Brexit and the Loss of Financial Passport: How are the Brits being Fooled?

#Brexit Facts

Today let’s discuss an extremely ‘unpopular’ topic that the UK politicians (both Labour and the Tories) have skilfully avoided since the Brexit vote. Surprisingly, the issue was also omitted from the General Election campaign: The UK will lose its financial passporting rights after Brexit!

Working for the ECB back then, I can tell that on the continent, the approach was fundamentally different. Right after the Brexit vote, we all knew that the loss of financial passporting rights was an ‘obvious’ consequence of the UK leaving the EU. Thus, various EU institutions started to get prepared to the new financial environment bringing about both challenges and sizeable opportunities for the EU. More importantly, this was no secret: While delusion and denial reigned in the UK, the ECB and the IMF officially called the UK-based banks to anticipate their relocation to the continent in order to smooth the transition process. Below, I will give you some basic facts to illustrate the gravity of the situation and how badly it is being handled by the UK government.

Why do financial services matter to the UK economy?

The financial services sector is the backbone of the UK economy, creating a significant share of value added, employment and tax revenues. Based on a narrow definition of financial services (excluding other finance-related activities), financial and insurance activities accounted for 7% of total UK Gross Value Added (£120bn) and also 7% of total UK employment (1.1m people) in 2015. Financial services generated 11% of overall UK tax revenues (£66bn) and attracted 45% of total Foreign Direct Investment in the UK.

The EU is the biggest market for financial services and the UK runs a large trade surplus in financial services vis-à-vis the rest of the EU. In other words, it exports more services to the EU27 than it imports from them. In 2015, the UK trade surplus with the EU27 amounted to £19.1bn in financial services. In particular, the City of London, is a major global hub providing wholesale financial services to the EU, such as trading and clearing of derivatives, foreign exchange transactions, repurchase agreements (repos), securities issuance, etc.

What is financial passporting?

‘Financial Passporting’ is the foundation of the EU single market for financial services. It facilitates cross-border trading by enabling institutions (e.g. bank, insurer fund) from one-member state to sell financial services across all EU states. For instance, (under the Capital Requirements Directive IV) a bank based in the UK can directly provide credit services to a corporate based in another EU state.

Cross-border banking activities of the UK with the EU (e.g. deposit taking, mortgage loans) highly rely on financial passport. In this way, UK banks can operate in a cost-efficient way, without having to set up subsidiaries in other member states (which would be subject to the host country financial supervision/ regulation and additional capital requirements).

On the other hand,  it is almost impossible for a non-EU firm to obtain a licence to provide cross-border banking or investment services to EU customers.

What will happen after Brexit?

One thing is extremely simple: After Brexit, the UK will not be able to keep the passport for the EU financial market if it seeks to restrict immigration and free movement of the labour. On top of this, retaining the passport (full access to the EU financial market) would also imply that Britain will continue to take the EU regulation on board without having any ability to influence it and will be subject to rulings of the European Court of Justice.

In the UK, the Brexit debate happens in a highly self-centered way, dominated by a misplaced sense of economic supremacy. Thus, the Brits are totally overlooking a key element: The EU does not want the UK to retain the passport for the EU financial market! Moving finance jobs back to the major EU cities, such as Frankfurt, Luxembourg, Dublin or Paris, is perceived as a great opportunity for the EU to improve scale and efficiency in financial services.

All in all, given the current Brexit stance of the UK government, keeping the financial passport appears highly unlikely. What is next then? After March 2019, financial firms will no longer be able to provide services from their UK headquarters to the rest of the EU. As a result, ten thousands of high paying jobs would migrate to the EU and this will lead to a significant fall in tax revenues. In addition, weaker demand for financial services in the city of London is likely to be a serious drag on economic growth.

This brings us back to my initial point: Since the Brexit vote, both Labour and the Tories preferred to keep the passporting issue vague, giving the illusion that there was some room to negotiate. The fact-based reality is that leaving the Single Market and restricting the free movement of labour means no more free access to the EU financial market. Obviously, this will have disastrous consequences for the UK economy in terms of growth, employment and tax revenues. Once again, Brexit politics chose populist hypocrisy and denial over a comprehensive cost estimation of leaving the Single Market.