Tag: EU

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

Selin Ozyurt

#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.

The Hidden cost of Brexit: How much could border controls and bureaucracy harm the UK manufacturers?

Selin Ozyurt

#Brexit Facts

Recent debate on Brexit has extensively discussed how badly would leaving the EU affect the UK services sector. Obviously, this is a worrying issue which could cause massive job losses, particularly in financial services sector. However, in this post, I would like to discuss the Brexit-related challenges to the UK manufacturing sector. This topic has received only limited attention despite the high economic cost it is likely to involve.

 

Why is the manufacturing sector important to the UK?

Manufacturing exports account for 45 per cent of total UK exports. Pharmaceuticals, aerospace, motor vehicles are the key export-oriented sectors of the UK. The EU is the largest export destination of the UK, accounting for 52 per cent of total exports. The UK manufacturers are strongly integrated into the EU supply chains where natural resources, raw materials and components cross the EU borders a few times before being transformed into finished products. To be more precise, nearly half of the UK’s intermediate goods imports and exports are with other EU countries. The EU27 supply chain also relies on the UK but to a smaller extent: The UK accounts for only 10 per cent of the EU27 intermediate goods exports/imports. The larger exposure of the UK to the EU27 supply chain as well as its relatively small size (only 17% of the EU27 GDP) suggest that any disruption to existing production networks after Brexit would be more harmful to the UK manufacturers (than to the EU27 ones).

Why is Brexit likely to disrupt the EU supply chain? After Brexit, the UK’s borders with the EU will all become external and will be subject to customs controls following the EU law/WTO rules. Under all possible Brexit scenarios (e.g. EEA, CETA, Customs Union, WTO) customs controls and non-tariff barriers are likely to imply  additional costs to trade, also in terms of waiting time.

Why does the waiting time matter for the supply chain? The EU and UK manufacturers follow the ‘just-in time’ principle which makes it necessary to move parts and components quickly and efficiently around the EU. In this way, producers keep stocks at a minimum level to reduce costs. Let’s take the automobile sector as example: The Society of Motor Manufacturers & Traders, estimates that imported components from the EU account for 60 per cent of a ‘British-built’ car. In the same way, two-thirds of UK motor components, are exported to the EU producers to end up in ‘foreign-built’ cars. Even a few days of delays due to customs controls could severely disturb production networks of the automobile industry.

Currently, the Brexit trade debate focusses on negotiating Free Trade Agreements and disregards the additional ‘trade cost’ implied by borders controls, non-tariff barriers and bureaucracy. Most UK exports to the EU are operated through the Channel ports which currently lack the staff, physical infrastructure or software capacity to deal with all-encompassing border controls.

Moreover, even under a zero-tariff agreement with the EU, the re-introduction of ‘rules of origin’ could seriously harm the UK/EU supply chains. In short, ‘rules of origin’ refers to a cumbersome bureaucratic procedure where exporters will have to prove that their goods originated in the UK and that everything that enters the UK has a verified country of origin. All in all, the resulting paperwork, custom delays and compliance costs could seriously paralyse the supply chains by making the UK suppliers less attractive to the EU producers. Recent evidence shows that some companies have already started to replace their UK supplier by the EU ones.

Could the UK manufacturers dump existing EU supply chains and quickly set-up new links in the UK?

The short answer to this question is ‘NO’. The UK workforce is severely lacking ‘vocational’ skills highly  required in sectors such as electrical and mechanical engineering. Without skilled workers in place, it will be almost impossible to build a self-sufficient infrastructure for the UK within a two-year period. Even with ‘good’ educational policies (which are rather unlikely to happen), it would take several years to train the UK workers. Moreover, restrictive immigration policies will not be of any help in filling the skills gap during this transition period.

All in all, my take is that even under a Free Trade Agreement with the EU, Brexit could severely harm the UK manufacturing sector due to the re-establishment of border controls. To minimise the adverse impact of Brexit on supply chains, targeted human capital formation policies should be quickly put in place in order to tackle the UK’s skills shortage problem after Brexit.

 

UK General Election 2017: Why is ‘economy’ being the elephant in the room?

Selin Ozyurt

#Brexit Facts

2017 UK General Election was all about Brexit, which is expected to be a long, painful and unprecedented process. Obviously, before making up their opinions, voters needed some clarity on how the parties planned to handle the Brexit-related issues.

Public debate in the UK General Election campaign was overwhelmingly dominated by issues like health & social spending on the elderly, nuclear weapons, terrorism, policing & security.

Have you noticed that there was a huge omission from the election debate and journalists let both parties get away with that? Yes, it is about Economics! Economy featured very little in the campaign of both major parties with no comprehensive debate on how they would  handle the heavy economic consequences of Brexit. Actually, they did not even bother to give an estimated cost of Brexit under the “hard Brexit” scenario which happens to be the favourite option of both Labour and the Tories (so that the UK can take the control of its borders back).

The UK economy is already showing serious signs of weaknesses mostly driven by the uncertainty surrounding the future EU-UK relationship. Let’s have a quick look to the UK economy as it stands in the first half of 2017:

  • Since the Brexit vote, the British Pound has been depreciating dramatically (about 18%), however exports growth remained disappointingly weak, aggravating the negative contribution of external trade to GDP.
  • Inflation stands well above the target of 2% and the Bank of England expects it to remain close to 3% throughout the year.
  • High inflation is eroding the purchasing power of consumers and real earnings are declining further every quarter.
  • The UK public debt is at historically high levels and lower growth prospects coupled with uncertainty surrounding Brexit negotiations is likely to reduce investors’ appetite to hold UK debt, also in the medium-term.

Against this background, I will pick only 3 issues from a long list of issues to be discussed in the 2017 UK General Election campaign:

  • Pound depreciation does not seem to naturally support the exporting sector. The UK manufacturing sector is extremely small, accounting for less than 10 % of total labour force. Moreover, it is highly inefficient with lower productivity than Italy’s. What kind of policies have the leaders in mind to enhance the exporting sector after leaving the EU?
  • Leaving the EU means leaving the Common Agricultural Policy (CAP). So far, the UK farmers have heavily relied on CAP subsidies, which are worth about £3.5bn a year, making up about 55% of farmers’ incomes. How would the farming sector survive without the EU funds? Would there be a new UK fund allocated to farming?
  • UK public debt is already at historically high levels. Brexit will result in a dramatic decline of tax revenues as a consequence of following developments: Lower economic growth, high inflation, loss of financial passporting rights for the EU, lower demand for services, the relocation of financial activities and the qualified migrants to the Continent, etc. How will the new government cope with declining public revenues without increasing taxes (as higher taxes would further drag the economy down)?

Whoever wins the election, (s)he had to deal with these issues immediately. Then, why was ‘economy’ the elephant in the room during the entire campaign? Did both Labour and Conservative parties even have a plan to deal with these key economic challenges coming with Brexit?

How many Brexiteers do still believe that there is a ‘cake’ and they will truly eat it soon? Sadly, post-truth politics thrived in the General Election and history repeated itself in less than a year. In the name of democracy, UK voters were asked to make a crucial choice for future generations without having any clarity on what they are signing for.