeating why I think Brexit is a very, very bad idea.

What are we talking about?

The City is worried that if the UK departs from the Single Market it will lose Passporting rights. A core consequence of Freedom of Movement for (financial) services is that authorisation granted to a banking business in one Member State will suffice for operations across the EU and it is not therefore required that the process be repeated in another. This principle – nowadays almost sacrosanct as a European principle of banking and financial law – is commonly referred to as ‘Passporting’. The notion of a ‘European passport’ is inexorably linked to the parallel concept of ‘passported activities’. Such activities are termed ‘activities subject to the mutual recognition’. The main reserved activities are, on the one hand, the acceptance of deposits or other repayable funds and, on the other, lending including, inter alia: consumer credit, mortgage credit, factoring, with or without recourse, financing of commercial transactions (including forfeiting). Also, it is important to note that this universal green light applies to the activities a financial institution wishes to perform in another Member State either by means of cross-border, distant services, or by means of a branch office in that other Member State.

Is this important?

The City is a key driver in the British economy. Britain has the highest ratio of services exports to GDP in the G7, at 13%. It also has the biggest share of financial services exports by some way, at 29% in 2012 (the US comes second at 15%). In 2014, financial and insurance services contributed £126.9 billion in gross value added (GVA) to the UK economy, 8.0% of the UK’s total GVA. London accounted for 50.5% of the total financial and insurance sector GVA in the UK in 2012. The sector’s contribution to UK jobs is around 3.4%. Trade in financial services also makes up a substantial proportion of the UK’s trade surplus in services. In 2013/14, the banking sector alone contributed £21.4 billion to UK tax receipts in corporation tax, income tax, national insurance and through the bank levy.

It is not perceived to be in anyone’s interests to sharply and artificially reduce the size of the financial sector in the short to medium term.

What can Brexit do?

Let us assume that Brexit does happen in one of its extreme versions, taking the country out of the Single Market. This will mean loss of Passporting rights, but it will not mean that the heady proportion of GDP contributed by financial services will disappear in its entirety. PwC estimates that the GVA of financial services to the economy will decline by 6-10% (roughly) by 2020, representing a reduction around £7-12 billion in value. Loss of employment is estimated between 70-100.000 in the financial services sector. Why is the projected impact so severe? One after all could point to banks operating successfully in countries outside the EU. An argument of the Leave camp is that reduced connection with Europe frees up options for increased trade in services (including financial services) beyond Europe.

The answer of why the impact is so severe is rather mundane. It is a matter of increased costs and upset balance sheets. No one is suggesting that banks headquartered in Britain will no longer be able to do business in Europe. The problem is that if the industry loses Passporting, compliance and administrative costs will increase markedly. Funds will need to move to the continent if accounts in Euros can no longer clear from London. While this does not mean that banks will close (after all, major banks already have a presence in the continent), it does suggest costs in the short and medium term. With the movement of funds, some (but not all) jobs will go. The cumulative impact of Brexit (especially if it also means exit from the Single Market) is that Britain will present a very different business proposition than it does now. This difference amounts to a few billion pounds wiped off the country’s GDP. This is not apocalyptic, but it is unavoidable if a hard-Brexit is the base scenario.

There is another aspect of Brexit impacts arising from a reduction to the size of the City. The Revenue will face a sharp loss of income if significant amounts of economic activity migrate to the continent. This, on top of increased budgetary needs due to a deteriorating economy (especially since the UK runs a budget deficit at around 6% at the moment) will be a bad hit to state finances.

Can other business, attracted from overseas, compensate? The answer to this question is yes, but only partly. The UK cannot, and should not, seek to become a big-island tax haven. It cannot jump from being the centre of European finance to Singapore-by-the-channel. Even if this were the aim, the price to pay for attracting international funds will be tax breaks and sharp tax cuts. This will not compensate for the loss of tax income, even if it helps firms retain a presence and preserves some part of the City.

Conclusion

Passporting is important and stepping out of a harmonised zone for the provision of financial services entails a loss of business which will not annihilate the sector, but will significantly reduce it. Any adjustment will take place over the longer term and in 2030, the City will still be smaller than it was in June 2016. Brexit, if it means exit from the Single Market, will not turn Canary Wharf into a parking lot, but it will not do any favours to the Treasury or growth in the British economy.

@iGlinavos