The economic and financial costs and benefits of the UK’s EU membership Contents

5The long-term impact of leaving the EU: the economic relationship between the UK and the EU


138.Any agreement on the UK’s withdrawal from the EU will have to address a large range of issues, including: the UK’s participation in EU-wide programmes; its contributions to the EU budget; the position of British staff working for European institutions; the status and treatment of UK nationals exercising free movement rights in other Member States; and the status and treatment of EU nationals exercising such rights in the UK. The focus of this report is on the economic relationship that the UK might have with the EU after leaving, and in particular the trade arrangements that it might conclude.

139.How far the UK’s economic relationship with the EU would be altered by Brexit would depend on the agreement that was eventually negotiated. In its analysis of the consequences of Brexit, the Centre for European Reform sets out seven alternative relationships, six of which are based on the experiences of other countries, including Turkey, Norway and Switzerland. Campaigners to leave have cited various examples as models that the UK might seek to follow, including Canada, Albania and Switzerland.122

140.Such comparisons can be instructive about the sort of post-Brexit arrangements that could be feasible. But they can also be misleading. The UK’s economic relationship with the EU is unlikely to be identical to that of any other country. As a large European country, the UK will seek, and probably be able to obtain, a unique arrangement. However, the terms of that arrangement would be constrained and conditioned by two forces: the views of other EU Member States and UK domestic opinion.

141.The views and interests of other EU Member States. A comprehensive economic and trade agreement with the EU would require the unanimous consent of all Member States’ governments and some Member States’ national parliaments.123 As Sir Jon Cunliffe put it, “there will be 27 Member States that will not necessarily all share the same view about what the European Union wants from the UK”.124 Recent events in the EU have shown that the interests of Member States are often not aligned with each other or with those of the UK. The disunity of the Eurozone and the challenges it has faced in making the changes necessary to put the single currency on a sustainable footing, are testament to this.

142.Domestic public opinion. A vote to leave the EU would be an expression of public dissatisfaction with the UK’s existing relationship, and it is likely that any new relationship would need to be different from the status quo. In opinion polls, the public has cited migration as something over which the Government should have greater control, as a major factor in determining their vote, and as something they would expect to fall following a vote to leave.125 The strength of feeling in this area indicates that there would be a political imperative to reach an agreement that gave the UK the ability to impose controls on migration from the rest of the EU. As Boris Johnson put it, “free movement would be wrong for us”.126 There may be other areas, such as social and employment regulation and EU budget contributions, where there could be pressure to achieve fundamental change, and repatriate powers currently exercised by the EU. At a minimum, the UK would exclude itself from the automatic jurisdiction of the ECJ.

143.These two forces would likely interact in a way that narrowed the range of possible economic arrangements eventually reached with the EU; for instance, the UK may find it difficult to satisfy public demands for restrictions on free movement, while securing unanimous agreement among EU Member States for unfettered access to the single market. As a Member State, the UK is bound by a set of rights and obligations, upheld and enforced respectively by the ECJ. It is unlikely that the UK could retain exactly the same rights, while significantly curtailing its obligations. Dr Niblett, said:

The British, in my opinion, will not have an easy time of saying, “Now we are out, we want to keep all the good stuff and we do not want the stuff that our citizens do not particularly like. We want to have access to the markets; we want to have all of the stuff that was the single market, but we do not want the people.” The deal for the EU is all four. [goods, services, capital and people]127

Interviewed on BBC television on 6 March 2016, Wolfgang Schauble, Germany’s Finance Minister said:

If the decision is taken to leave, the UK will no longer be in the single market unless you find a new treaty, a new contract where you can be a member of the single market without actually being a member of the EU, and you will still have to accept the free movement of people as well, that goes with it, and you have to pay contributions as well. So it doesn’t really make sense.128

Angela Merkel has spoken in similar terms:

It [ … ] goes without saying that there are things that are non-negotiable. That there are achievements of European integration that cannot be haggled over, for example the principle of free movement and the principle of non-discrimination.129

144.Jean-Claude Juncker has said that “freedom of movement since the Fifties is the basic principle of the European way of co-operating. These rules will not be changed.” He has also said that “deserters won’t be welcomed with open arms.”130 The European Union General Affairs Council has concluded that “free movement of persons is a fundamental pillar of EU policy and that the internal market and its four freedoms are indivisible”.131 The European Commission states that “the cornerstones of the single market are the free movement of people, goods, services and capital”. 132

145.Campaigners to leave the EU have presented different visions of the sort of trade arrangements that the UK would have with the rest of the EU. The Vote Leave website states that “there is a European free trade zone from Iceland to the Russian border and we will be part of it”. In evidence to the Committee, Dominic Cummings made clear that this trade zone covered “free trade in goods”,133 and argued that being part of a single market in services was “deeply destructive” for the UK.134 However, tariffs are levied by the EU on certain goods and in certain countries within the “European free trade zone.” The Leave.EU website states that:

Given that the EU sells far more to us than we do to them, the remaining EU member states will seek a trade agreement with the UK that seeks to maintain the same level of free exchange of goods, services and capital as is the case today.

146.In the weeks leading up to the publication of this Report, spokespeople representing Vote Leave have converged on a view that the UK should have “access to” the single market, but not be “part of it”. Michael Gove said in an interview on 8 May that “we should be outside the single market.135 We should have access to the single market, but we should not be governed by the rules that the European Court of Justice imposes on us, which cost business and restrict freedom”. Boris Johnson said in a speech the following day that “what we want is for Britain to be like many other countries in having free-trade access to the territory covered by the Single Market–but not to be subject to the vast, growing and politically-driven empire of EU law”.136

147.After Brexit, the UK’s future relationship with the EU would be unlikely to mimic that of any other country; in this narrow sense, there would indeed be, as Boris Johnson put it, “a British deal”. However, any comprehensive arrangement providing access to EU goods and services markets would require the unanimous consent of the 27 remaining EU Member States.

148.If it is not to call into question the whole purpose of the referendum, a post-Brexit agreement would have to achieve substantive change to the UK’s relationship with the EU. In achieving that change, there would be a trade-off between the extent to which the UK is able to obtain access to EU markets, and the extent to which it regained control over areas where the EU currently has competence. In particular, acquiring greater control over migration policy might well come at the cost of some curtailment of access to other parts of the single market, and hence a reduction in EU trade. In deciding on what sort of relationship to seek, the Government would have to weigh the benefits of additional control against the costs of reduced market access. To sell into the Single Market, its relevant regulatory standards must be met.

149.Achieving the unanimous consent of EU Member States to a comprehensive trade deal would be a significant challenge. Counting in the UK’s favour is the fact that, on leaving, it would become the EU’s largest single trading partner for goods, just ahead of the United States. Moreover, it would be starting from a position of close integration, with the intention of loosening it in certain areas; this is markedly different from conventional trade negotiations, which start from a position of loose integration with the intention of tightening it. Set against this is the fact that Brexit could represent a crisis for the EU. The goodwill of other EU members could not necessarily be relied upon.

150.The sort of deal the UK would reach with the EU, and the access it would have to its markets in the long term, is highly uncertain. It is disingenuous to claim with any confidence, as some representatives from the leave campaign groups have done, that the UK would be able to leave the EU, drop free movement and continue to have the same rights to trade with EU Member States as it does now. The UK would certainly have access, at some level, to the single market on leaving. The question is not whether the UK would have access to the single market, but how far that access would differ from what it enjoys at present. This is a difficult question; nonetheless, the leave campaigns’ leading spokespeople have not answered it.

Implications of different trade relationships


151.The Member States of the EU collectively form the UK’s single largest trading partner by a significant margin. The evidence heard by the Committee supports the view that the EU will continue to be the UK’s most important trading partner for some time to come, irrespective of the referendum result.

152.However, as noted above, it is almost certain that the UK’s trade relationship with the EU would change if it leaves. The extent and nature of this change depends on the agreement the UK Government negotiates. For reasons discussed below, trade in agricultural goods and trade in services–particularly financial services–are most likely to be affected, because in these sectors, the extent and nature of access to EU markets is most likely to differ from the status quo.

153.Whatever relationship it negotiated, it is likely that the UK’s access to EU markets, and hence its trade with the EU, would be lower if it left than if it remained. It is likely to incur higher tariffs than if it remained. There would also probably be a trade-off, inherent in all forms of economic integration, between the extent of EU market access, and the extent to which the UK would be able to regulate products and markets in the way that it wanted. An important question is whether the freedoms and powers that the UK acquired following Brexit–to conduct an independent trade policy, pursue a different approach to migration, and establish a more liberal regulatory framework–could be exercised in a way that counteracted and outweighed the costs arising from a loss of EU market access. It is far from clear whether this would be the case.

Implications for trade in goods

WTO option

154.The ‘purest’ form of Brexit would involve the eschewing of any trade agreement with the EU, and UK reliance on its membership of the World Trade Organisation (WTO) as a basis for trade. This would free the UK from any obligations to follow EU rules, contribute to the EU budget or allow the free movement of people.

155.A core element of WTO membership is the principle of non-discrimination. This requires WTO members not to treat any member less advantageously than any other, unless they have negotiated a preferential trading agreement with them. The effect of this principle is that the EU could not apply punitive tariffs to UK exports, but nor, outside of a formal agreement, could it apply preferential ones either. Equally, if the UK wished to lower or raise tariffs on the rest of the EU, it would have to do the same for the rest of the world.

156.Over time, the EU has substantially cut the tariffs it applies under WTO rules (known as most favoured nation, or MFN tariffs), from a trade-weighted average of 7.4 per cent in 1995 to 2.4 per cent in 2014.137 In this sense, the cost to exporters of leaving the EU and relying on WTO membership is lower than it would have been in the past. However, in certain areas, such as the automotive, apparel (clothes) and agricultural sectors, tariffs remain high. The table below shows the top ten products where the combination of export volume and tariffs would result in the highest increase in tariff costs under WTO rules.

Table 3: ten products with largest potential for increase in tariff costs under WTO rules

average tariff rate (per cent)

exports to EU (£m)

approximate “post Brexit” tariff cost (£m)

Motor cars**




Aircraft parts




Refined oil




Motor vehicle parts and accessories




Women’s or girls’ suits, jackets, dresses, skirts, trousers etc




Food preparations not elsewhere specified




Jerseys, pullovers, cardigans, waistcoats etc., knitted or crocheted




Leather footwear




Turbo-jets, turbo-propellers and other gas turbines




Wine of fresh grape




Sources: WTO tariff database and uktradeinfo database

157.Table 3 shows that were the UK to leave the EU and rely on WTO rules, car exporters, for instance, would face around £1bn in additional tariff costs, while exporters of aircraft parts and engines would face additional costs of around £200m. Such tariffs could cause reductions in competitiveness of 4-12 per cent. Cutting wages enough to compensate for this would be extremely difficult and production capacity might be lost. This might provide incentives for reciprocal tariff reductions across the EU. If it did not there might be some import substitution.

158. John Mills, founder and Chairman of JML, said of the WTO option that

“the level of tariffs now on most industrial goods is very low. There are a few examples [ … ] where the situation would be more difficult, but you would have the exchange rate going down maybe to compensate for this.”138

159. The UK would also face non-tariff barriers to goods trade, such as customs procedures and product standards. WTO membership prohibits discriminatory non-tariff barriers but it would not, by itself, provide a means of approaching regulatory disputes in the way that is offered in a number of the EU’s Free-Trade Agreements. In its long-term analysis of the economic impact of EU membership, the Treasury estimated that non-tariff barriers on EU goods imports were 2.5 times larger than average tariff rates.139

160.Most studies of the impact of leaving the EU consider the WTO option to be the worst in economic terms, because it would lead to the greatest reduction in trade. A notable exception is a study by Patrick Minford, which found that if the UK withdrew from the EU and unilaterally abolished all import tariffs, GDP would be 4 per cent higher.140

161.Asked whether the UK should unilaterally remove all tariffs on leaving the EU, the economists from which the Committee heard were in broad agreement that it would be a good thing, at least in principle. Simon Tilford said “yes, but you also need to work hard to ensure maximum access to export sectors”.141 Roger Bootle said “there are circumstances in which I would not be in favour of it, but my presumption would be, yes, that it is a good thing”.142 Philippe Legrain agreed, but noted that eliminating tariffs would have implications for negotiating market access to other countries:

In order to gain access to, or for your firms to be able to operate in, other markets, you do need to negotiate under the presumption that other countries either do not maintain unilateral free trade or regulate their economies in some way.143

Negotiated arrangement

162.The conclusion of most evidence, and the general view of both expert witnesses and most leave campaigners, is that, after leaving, the UK should seek to negotiate a trade agreement with the rest of the EU. In general, expert witnesses considered that it would be materially more difficult to reach an agreement eliminating tariffs on agricultural produce than on manufactured goods. The EU protects its agricultural sector from foreign competition through a combination of subsidies, delivered through the CAP, and high tariffs on produce imported from outside the EU. Outside the EU and the CAP, the UK would have to decide whether and how to support the agricultural sector. Boris Johnson said that “it is very important for my side of the argument to stress that we believe in subsidising and supporting agriculture”. He also claimed that “Nissan have said they would continue to invest irrespective [of the referendum outcome]”. However, Nissan has said that “our preference as a business is, of course, that the UK stays within Europe–it makes the most sense for jobs, trade and costs. For us, a position of stability is more positive than a collection of unknowns”.

It was then put to Mr Johnson that:

We get £27 billion every year. A period of uncertainty while you were deciding what a British deal meant would undoubtedly mean that we lost investment for a period of perhaps two years. Is that not a worry for those people who have jobs in the North East in manufacturing?

He replied:

It should not be a worry and I hope very much that people will do their best to persuade those who are anxious that there is no need for them to worry.

This reply, among others, appeared to be unsubstantiated by evidence.

163.Providing support outside the framework of the CAP would raise the prospect of differences between the way that the UK and the rest of the EU provides support to the sector. Such differences could justify the retention of tariffs. Andy Lebrecht, former Deputy Permanent Representative to the EU, Professor Dougan and Dr Niblett all agreed with the proposition that tariff-free access to EU agricultural markets would be “unquestionably conditional on continued membership of the common agricultural policy”.144 Norway and Switzerland, for instance, do not have tariff-free access to EU agricultural markets. However, the UK is only partially self-sufficient in agriculture and could import tariff-free from the rest of the world outside the EU customs union.

164.Trading under a free trade agreement would involve additional administrative procedures that do not exist at the moment. In particular, countries that do not share the EU’s common external tariff, such as Norway and Switzerland, must comply with the EU’s Rules of Origin requirements. These ensure that the correct tariff is paid on goods that might have entered the EU from a country with which it trades on a preferential basis (e.g. Norway) but originate or contain materials from somewhere with which it does not (e.g. China). A 2013 study by the Centre for Economic Policy Research estimated that rules of origin raised trade costs by 4 per cent to 15 per cent.145 In written evidence, the Scotch Whisky Association (SWA) listed other reasons why the costs of trade might increase and market access be hindered on leaving the EU, even though the EU’s external tariff on spirits is already zero:

165.Steve McQuillan, Chief Executive of Avingtrans plc, also raised concerns that, even under a free trade agreement, UK manufacturers would be disadvantaged, relative to their EU competitors, over time:

The problem is that the big trading teams, like car manufacturers, would probably find their way through it anyway. [ … ] The problem is that a lot of UK manufacturing is not that. It is not Jaguar Land Rover. It is people like us you have never heard of, and you are probably never going to hear of unless we sit in front of you in a Committee like this. Those supply chains would be subtly negatively affected in sorts of ways that would probably never even come to your attention, because of lack of standardisation and because of small prejudices being put up: “The UK exited. We do not like that anymore. We are going to have less to do with them, or we are going to subtly preferentially go with someone who is inside the trading bloc rather than someone who is outside the trading bloc.” That effect would be insidious and quite slow.147

166.The tariffs levied by the EU on imported goods have fallen substantially over the last two decades. In this sense, the cost of leaving the EU and relying on WTO rules as a basis for trade is not as costly as it once was. However, EU tariffs still cover 90 per cent of the UK’s goods exports to the EU by value, and remain high enough in certain sectors to risk prejudicing UK exporters’ price competitiveness in EU markets, and the UK’s position in the manufacturing supply chain. A trade agreement with the EU that provided for tariff-free access for manufactured goods would therefore carry considerable attractions, and a failure to agree one would be economically costly. The UK has traded freely in manufactured goods with the EU for more than forty years. But it is not impossible that Brexit would result in a return to tariffs.

167.The situation for agricultural goods is more complex, partly because this sector is protected by the CAP and a high external tariff. While the Committee recognises the important intentions sought by the CAP, despite recent reforms it is still, according to witnesses, wasteful and inefficient. But if the UK wishes to maintain tariff-free access to EU markets for agricultural produce, its capacity to protect farmers differently after Brexit might be constrained.

168.Even under a free trade agreement that eliminated all tariffs, the costs of trading with the EU would be likely to rise as a result of non-tariff barriers to trade, including rules of origin requirements and customs procedures. Further non-tariff barriers to goods trade might develop over time if the UK was not able to influence single market rules or the development of relevant WTO rules.

169.Despite the attraction to some economists of withdrawing from the EU and unilaterally eliminating tariffs, this has not been a major part of the campaign, so in the event of Brexit this would be a decision for the democratically-elected Government to make. Unilateral tariff abolition, however merited on economic grounds, is unlikely to secure domestic political agreement. This is partly because exporters would want to secure preferential market access to other countries through trade agreements, and tariffs are bargaining chips to secure that access. Even more difficult to handle would be the concerns of domestic industries currently protected by the EU’s external tariffs. The interests of those international companies who have invested in the UK, in part to exploit the UK’s membership of the single market, needs to be taken into account. Their continued future investment in the UK will be influenced by the trade relationship secured in a post-Brexit era.

Implications for trade in services

170.This section considers the implications of Brexit for the UK’s trade in services with the EU generally. The Committee took evidence in particular on the implications for financial services. This is considered in the subsequent section.

171.Although there are no tariffs on services, barriers to trade in this sector are generally higher than for goods. This is because services markets are typically more highly regulated, either for public policy reasons or to protect domestic firms, and differences in regulatory regimes between countries can shut off cross-border trade entirely. Linguistic and cultural differences may also inhibit services trade. These barriers, together with the fact that many services intrinsically cannot be provided across borders, help to explain why services account for 70 per cent of global output, but only one fifth of global trade.148

172.Although there has been progress in recent decades, witnesses acknowledged that the EU’s single market in services–in effect, the freedom to provide services in other EU Member States–was far from complete; Dr Niblett said “it is 30 per cent or so and there is a long way to go”;149 Will Straw said “it has not been perfect”.150 Barriers to services trade within the EU include: differences in the way services are regulated between Member States; favourable tax treatment for services purchased from local providers; residence requirements for shareholders, staff and regulated professions; and failure to recognise diplomas and professional qualifications. A recent report by the European Court of Auditors found significant shortcomings in Member States’ compliance with the requirements of the Services Directive, the principal legal instrument to reduce legal and administrative barriers to services trade–even though it was supposed to have been fully implemented by 2009.151

173.However, for some sectors, the EU provides a level of market access that is not replicated in any other international trading arrangement. This is particularly true of financial services, where ‘passporting’ allows firms to provide services across the EU, while remaining regulated in their ‘home’ country. The implications of Brexit for financial services is considered later in this Chapter.

174.There are initiatives further to reduce barriers to services trade, including the Digital Single Market project and the Capital Markets Union. Most witnesses agreed that the UK stood to benefit from these developments, given its competitiveness in services. Dominic Cummings, however, questioned whether a single market in services was a good thing at all, on the grounds that it would lead to further regulatory harmonisation: he argued that a single market in services would be “deeply destructive” for the UK.152 Given that the UK has a trade surplus of £21 billion with the EU,153 offsetting a trade deficit in goods, protecting and expanding the UK’s access to the single market in services would be important.

WTO option

175.As with goods trade, if no agreement with the EU is reached on services, market access will be determined by the WTO’s General Agreement on Trade in Services (GATS). Under GATS, EU Member States choose which sectors they are prepared to liberalise and the time scale over which they wish to do so. As with goods trade under the WTO framework, a principle of non-discrimination applies, meaning that any restrictions on market access must be applied equally across all countries. However, there is no presumed right of market access, nor any means of tackling non-discriminatory barriers. Simon Tilford said that “the WTO has made virtually no progress whatsoever in breaking down barriers to the trade in services”.154 James Chew of HSBC said “if you are on WTO, your access to the single market is very difficult”.155 Professor Dougan said that access to services markets under GATS was “around about where the single market was in the 1970s”.156 A paper for the NIESR, Free movement of services, migration and leaving the EU, states that GATS “offers a much more limited freedom to provide services in other Member States on equal terms with domestic service providers.”

Negotiated agreement

176.The UK sells more services to the rest of the EU than it buys. This trade surplus in services partially counterbalances its goods trade deficit with the rest of the EU. It has been argued that the UK therefore has a particular interest in retaining, as far as possible, access to EU services markets.

177.There are, however, different views among leave campaigners on how far the UK should seek an agreement covering services trade. Boris Johnson told the Committee that “we should have a free trade arrangement that continued to give access to UK goods and services on the European continent”. Vote Leave’s website states that the UK should be part of a “European free trade zone stretching from Iceland to the Russian Border”. Dominic Cummings confirmed that this zone was not covered by a single trade agreement, but that “generally speaking, there is free trade in goods over that entire area”. Meanwhile, the Leave.EU website states that “the remaining EU Member States will seek a trade agreement with the UK that seeks to maintain the same level of free exchange of goods, services and capital as is the case today.” Richard Tice of Leave.EU emphasised in evidence the UK’s greater trade surplus in services with the USA compared to the EU. He said:

We should remember we do not have to have a free trade agreement in order to very successfully trade with another country. For example, we have a greater trade surplus in services with the United States of 350 million people, with whom we do not have a free trade agreement, than we have with the EU of 500 million people. You do not need trade agreements in order to very successfully trade with other countries.157

178.In general, witnesses considered that concluding a deal on services would be more difficult than for goods. In particular, in the financial services, transport and telecommunications sectors, the EU has developed a common regulatory framework that effectively replaces national regulation. Access to these markets could require the UK to maintain equivalence with the rules governing these sectors, even as they develop over time. Professor Dougan said “if you want extensive access to the single market, the price you have to pay is homogeneity with the rules adopted by the EU for the EU”.158 Guy Sears, Interim CEO of the Investment Association, said that “to provide the professional services that are the majority of the business and activity that goes on in the UK to clients in the EU or for funds in the EU, there would be a requirement to show equivalence in the UK”.159

179.The trade deals that the EU has negotiated to date provide for some liberalisation in services trade. For instance the EU-Canada free trade agreement, which the Commission describes as “the most comprehensive the EU has ever concluded”, opens up certain sectors, such as postal services and maritime transport. However, the list of reservations (carve-outs from trade liberalisation commitments) is extensive, and EU Member States retain the right to discriminate against Canadian service exporters. Open Europe states that the Canada-EU agreement, “is still some way from replicating the level of access to the single market the UK currently enjoys as a member of the EU”.160 Professor Dougan said that “when we talk about having a free trade agreement with the EU, whether it is the Canadian version or any other version, we are not really talking about anything comparable to the single market in terms of market access and market integration”.161

180.Successive UK governments have sought to improve the EU single market in services. In many respects, progress has been disappointing. However, if the UK remains in the EU, it may well benefit from initiatives such as the capital markets union and the digital single market, and have a role in shaping them to its benefit. This assumes that the EU is more successful in future at implementing a single market in services than it has been in the past.

181.Were it to leave the EU and rely on WTO membership alone, the UK’s current access to EU services markets could not be assumed to continue. The long-standing difficulties of opening up services markets in the EU illustrate the caution with which some Member States approach trade liberalisation in this area, even within the single market.

182.After Brexit, it is not certain that the UK would be able to reach an agreement with the rest of the EU that preserved its long-term access to services markets. Any agreement would probably require the UK to show that the regulation of firms operating in these sectors that wish to do business on the continent was equivalent to that prevailing in the rest of the EU, thereby limiting the freedom the UK gains from Brexit to regulate services industries in the way that it saw fit, and subjecting the UK to regulation over which it has no say or explicit influence.

Focus on financial services

183.The City of London has been a pre-eminent international financial centre for several hundred years. Today, it is the leading global centre for cross-border bank lending, and several forms of derivative trading activity and insurance services. It is overwhelmingly dominant within the EU; three-quarters of EU capital markets and banking revenue is earned in the UK and 37 per cent of assets under management in the EU are managed in the UK.162

184.The financial services industry in the City is highly internationalised. In its report on EU membership, the Bank of England noted that “around half of the world’s largest financial firms have their European headquarters in the UK”. Of the nearly 250 foreign banks operating in the UK, 170 are incorporated outside the EEA. The assets of foreign banks located in the UK are nearly as large (186 per cent of GDP) as those of UK-headquartered banks (200 per cent of GDP).163 The UK is the largest net exporter of financial services and insurance in the world, with a trade surplus that is more than double that of any other country. In 2013, UK net exports in these sectors were $71bn. Around one third of that trade surplus is estimated to come from trade with other EU Member States.164


185.A key development in the EU single market in financial services was the establishment of the passporting regime. This is a shorthand term for a collection of measures in EU secondary law that enable financial institutions to provide certain services to other EU Member States, while remaining regulated by their home authority. For banks, the passporting regime allows banks headquartered in the UK, or non-EU banks with a subsidiary in the UK, to operate in the rest of the EEA (either on a cross-border basis, or by establishing a branch), while remaining regulated by the UK authorities. In their submission to the Government’s Balance of Competences Review in March 2013, the City of London Corporation argued that “firms invest in London because they know that they can benefit from access to 27 markets via the EU passport for financial services”.165

186.Other passports exist to allow asset managers and other investment firms to conduct business in the rest of the EU, while remaining regulated in their home state; for instance, passporting provisions allows firms to market investment schemes to investors (including retail investors) across the EEA, and to provide financial advice to clients in other EEA countries.

187.In evidence to the Parliamentary Commission on Banking Standards, written before the possibility of a referendum was publicly announced by the Prime Minister, Goldman Sachs and JP Morgan described the importance of passporting to their decision to locate in the UK:

In common with financial institutions across the City our ability to provide services to clients and engage in investment activities throughout Europe is dependent on the passport that London-based firms enjoy to operate on a cross-border basis within the Union. If the UK leaves [the EU], it is likely that the passport will no longer be available, thereby forcing firms that wish to access EU markets to move their operations to within those markets166[Goldman Sachs]

We value the flexibility London offers as a platform for access to the Single Market in a variety of formats. Our trading activity in London benefits from an EU passport across the EU.167 [JP Morgan]

188.The Committee also asked representatives from the asset management industry for their views on the importance of passporting. Guy Sears said that it had “brought significant benefits to the UK’s fund industry”, noting that, of the £5.5 trillion managed by members of the Investment Association, £1.2 trillion was managed on behalf of EU-based clients not in the UK.168 Not all of this is passported money. John Barrass, Deputy CEO of the Wealth Management Association, said that “in terms of how the EU works for us, the big benefit is in the passport” because “where you acquire clients overseas, you are able to service them from your office in the UK”.169 He acknowledged, however, that for smaller and domestically-focussed firms, the benefits of passporting are “not so great”.170

189.Witnesses had mixed views on whether the passport could be preserved were the UK to leave the EU. Roger Bootle said that “it is possible it could be maintained”. Phillippe Legrain described it as “extremely implausible” owing to “the size of the UK financial services, and given the hostility that exists towards financial services and the so-called Anglo-Saxon model”. Simon Tilford said that it could only ever be maintained on condition that “Britain agreed to abide by all EU rules and regulations in this area despite having no say over them”. 171

190.Guy Sears also made the point that, in order to maintain the passport, the UK would be likely to have to show equivalence with EU regulation, drawing a parallel with the EU’s engagement with the United States: “Equivalence is the way in which the European Union as a market engages with other markets, and we would become another market.”172 John Barrass agreed, and expressed concern about a loss of influence over the development of financial services regulation that the UK might nonetheless have to comply with:“ We would simply have to look at it [EU financial regulation] and decide how we deal with it here”.173 Lord Hill also said that the UK would have to show equivalence in order to continue with passporting arrangements, although as EU Commissioner for Financial Services, he said that the Commission was “as open as we can be” to other markets, and that he was seeking to “improve the way that we do equivalence processes”.174

191.The Governor said that replicating the current passporting regime would require a “mutual recognition framework”, and that “as one moves away from that, it is reasonable to expect that certain firms would take a view in terms of relocation”.175 Asked specifically whether there would be a degree of loss of business in the City of London were the UK not to be recognised by the EU as having an equivalent regulatory framework, he replied “that is without question”.176

192.Speaking on the Andrew Marr Show on 15 May 2016, former City Minister Andrea Leadsom disagreed, explaining her view that using subsidiaries negates the need for passporting, she argued:

the UK trades more dollars than in the States. The UK is a massive global financial services centre. Just Canary Wharf, one tiny bit of it, is bigger than the entire Frankfurt financial district. Outside of London, we have masses of financial services centres–in Birmingham, Manchester, Edinburgh, Aberdeen, even Bournemouth, even Northampton. You know, this is a huge, vast industry. It’s not going anywhere.177

193.The passporting regime provides benefits to financial firms that undertake cross-border activity, including large banks and some asset managers. Whether or not the UK negotiated a comprehensive trade agreement with the EU, maintaining the passporting would probably require the UK to show equivalence with EU regulation. This would limit the UK’s flexibility, from outside the EU, to set its own regulatory framework, and it would lead to a loss of influence over financial regulation with which it might nonetheless have to comply or adhere. In this sector, the trade-off between domestic regulatory control and market access is particularly acute.

194.Any decision on whether the UK’s regulatory framework was equivalent, and hence whether the passporting regime could be preserved, would ultimately have to be approved by the European Parliament and Council. It therefore has the potential to become politicised. It is possible that other EU institutions or Governments might no longer wish to allow such a large proportion of financial services activity to take place in what would become an offshore centre. Nonetheless, the UK financial services industry supports the development of businesses, investment in new technology, and growth and employment across the EU. There could be a degree of mutual interest in the UK having high levels of access to EU financial markets. Moreover, the free movement of capital is not going to be abolished and it is this more than the single market in services that allows businesses to come to the UK.

195. A loss of passporting would not be fatal for the UK’s financial services industry; its competitiveness is founded on a wider constellation of factors, including time zone, language and the legal system. But it would be plausible to suppose that some relocation of activity, particularly by foreign banks that currently base their European operations in London, might take place, as the Governor has suggested.

Euro clearing

196.In response to the global financial crisis, the G20 committed to moving more derivatives trading away from bilateral, over-the-counter transactions, to central counterparties (CCPs)178, with the intention of bringing greater transparency and security to these markets. Around 50 per cent of the global over-the-counter (OTC) interest rate derivatives market (the largest segment of the OTC derivatives market) is now centrally-cleared, compared to 16 per cent in 2007.179

197.There are four central counterparties (CCPs) located in the UK, though only one (LCH) is owned by a UK group. The Bank states that “these CCPs are heavily used by market participants globally, commensurate with the size and nature of the UK’s financial system.” Three-quarters of European derivatives trades take place in London.180

198.In 2012, the European Central Bank (ECB) published a ‘location policy’ that would have required CCPs dealing in large volumes of euro-denominated transactions to locate within the Eurozone.181 The rationale for the policy followed from the increasingly important role CCPs were coming to play in financial markets as a result of the G20 commitments. CCPs were assuming systemic importance, and might have consequently required euro liquidity, which was in the sole gift of the ECB. As the Bank of England put it, “it is important for the safety and soundness of CCPs that they have access to liquidity arrangements in the currencies they clear”.182 The UK requested a judicial review of the policy by the ECJ, which in 2015 annulled the location policy on the grounds that the ECB did not have competence for CCPs. Shortly afterwards, the Bank and the ECB agreed joint oversight arrangements for CCPs, and a swap agreement was established to allow for multi-currency liquidity support.183

199.The controversy over the location policy raises a question of whether the EU authorities would continue to permit CCPs dealing in euro-denominated transactions to be located in the UK if it left the EU. Lord Hill, EU Commissioner for Financial Services, was asked to provide written evidence on the implications of leaving the EU for CCPs. He wrote:

“Equivalence” provisions in existing legislation, for example, in the European Market Infrastructure Regulation, allows CCPs from third countries to provide services to EU banks and trading venues under certain conditions. But equivalence takes time to negotiate [ … ] Moreover, although EMIR offers protection against discrimination on grounds of currency, these provisions do not apply to third countries.

In short, there can be no discrimination within the EU. But outside, there can be no guarantee that the clearing of large euro denominated transactions in the UK could be undertaken on the same terms as today, in terms of to whom services can be provided or under what conditions.184

200.Asked about the implications of a relocation of CCPs within the Eurozone, James Chew, Group Head of Regulatory Policy and Strategy at HSBC, said “it would be unhelpful for a lot of people if those arrangements were not in place and clearing of euros had to move into Europe. More euros are traded in London than are traded probably anywhere else, so that would not be a good outcome”.185

201.As with passporting, the UK’s regulatory regime would have to be recognised as equivalent in order for CCPs to continue dealing in euro-denominated transactions. Outside the EU, the UK Government would be less able to resist any further pressure for CCPs to relocate within the Eurozone. It would not have recourse to the ECJ, as it did in 2012.

Implications for inward foreign direct investment

202.At over £1 trillion, the UK had the third largest stock of inward foreign direct investment (FDI) in the world in 2014, behind the United States and China, around half of which is from other EU Member States. The UK has long been the top recipient of FDI inflows into the EU and is often recognised as among the most attractive locations for foreign investment. A 2015 Ernst and Young survey of 400 investors asked to name their first-choice investment destination put the UK fourth globally, behind the US, China and India. In 2014, the UK’s FDI inflows increased by 50 per cent in a year when the global value of FDI flows fell by 11 per cent. In its 2014–15 Inward Investment Report, UKTI estimated that “almost 85,000 new jobs were created by inward investment projects” in 2014–15, and that another 23,000 existing jobs were “safeguarded”.

203.In written evidence to the Committee, the TUC note that:

while an overreliance upon foreign investment could leave our economy vulnerable to international economic shocks, a significant reduction in EU investment, which would be the likely consequence of the UK leaving the European Union, would be likely to harm our growth rate, with consequent negative effects for employment”. The Bank of England states that “FDI assists economic integration by creating stable and long-lasting links between economies”.186 There is some empirical evidence to support the theory that FDI produces economic benefits by raising productivity and living standards, although the UK’s recent strong FDI performance has not been reflected in its productivity, wage or export growth.

204.The UK’s substantial current account deficit, standing at around 7% of GDP, is principally financed by FDI. If FDI fell, a material weakening of the currency and associated inflation may follow. The Bank of England states that “FDI assists economic integration by creating stable and long-lasting links between economies”.187 FDI is held to produce economic benefits by raising productivity and living standards and creating jobs–85,000 in 2014 alone according to the CBI–although the UK’s recent strong FDI performance has not been reflected in its productivity, wage or export growth.

205.As discussed in Chapter 3, a vote to leave would likely trigger a slowdown in inward foreign investment for as long as the UK’s future relationship with the EU remained uncertain. The Committee also took evidence on how FDI might be affected in the long term by a vote to leave, in effect, how far EU membership was an important factor in attracting FDI to the UK and keeping it there. Membership might act as a draw for inward investment to the UK because it allows multinationals based outside the EU to access EU markets without facing tariff and non-tariff barriers. For similar reasons, companies headquartered elsewhere in the EU can bring UK-based operations into their supply chain at a lower cost. FDI will follow profitable opportunities wherever they lie.

206.Philippe Legrain made clear that a number of factors contributed to the UK’s attractiveness to foreign investors:

Britain is a very attractive economy to invest in, whether it is because of the flexible labour market, the high level of skills, the rule of law, membership of the EU, general openness, political stability, the English language, the golf courses or all sorts of other things.188

Simon Tilford echoed the point that FDI was driven by a constellation of factors:

There are lots of reasons why foreign companies invest in the UK. It is partly our openness; it is partly that we are not concerned about foreign ownership of our assets; it is partly language. It is quite clear that lots of companies invest in the UK in order to serve the broader EU market, because FDI is, to a large extent, driven by market size.189

Roger Bootle said that, in the long-run, the effect on FDI would depend on how successful the UK was outside the EU:

Supposing we left and we were not able to negotiate a very favourable trade agreement with regard to manufacturers, the City, and so on and so forth; supposing also we did not rescind lots of regulations; supposing, in the worst-case scenario, we were still shoving our budget contributions towards Brussels; and supposing the job impact of the loss of trade with Europe was very severe, the overall economic performance of the UK would be pretty poor. In those circumstances, would we expect FDI to be the same, lower or higher than it was before? I do not think it is difficult to answer the question.190

207.The Treasury’s analysis of the long-term impact of leaving the EU found that membership increased FDI flows from countries within the EU by 35 per cent. However, it did not find that membership had a statistically significant effect on inward investment from countries outside the EU.191 Mark Bowman was asked about this result. He said that “the reasons for this is limitations with the data and a very short series of available data”192, adding that “all intuition suggests that you would [expect to see an effect]”193.

208.There is anecdotal evidence that major overseas investors are already suspending their investment programmes in the UK due to the fear of a Brexit vote. For example, the European head of KKR (the world’s second largest private equity firm) was quoted in the Wall Street Journal on 3rd May 2016 saying that KKR will not make any UK investments until after the referendum for fear of a Brexit vote and that in the event of a Brexit vote, will re-locate some operations to Dublin, Paris Madrid or Luxembourg.194

209.In the run-up to the referendum, a number of overseas firms have made statements about the impact of leaving the EU on their operations in the UK. Many have made clear their long-term commitment to the UK whatever the outcome of the vote. Others have suggested that, while Brexit might not cause them to wind down their existing operations, it may affect future investment plans. For instance, Siemens said in a memo to staff that “a decision to stay in the EU would [ … ] make it far easier for Siemens to continue to invest in and grow our business in the UK”.195 Johan van Zyl, President and CEO of Toyota Motor Europe has said “we are concerned that leaving would create additional business challenges. As a result we believe continued British membership of the EU is best for our operations and their long term competitiveness.”196 Hitachi said “a potential departure from the EU creates uncertainty in terms of economics, trade, skills and talent–particularly in manufacturing, and would affect the stability that we need for continued investment and long-term growth.”197

210.In a recent poll of 667 international businesses from seven countries with operations in the UK, 78 per cent responded that Brexit would have a negative impact on their business (with 6 per cent taking the opposite view that it would be positive), and 60 per cent said that Brexit would have a negative impact on their future investment plans (with 6 per cent taking the opposite view that it would have a positive impact).

211.The UK’s flexible labour markets, strong rule of law, independent judiciary and relatively skilled workforce would continue to make it an attractive location for inward FDI, whether or not it was in the EU. However, warnings by manufacturers such as Siemens and Toyota about the potential impact of Brexit on their future investment plans are significant, even though some companies said the same about not joining the euro. So too are the concerns expressed by a large majority of international firms in a recent poll, that Brexit would have a negative impact on their business and on their future investment plans in the UK.

212.Statistically proving the existence and extent of the effect of EU membership on FDI is difficult; in their analysis, the Treasury were unable to show that membership attracted FDI from non-EU countries. However, just as the finding that leaving the EU will cost each household £4,300 should be treated with caveats, similarly not too much store should be set by this result. There is considerable evidence from companies that the market access afforded by EU membership encourages inward investment to the UK from both EU and non-EU countries, particularly in the financial services and manufacturing sectors.

213.How far FDI was negatively affected by Brexit would depend both on the extent of market access that the UK negotiated on leaving the EU, and how far it was able to increase its attractiveness to foreign investors by changing its regulatory framework and striking trade deals with non-EU countries. It is beyond the scope of this report accurately to assess or predict the size of the impact.

122 Centre for European Reform, If the UK votes to leave: the seven alternatives to EU membership, January 2016

123 If a trade agreement is classified as ‘mixed competence’ (i.e. EU and Member State competence), the Council (generally acting by qualified majority), the European Parliament and the national parliaments of all 28 Member States must separately ratify it. The scope of the EU’s competence in trade policy was greatly expanded by the Treaty of Lisbon, which brought agreements covering services trade, trade-related aspects of intellectual property and foreign direct investment within the EU’s exclusive competence. Nonetheless, recent comprehensive trade agreements, such as the Canada-EU and South Korea-EU have contained elements that fall outside EU competence and have been classified as ‘mixed’. The EU-US Transatlantic Trade and Investment Partnership is also widely expected to be a mixed competence agreement.

124 Q1124

125 For instance, in an Ipsos MORI poll of conducted during 14-25 April 2016, two-thirds of c.4,000 respondents expected migration to decrease over the following five years if the UK left the EU; two-thirds agreed with the statement “Britain should campaign for greater controls on EU citizens”; and 54 per cent agreed with the statement “the Government should have total control over who comes into Britain even if this means coming out of the EU to achieve it”. In the same poll, 48 per cent of respondents identified “the number of immigrants coming into Britain” as one of the issues that would be very important in determining their vote, and 47 per cent identified “the cost of EU immigration on Britain’s welfare system” (respondents were allowed to choose more than one option).

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128 BBC One, the Andrew Marr show, 6 March 2016

129 Angela Merkel, statement to the Bundestag, 15 October 2015

130 Le Monde on 20 May 2016

131 Council of the European Union: Council conclusions on a homogeneous extended single market and EU relations with Non-EU Western European countries General Affairs Council meeting, 16 December 2014

132 European Commission, The European Union explained: internal market, November 2014, p3

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135 BBC One, the Andrew Marr show, 8 May 2016

136 Boris Johnson, The liberal cosmopolitan case to Vote Leave, speech at Vote Leave event, 9 May

137 World Bank database

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139 HM Treasury analysis: the long-term economic impact of EU membership, April 2016, p135

140 Economists for Brexit, The Economy after Brexit, p13

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145 Centre for Economic Policy Research, Trade and investment balance of competence review – project report, November 2013

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148 UNCTAD database; World Bank database; IMF World Economic Outlook database

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151 European Court of Auditors, Special Report No 5/2016: Has the Commission ensured effective implementation of the Services Directive? March 2016

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153 ONS, UK economic accounts, series L86M

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160 Open Europe, What could the EU-Canada free trade deal tell us about Brexit? 15 March 2016

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162 HM Government, Review of the balance of competences between the UK and the EU. The Single Market: financial services and the free movement of capital, October 2013

163 Bank of England, EU membership and the Bank of England, October 2015

164 HM Government, Review of the balance of competences between the UK and the EU. The Single Market: financial services and the free movement of capital, October 2013

165 City of London Corporation, response to the Government’s review of the balance of competences between the UK and the European Union, March 2013

166 Written evidence from Goldman Sachs International to the Parliamentary Commission on Banking Standards, June 2013, Para 56

167 Written evidence from JP Morgan Chase & Co. to the Parliamentary Commission on Banking Standards, June 2013, Answer to Q10

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177 Andrea Leadsom MP, interview with Andrew Marr, 15 May 2016

178 A CCP places itself between the original counterparties to a transaction, effectively guaranteeing that if one counterparty fails, the CCP will continue to perform on the transaction to the other party. A CCP protects itself by taking collateral (‘margin’) from each party and by collecting a ‘default fund’ from its members to meet losses that exceed the margin it holds.

179 Bank of England news release, European Central bank and Bank of England announce measure to enhance financial stability in relation to centrally cleared markets in the EU, 29 March 2015

180 Bank of England, EU membership and the Bank of England, October 2015

181 European Central Bank, Eurosystem oversight policy framework, February 2012

182 Bank of England News Release, European Central bank location policy for Central Counterparties, 4 March 2015

183 Bank of England news release, European Central bank and Bank of England announce measure to enhance financial stability in relation to centrally cleared markets in the EU, 29 March 2015

184 Letter from Lord Hill to Rt Hon Andrew Tyrie MP, <date>

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186 EUK0013

187 Bank of England, EU membership and the Bank of England, October 2015

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191 HM Treasury analysis: the long-term economic impact of EU membership, April 2016, p172, Table A.8

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194 Wall Street Journal: U.K. Vote on Europe Deters KKR From Deals 3 May 2016

195 Siemens plc statement on Britain and the EU, 13 April 2016

196 Statement from Toyota in regards to the UK EU Referendum, 23 June 2016

197 Official Statement from Hitachi Ltd regarding the EU Referendum, 21 March 2016

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27 May 2016