The U.K.’s looming in/out referendum on European Union membership, which may come as early as June, has sparked jitters, with analysts predicting declines in everything from London property prices to the pound. But what would so-called Brexit really mean for the City of London? Here are answers to common questions, based on research notes and interviews with analysts, lawyers and bankers.
What is at stake? Financial services account for 180 billion pounds ($258 billion) a year — about 12 percent — of U.K. economic output and contribute 66 billion pounds in taxes. In some areas, like foreign exchange trading (41 percent of the world total) and over-the counter derivatives (49 percent), London is the undisputed global leader. Opponents of a Brexit fear a departure would precipitate years of uncertainty and steady waning of influence and market share.
What is passporting and why does it matter? Under the current regime, any U.K.-authorized firm is free to do business in any other European Economic Area state by applying for a “passport” from British regulators. For non-EU banks like JPMorgan Chase & Co., Credit Suisse Group AG or Nomura Holdings Inc., the ability to access the region’s 500 million customers from a base in London has been an important draw. Without it, many firms may seriously consider “upping sticks.”
An exit wouldn’t automatically mean an end to passporting rights, but the British prime minister would have to negotiate hard to keep them. The remaining EU members won’t want to incentivize other countries to follow suit. Loss of passporting could result in exports of financial services to the EU falling by half, or about 10 billion pounds [$14.2 billion], according to a study commissioned by fund manager Neil Woodford. Frankfurt and Paris would gladly pick up the pieces.
How would a Brexit work? The problem with contingency planning is that talks on the U.K.’s future relationship with the bloc would only begin after a vote to leave, resulting in a two-year negotiation.
In the so-called Norwegian model, the U.K. leaves the EU but remains part of the EEA. In a “hard exit,” the U.K. loses influence over EU legislation and kisses goodbye to passporting. A middle scenario would see the U.K. retain passporting but secure autonomy over key issues outside of finance, such as immigration. That could be conditional on the U.K. ensuring its financial regulations are on par with those in the EU.
What would Brexit mean for the banks? Every day more than a trillion dollars worth of euros change hands in London, close to half the global total, according to the Bank for International Settlements. The city’s global dominance of the foreign-exchange market is likely to be tested by any Brexit package that fails to guarantee a continuation of access to the single market.
Last year the European Central Bank lost its bid to force clearing houses handling euro-denominated trades to be based in the 19-nation Eurozone. If it left the EU, Britain wouldn’t be so lucky again, and it may make little sense for firms to run their euro trading divisions outside of the EU, lawyers say.
Over-the-counter derivatives are another area for concern. About three-quarters of all trading in such instruments in Europe currently takes place in the British capital. Without access to the single market, much of that is likely to migrate, according to lawyers and bankers who say that U.S. banks are already mulling moving operations. Still, London’s vast pool of skilled labor and back-office infrastructure will be tough to replicate, and mean any loss of market share may be a slow drip rather than a sharp decline.
For big firms with offices across Europe, shifting from London to Luxembourg or Dublin may not be such a challenge, lawyers say. For others, moving thousands of staff would be a huge upheaval. All agree that it would be costly.
What do the banks think of it all? Most firms are drawing up contingency plans and keeping quiet until they know what they are up against, but a few have stuck their heads over the parapet:
- HSBC Holdings Plc announced this week that it will keep its headquarters in the U.K., but may have to move 1,000 of its 5,000 London investment banking employees to Paris.
- Goldman Sachs Group Inc. has put its weight behind staying in the EU, and expects to move some of its offices to continental Europe in the event of an exit vote.
- UBS Group AG Chairman Axel Weber told delegates at an event in London that he was confident the U.K. could secure a favorable deal that need not damage the City of London.
- Deutsche Bank AG Co-CEO Juergen Fitschen said the German lender is studying the implications of the U.K. leaving, and that companies can contribute to the debate to help avoid “stupid decisions.” He also said London’s appeal as a “cultural center” won’t change overnight.
What about the fund managers? And insurers? For hedge funds and other asset managers, many of their investment pools are already registered elsewhere in Europe. U.K. fund managers have so far been fairly sanguine, with Henderson Group Plc and Ashmore Group Plc saying they expect minimal fall-out from an exit vote. One potential sticking point is that under current rules, only members of the EEA can sell UCITS funds, a 6 trillion-euro ($6.7 trillion) market globally.
A UCITS (Undertakings for The Collective Investment Of Transferable Securities) mutual fund can be sold to any investor within the EU regardless of the country it’s domiciled in. Regulators may not welcome fund managers trying to skirt the rules by setting up satellite offices on the continent while still managing funds from the U.K.
Among hedge-fund managers, Crispin Odey, founder of Odey Asset Management, is a vocal advocate for the “out” campaign, claiming the EU has morphed from an economic to a political union. Tosca fund economist Savvas Savouri says concerns about the U.K. losing market share in financial services are overblown because there is no “plausible alternative.”
David Harding, founder of Winton Capital Management, which oversees $30 billion, backs staying in the EU.
For insurers, the biggest concern is maintaining access to the EU’s 500 million potential customers. Under the passport system, insurers are free to set up branches in other European states. That would be threatened in the event of an exit, according to Lloyd’s of London Chief Risk Officer Sean McGovern.
“The U.K.’s membership of the EU has been part of this success story,” McGovern warned in a speech earlier this month. “We believe that it will be key to our future growth and development.”
How likely is Brexit? Polling results have been mixed. The latest Ipsos Mori telephone poll from Feb. 16 showed 54 percent would vote to remain, versus 36 percent looking to leave. An ICM online poll from Feb. 7 had 42 percent favoring Brexit and 41 percent voting to stay.
–With assistance from Sarah Jones and Will Wainewright.
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