Tag: Single Market

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.

Evils Never Come Alone: Brexit & Sharp Depreciation of the Pound – What is Next?

Selin Ozyurt

#Brexit Facts

One of the immediate consequences of the Brexit vote in June 2016 was the sharp depreciation of the pound against virtually all major currencies. The pound has not recovered since then and showed strong volatility during major political events (e.g. May’s October 2016 Speech, the announcement of the snap general election). It is striking that the UK government did not communicate much about the causes and consequences of the depreciation. In the general election campaign the depreciation  was treated as an external ‘calamity’ and his painful consequences for the Brits were mostly excluded from the political debate.

Main economic impacts of  the currency depreciation on the UK economy are:

  • High inflation, mostly driven by high energy and food prices
  • Erosion of the purchasing power and wealth of households
  • Declining real wages (for the first time since mid-2014)
  • Weaker demand: slowdown of consumption and investment

As opposed to Brexiteers’ expectations, a cheaper currency did not support growth by boosting  exports. The economy lost momentum and the UK became the slowest growing G7 country in the first quarter of 2017.

Part 1: Why did the pound fall sharply after the Brexit vote?

Let’s have a closer look at the reasons behind the dramatic fall of the pound. You will see that, the ‘why’ of the depreciation is tightly related to the policies followed by the government. I will only mention 3 guiding principles of international finance, which will explain the situation:

  • Financial markets seek to price ‘today’ what they expect to happen in the ‘future’.
  • Capital tends to flow to countries that can make productive use of it or where assets are safe.
  • Investors do not like uncertainty!

The pound fell immediately following the Brexit vote as markets believed that UK economy would grow slower and be less productive after leaving the Single Market. The core belief was that the value of the pound would remain persistently low after Brexit. Thus, massive pound sell-offs followed the  vote. The perverse effect of the sell-offs was  immediate pound  depreciation although the UK economy was doing ‘fairly’ good at that time.

This brings me to the next question: Why would the UK economic growth and productivity slowdown after leaving the EU? UK economy has significantly benefited from access to the Single Market via increased specialisation (especially in financial services) and better efficiency. In this sense, leaving such a large common market is equivalent to a ‘deglobalisation’ shock and scaling down production. To illustrate, financial services being scattered across major European cities would mean less specialisation, less efficiency and lower productivity for the city of London.

Moreover, restrictions to labour migration will eventually weigh on  growth and productivity. Skill shortage is already a serious issue in some  sectors such as information technology, healthcare and engineering. More importantly, the UK immigrant workers happen to be more educated on average than the natives. All in all, labour migration restrictions  are estimated to reduce the UK GDP by 0.6% to 1.2% until 2020  (Portes and Forte 2017).

Here is the warning by the HM Treasury before the Brexit vote:

“If voters choose to leave the EU, Britain would be “permanently poorer”! Productivity and GDP per person would be lower in all alternative scenarios, as the costs would substantially outweigh any potential benefit of leaving the Single Market. Separating from the EU would reduce GDP by 6% to 7.5% permanently.”

Last but not least, financial investors do not like “uncertainty”. The uncertainty around the future UK-EU relationship was one of the major forces driving the pound down over the last year. In particular, the incoherent approach of the government to the negotiations created serious doubts about their capability to negotiate an ‘acceptable’ deal for the UK. In an uncertain economic environment, firms adopt a ‘wait and see’ approach and delay investment decisions. Again, weaker investment becomes a drag on economic growth and productivity.