This story is part of a POLITICO special report on Brexit and the City: What a UK exit from the European Union would mean for the Continent’s financial hub.
LONDON — The dire consequences of a potential Brexit for the U.K. financial services industry, the largest in Europe, are a staple of the “In” supporters’ case against a vote to leave the EU in the June 23 referendum. “Out” campaigners, instead, argue that the U.K. economy, including the banking and finance sectors, would be better off if Britain were free from burdensome European regulation and bureaucracy.
Some organizations, like Open Europe, have claimed that the 100 most expensive EU regulations, many of which are linked to financial services, cost the British economy about £33 billion (€42 billion) each year. The U.K government, however, has refuted such figures arguing that while numbers are extremely hard to pinpoint, the direct and indirect advantages of being part of the single market far outweigh the costs.
Official so-called “impact assessments” have quantified that the overall economic benefits of being part of the EU is £58.6 billion per year.
POLITICO has further analyzed the potential effects of a Brexit on nine aspects crucial to financial services (in no particular order):
No more automatic ‘passporting’
EU legislation currently allows non-European firms that are registered in at least one of the bloc’s 28 jurisdictions to access the single market. Commonly known as “passporting,” this set-up — one of the most significant features of the single market — has allowed major global financial institutions to operate across Europe through their U.K. headquarters.
Passporting and mutual recognition are only available to EU-legal entities and products. Third countries do not benefit from such rights, even if operating through a European branch. In the past two decades, British governments have been very active in negotiating the terms of the U.K.’s participation in the single market, retaining independence in certain areas, even as it benefits from passporting.
Investment and corporate banking, wealth management, trading venues, data providers, and financial market infrastructure are most likely to be affected by restrictions to passporting imposed after Brexit. The Markets in Financial Instruments Directive (MiFID) II, which will come into force in January 2018, should provide a new “third-country passport regime.” But such rules are yet to be granted to non-EU countries and will be part of discussions in Brussels in which Britain would no longer take part.
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London’s real estate market fizzles
This is an area where the negative impact of a potential Brexit is already being felt. International investors are adopting a “wait-and-see” approach en masse, and many buying decisions are being postponed. At the beginning of the year, a report by Credit Suisse said house prices would fall about 5 percent in the medium term, because of lower demand linked to reduced immigration and the loss of London’s pre-eminent role as a global financial center. But the uncertainty will hit the city’s commercial real estate even harder.
Official figures showed that investments in central London’s office buildings dropped 52 percent in April, down to £2.2 billion, compared to the end of 2015. The figure is the lowest since 2012 and almost 30 percent below the quarterly average of the last 10 years. The shares of leading commercial real estate investment firms like British Land and Securities Land have dropped over 20 percent since mid-2015.
UK securities may need 27 prospectuses
Under current EU legislation, the issuance of securities such as stocks, bonds and derivatives is simplified by harmonized regulation. In particular, the 2003 Prospectus Directive allows European banks to use a single prospectus to sell financial products in more than one country, while the 2004 Transparency Directive helps protect investors through detailed disclosure rules and enhanced information sharing.
In case of a Brexit, the U.K. would have to pass new laws to replace the Prospectus Directive. Any prospectus required to market securities issued in the U.K. in the EU, or vice versa, would have to be approved by each national jurisdiction, causing an increase in costs and a delay in operations. Britain would also have to amend both the Financial Services and Markets Act 2000 and the FCA Handbook to scrap the implementation of the Transparency Directive, and then draw up a new national framework.
It is very unlikely British regulators would encourage weaker rules, therefore new legislation would probably look very much like the current EU regulations — minus the right to operate across the single market.
Access withers to biggest insurance Pie
If the U.K. decides to leave the bloc, free access to the world’s largest single insurance market — the EU accounts for over 30 percent of total global insurance activities — will end, and underwriting laws would have to be renegotiated.
The EU single market gives U.K. insurers access to a market of over 500 million people and a total of €1.4 trillion in insurance premiums. Furthermore, British insurers are supervised by the U.K. Prudential Regulation Authority, which has exclusive responsibility for all the operations they carry out, including within the EU. This means British firms are not obliged to deploy funds on the Continent to meet liabilities under EU rules, nor do they have to report to local supervisors. In case of a Brexit, this would also very likely change.
But many have pointed out that the EU’s 2009 Solvency II Directive on insurers has increased regulatory costs. Critics suggest that leaving the EU would ease requirements and charges for U.K. insurers.
Possible relocations of wholesale banking
The U.K. has dominated the European wholesale banking industry since the beginning of the EU’s monetary union in the late 1990s. The services British lenders offer to other banks or large corporate clients, companies, mortgage brokers, and real estate developers are highly integrated within the bloc. Last year, the share of the U.K.’s cross-border lending was 17 percent, against France and Germany’s 9 percent. The foreign exchange turnover was 41 percent, compared to 3 percent in France and Germany.
European bank exposure to the U.K. is also huge at $1.7 billion, so it would be extremely costly for EU banks to relocate wholesale activities away from Britain. But relocation would be practically inevitable in case of a Brexit, especially considering the fact that the rest of EU member countries and their financial institutions want euro-denominated wholesale banking moved to the Continent under the helm of the European Central Bank.
Politicians and analysts alike have also made clear that the impact on wholesale banking would be felt far beyond London in other U.K. financial centers such as Edinburgh, Leeds, Glasgow and the Crown dependencies.
More headaches for UK tax regime
The implications of a Brexit for the U.K.’s tax regime would be varied. First and foremost, Britain will be freed from the VAT Directive, which currently requires British companies to charge and pay a “value-added tax” on domestic supplies of goods and services. However, VAT makes up a large chunk of the U.K. government’s tax revenue: For 2015-2016 it was 6 percent of the country’s GDP, roughly £120 billion.
The U.K. would certainly set up a sales tax of its own. But this could end up being more expensive for businesses which trade with EU customers and suppliers as a result of combining the two systems. After leaving the bloc, Britain wouldn’t be bound by the Parent-Subsidiary Directive, which provides a one-time taxation mechanism for subsidiaries that distribute profits to a parent company in another member country. Once this directive is scrapped, a parent company in the U.K. and subsidiaries around Europe — or vice versa — could be subject to taxation for profit distribution both in the U.K. and in another European country.
Shut out of the Capital Markets Union
With the launch of the Capital Markets Union (CMU) action plan last September, the European Commission promised to enhance non-bank sources of funding for European businesses in an effort to boost growth and jobs in Europe. Led by the British Commissioner for Financial Services Jonathan Hill, the Commission now wants to stimulate other sectors — venture capital and pension funds, for instance — and improve existing passporting rules for investment funds.
In case of a Brexit, the U.K. and the City would not benefit from the flow of capital that the Commission plans to trigger and may lose ground to other EU countries. In particular, small and medium-sized British enterprises would benefit less from an improved EU-wide capital market — a key objective of the plan.
Will there be an exodus of EU workers?
According to the last census in 2011, the City of London employed more than 10 percent non-British EU citizens, or over 38,000 people out of 360,000. Among the most represented nationalities were Irish (6,800) and French (6,200), followed by Italians (4,500) and Germans (3,600). It is unclear what would happen to these non-British EU workers in the City if Britain were to leave the EU.
But their situation would be unlikely to change overnight. Under Article 50 of the Treaty on the European Union, EU laws would still apply during the Brexit negotiations, which could last up to two years, or more if the European Council and the U.K. agree to extend this timeline. After the end of the negotiation period, everything will depend on the agreement that the U.K. strikes with the EU.
Threats to forex market’s domination
One of the most reliable market indicators of Brexit fears so far has been the pound. While its volatility has increased, the value decreases whenever the market thinks Brexit is likely. The bigger impact might be London losing its dominant position in the global currency-trading market, where it controls around half of the $5-trillion-a-day in currency trades.
The European Central Bank has already tried to require clearinghouses handling euro-denominated trade to be located in the eurozone, but lost to the U.K. at the European Court of Justice in March 2015. This could change if the U.K. is no longer inside the EU. In a poll by ACI Financial Markets Association in early April, two-thirds of respondents said that Brexit would endanger London’s position as the world’s hub for foreign-exchange trading.