As the date for Britain’s exit from the European Union inches closer, the U.K. is in turmoil over how exactly that withdrawal will look.
Since July, two high-profile pro-Brexit leaders, David Davis and Boris Johnson, have quit the cabinet and British Prime Minister Theresa May released a white paper outlining the government’s vision for its post-Brexit relationship with the European Union.
The renewed risk of a “no-deal Brexit,” in which Britain would leave the EU without having reached an agreement on its ties to the rest of Europe, has become “uncomfortably high,” Bank of England Governor Mark Carney told the BBC on Friday.
And while the deadline for Britain’s withdrawal is March 29, 2019, negotiators reportedly see the next two to three months as crucial, naming October as the time by which a deal must be finalized so it can be ratified by the exit date.
Though a lot remains up in the air right now, it seems clear that in our global economy we can expect Brexit to affect the finance industry and real estate market, as well as trigger a possible global shift in financial power and economic stability.
We don’t know exactly how those changes will play out, but here’s our guide to two of the biggest issues to look out for and what their impact could be.
UK-EU financial services deal
Will Britain strike a deal with the European Union that would give the U.K. a say over the financial regulations to which it must adhere in interactions with EU markets? And what would ultimately make it into such a deal?
The City of London initially sought a “mutual recognition” framework that would allow for both parties to broadly accept each other’s financial regulations, but EU officials have already rejected it.
The white paper released last month proposed a negotiated deal that would expand the rights granted to other non-EU countries under the “equivalence” system, which requires third-country financial regulations to be equivalent with EU regulations.
The EU’s chief negotiator has softened his opposition to the white paper after U.K. negotiators agreed the European Union would have the final say on Britain’s access to European markets, the Financial Times reported. This would appear to indicate that the U.K. is prepared to accept roughly the same level of control over financial regulations as non-EU countries such as the U.S.
IMPACT: Some are concerned that a playing field that makes Britain more level with its non-EU counterparts could reduce the U.K.’s competitive edge and that of its financial institutions.
Howard Davies, chairman of the Royal Bank of Scotland, has downplayed this risk. The choice between Britain’s accepting EU rules (to retain market access) and retaining control of regulation (but losing market access) is actually a “false dilemma,” writes Davies. That’s because the U.K. remains a party to the Basel Accords, which form the basis for much of the EU bank regulations on issues such as capital requirements, irrespective of Britain’s withdrawal from the European Union.
On the other hand, a PricewaterhouseCoopers analysis of the impact of Brexit found that “disruptions to the level of market access in financial services are economically costly,” with the U.K. bearing the brunt of the negative ramifications. In such a situation, Britain “experiences a direct loss of financial services activity and also loses from the wider fragmentation of EU financial markets,” the report found.
If British banks are not granted the extra benefits they are seeking in a financial relationship with the EU, this could give U.S. and Asian financial institutions a boost in Europe by opening up competition. That could potentially have a negative effect on British banks such as HSBC and Barclays – both in terms of their bottom line and their capacity and appetite for loan origination.
The uncertainty surrounding a financial services arrangement has already begun to set off a domino effect, with many banks putting more resources into European hubs outside London – a trend that could very well unseat London as Europe’s financial capital. As addressed below, it could also have negative repercussions on the British economy and, by extension, the global economy, and shift the political and financial landscape in Europe and around the world.
Post-Brexit financial capital of Europe
London has flourished as a financial center partly because global banks have been able to use the city as a base from which to sell their services throughout the European Union. But that is looking more and more like history, writes Bloomberg’s Gavin Finch. “With the clock ticking on Britain’s exit from the 28-nation trading bloc – the complicated international divorce known as Brexit – the city’s status as a banking hub is under threat,” he writes.
What exactly would Britain be losing out on?
Well, finance and related professional services bring about $248 billion annually into Britain, representing 12% of the British economy. Within the EU, the U.K. hosts the largest financial services sector – accounting for 24% of the gross value added produced by that sector in the EU in 2015, the PwC report on the impact of Brexit found. At 15.9%, Germany came in a distant second, and was followed by France, Italy and the Netherlands.
Now that London’s standing in the finance world is being threatened by the specter of restricted access to the EU market, those numbers signal the extent of the city’s exposure to Brexit fallout. London could lose 10,000 banking jobs and 20,000 roles in financial services, with $2.1 trillion of assets potentially being moved out of the U.K. due to Brexit, according to the Brussels-based economic think tank Bruegel.
One open question is which city is next in line to become Europe’s financial center.
For a while it was looking like Frankfurt would replace London as the financial capital of Europe, with the Association of Foreign Banks in Germany saying in March it expected about 20 banks to expand their presence in Germany after Brexit and thousands of new finance-related jobs to be created in Frankfurt. Morgan Stanley, for instance, has chosen Frankfurt as the site for a second European hub in addition to London, and may relocate 200 employees out of Britain.
Indeed, London’s role in euro clearing, in which it has served as the primary clearinghouse for euro-denominated financial products, appears set to diminish. Deutsche Bank is one of the latest institutions to move much of its euro-clearing activities out of London. The bank has shifted its euro trade to a base in Frankfurt, where its headquarters are located (though Deutsche says jobs have not been affectedby the change).
But as more financial institutions have decided where to move at least part of their operations ‒ even as they continue to retain a presence in London ‒ it is increasingly looking like that financial power might be diffuse rather than concentrated in a single city. London and Frankfurt have found competition in contenders like Paris and Dublin.
“Most banks are spreading jobs widely across Europe to keep all relocation options open,” said Hubertus Vaeth, managing director of Frankfurt Main Finance, the financial center initiative for Frankfurt am Main.
Big banks that seem to be hedging their bets on Europe’s future include Bank of America, Citigroup, Goldman Sachs and JPMorgan.
Bank of America has selected Dublin as its new base of EU operations, and is also expanding investment banking activities in Paris ‒ as well as extending the lease on its London headquarters until 2032. Citigroup chose Frankfurt as its new European trading hub, while also boosting its Paris offices and setting up an innovation centerin London. Goldman Sachs has said it will have hubs in both Frankfurt and Paris, where the European Banking Authority is moving.
And JPMorgan Chase, which recently asked several dozen U.K. employees to consider relocation, has banking licenses in Frankfurt, Dublin and Luxembourg, and is adding staff in cities including Paris, Madrid and Milan. Depending on the result of Brexit talks, more than 4,000 JPMorgan jobs (of its 16,000 in the U.K.) could get shipped out of Britain.
British banks are looking beyond London too, with Barclays expanding its operations in Dublin and moving some investment banking jobs to Frankfurt, and HSBC relocating jobs and parts of its business to Paris. Even the London Stock Exchange has started implementing contingency plans to prepare for the possibility of a no-deal Brexit.
IMPACT: The fragmentation of the financial services industry comes with a hefty price tag, PricewaterhouseCoopers found in its report analyzing the impact of Brexit.
On the level of individual financial institutions, there are, of course, the one-time costs of relocation. Beyond that, the report warns of ongoing costs for financial services firms operating in Europe and reduced efficiency of the financial services sector as a whole, citing lower labor productivity, higher capital and liquidity requirements for subsidiary bank branch operations, the duplication of corporate and operational costs, and a reduction in the depth of market liquidity.
Even the locations that seem poised to be the winners here, by gaining a bigger share of the financial services sector as London loses its luster, “are also more negatively impacted from the fragmentation of EU financial markets, so for them the overall impact is still negative,” the report found.
A global shift away from London could well have negative repercussions on British-based financial institutions and corporations, the City of London, the British economy and the health of the pound. But the dominos may not stop there. The interconnectedness of our global economy indicates that those repercussions could easily spread to the EU and the rest of the world.
The British economy could experience such a major downturn, JPMorgan CEO Jamie Dimon said in July, that it “will have an impact on global growth, and so Brexit could hurt everybody a bit.”
Britain’s close economic ties with the EU market mean that not only does the U.K. need to worry about basics like its food supply, but the European Union – as Britain’s biggest trading partner, accounting for 44% of U.K. exports – also has cause for concern.
U.S.-based banks are hardly immune either. Major U.S. investment banks have been using London as a base for European capital markets, with 80% of their EMEA (Europe, Middle East and Africa) revenues generated in the U.K. as of 2014, the PwC report found.
The impact of Brexit is not necessarily going to be negative all around, of course. For instance, while some investors and lenders may turn their backs on what they fear is a sinking Britain, opportunistic investors may see U.K. properties or shares of U.K.-based corporations as undervalued ‒ and rush to buy at attractive yields.
As for British and possibly EU-based financial institutions, they may find it makes more sense to look toward the U.S. for new activity given the difficulties in reaching a U.K.-EU deal. There is certainly room for growth; in 2017, no British banks were among the top 10 commercial real estate lenders in New York City, and HSBC was the only one in the top 20, a CrediFi analysis has found. Yet at the same time, U.K. banks may be constrained by an increased cost of capital if they face a weakened economy and currency at home.
Indeed, though much of the talk about who could benefit from Brexit has centered around prospective European substitutes for London, it may be markets across the Atlantic that are poised to gain at least as much.
Setting aside the prospect of trade wars, the U.S. economy, financial system and real estate market may come to be perceived as among the world’s most stable in the midst of Brexit-induced European upheaval. More specifically, New York City could potentially be a bigger winner than a Frankfurt or Paris embroiled in a de facto power-sharing situation with other European cities. All that dispersed financial activity may make it tough for any one city to challenge the Big Apple as the world’s one-stop financial epicenter.
In addition, real estate (at least outside the U.K.) may become more attractive as a reassuringly tangible asset class, particularly if British and European financial markets and foreign exchange rates become increasingly volatile. Gateway cities and secondary markets in the U.S. could see a rise in the appeal and value of their real estate just as property prices drop in Britain and possibly other parts of Europe.
And global alliances may also shift, with Brexit fears potentially trumping U.S.-China tensions.
Though there may be some winners in the still-murky post-Brexit future, it seems likely that Britain’s exit from the European Union ‒ especially if it takes place without a negotiated deal ‒ will have negative repercussions that affect not just the U.K. economy but also economic stability around the world.