The financial services industry constitutes around 7% of UK GDP, directly employs 1.1 million people, two-thirds of them outside London, and contributes a significant proportion of tax revenue. Avoiding major disruption to this industry and the resulting job losses should be a high priority in the Government’s negotiations on leaving the EU. This report examines the likely impacts of Brexit on UK financial services and seeks to identify issues that the Government will have to contend with as it attempts to reach deals on the UK’s withdrawal terms and its future relationship with the EU.
We find that a key priority will be to ensure that there is an adequate transition period, avoiding a ‘cliff edge’ both at the moment of withdrawal following the Article 50 process and as the UK and the EU move towards a new relationship. It will of course be in the interests of businesses to be able to plan for the future on a firm footing, but we believe that achieving such clarity will also assist regulators in adapting to new circumstances, the wider UK economy and the European economy as whole. The danger is that, in the absence of clarity, firms will restructure or relocate on the basis of a ‘worst case’ scenario. We call for an early commitment from both sides in the negotiation that there will be a transition period.
The length and terms of a transition period will depend on the extent to which a new relationship with the EU differs from the current arrangements. The Government is seeking a bespoke deal with the EU, but at this stage it is not clear how much access to the single market will be sought; it is even less clear how much will be achieved. The existing business models of UK-based financial services rely to a degree on ‘passporting’ rights granted in several pieces of EU legislation, and it has been estimated that around £40 to £50 billion of annual revenues are related to the EU. Were the negotiations to result in the UK being treated in the same manner as any other non-EEA ‘third country’, the UK could find itself seeking equivalence under legislative provisions that are patchy, unreliable and vulnerable to political influence. It has recently been reported that the European Commission is proposing to tighten the equivalence provisions in EU legislation: this highlights the unpredictability of such a regime. We conclude that, if the current passporting regime is not maintained, the Government should seek a deal to bolster the current equivalence arrangements for third-country access, to cover gaps in the regime and to ensure the continuation of equivalence decisions as financial services regulation develops.
A vital task will be to determine the extent to which firms currently rely on passporting and the degree to which equivalence provisions might provide a substitute. The Government should go into the negotiations with the strongest possible evidence base. This will not be an easy task: we heard that even the firms themselves did not have a clear idea of their reliance on passporting.
Establishing the likely impact of a reduction in market access will be made more difficult by the existence of the so-called UK financial ‘ecosystem’, in which network effects resulting from the concentration of services increase the efficiency of the system. The UK currently benefits from the co-location and interconnection of firms providing a range of financial and professional services: a change to the business conditions for one of those services could affect many others.
London is currently ranked as the leading financial services centre in the world, closely followed by New York. Other European cities are far behind. There is a tension, in that unpicking a highly developed ecosystem such as exists in London or New York could have unpredictable effects. It would also be very difficult to replicate it, in the short term at least, in a less developed centre. We were told that much of the business lost by the UK would be more likely to relocate to New York than to the EU.
The strength of the UK’s financial services industry, means that the UK has a large trade surplus in financial services with the EU. Though this demonstrates the extent to which the industry benefits from access to the EU market, it also demonstrates the reliance of the wider EU economy on the services provided in the UK. If the UK ecosystem cannot be replicated in the EU, which is not a realistic prospect according to the evidence we heard, we conclude that it would not be in the EU’s economic interest for services to be provided less efficiently, or in New York instead of London.
One example of this is euro-denominated clearing, of which the UK is the leading centre. The European Central Bank has already attempted to repatriate euro-denominated clearing to the eurozone, and the issue was reopened, by the President of France among others, shortly after the June referendum. Repatriation could happen. But the difficulties associated with replicating the services currently provided in the UK give us some hope that a deal might be reached that would be in the mutual economic interest of both the UK and the EU.
1 See paragraphs 40–59.