The Impact of Brexit on Financial Services: When We (re)discover the Value of Passporting
On the 23rd of June, the “yes” vote to Great Britain’s referendum on EU membership had the effect of an earthquake. Nobody really expected it, had prepared for it and evaluated its costs. For the first time since the beginning of The European Coal and Steel Community, a country opted out of the European Union.
Brexit: the short-term political and economic storm
The first ripple effect of the Brexit was the resignation of David Cameron, the nomination of Theresa May with an entire cabinet reshuffle and the crisis in the Labour party which still goes on today. The most visible short-term impact of Brexit on the economy was the plunge in the value of the pound, which reached even lower levels than during the 2008 crisis.
At the end of August, the 5-year breakeven inflation rate climbed to 2.7 per cent, its highest level since 2014. It has surged 40 basis points since the UK voted to leave the EU and 55bps since the start of the year. Some UK markets were deeply affected as housing. Property groups have been hard-hit since the vote as investors fear the impact of economic uncertainty on sales volumes and prices. Shares in Berkeley Group, one of the main housebuilders in the UK, have fallen 19 per cent, which forced it out of the FTSE 100 in August. On the contrary, economic uncertainty has increased gold prices by 25% so far this year and the housebuilder will be replaced by gold miner Polymetal.
The long term uncertainty – 4 possible scenarios
While the referendum’s outcome has had a significant impact on the public’s mindset and on the cabinet, it is still not clear yet what the long term impact of the decision will be. Plenty of ink has been used to describe what could happen, but there are four main options to be considered:
The European Economic Area membership. As does Norway, the UK would be able to access the Single Market. It implies not only accepting free movement of labour, as well as capital, goods & services, particularly financial services, but also complying with EU rules and contributing to EU budget. Everything without the ability to vote on EU legislation.
The European Free Trade Association membership (The Swiss choice). It allows a high degree of access to the Single Market for goods, but restricted degree for services. The UK would loose the passporting and maintain free movement of labour and EU contributions.
The Canada option includes a comprehensive free trade agreement with EU-level ratification, but excludes Single Market in services.
A last option would be to have customs union with the EU as Turkey has, in order to trade tariff free on goods.
For the payment industry, one of the core advantage of the European Union is the notion of passporting. Financial authorisations such as the payment institution license, the E-Money institution license or the banking licence, obtained in one of the EU countries were easily recognised and obtainable in the other countries. It means that a registered payment institution located in the UK, after being recognised by the local authorities as such, could offer its services to companies located in any other European country without having to register again in each state. This passporting concept doesn’t even exist between the states of the United States of America. Any business entity which provides payment instruments is required to register as Money Transmitter in each state as regulatory laws vary from one state to the other. The only negotiation agreement which would maintain passporting as it is today is the EEA membership, and it is quite unlikely that the UK will negotiate on this basis for obvious national positions. Voters in favour of Brexit hugely supported migration restrictions and rejected the costs of the EU. As a result, the financial industry is bound to suffer a regulatory earthquake. But no one can predict today the creativity of the negotiators and the regulators. Many ways can be found mixing the four aforesaid scenarios.
The UK startup ecosystem: disapproval but optimism
One legitimate question is: how will the financial start-ups react to any potential policy changes? The most probable situation is that they will be very agile. TechCity UK, the government community championing the digital sector in the UK, launched a survey in the aftermath of the referendum. They surveyed 1,205 people working in tech between 27 June and 5 July.
The startup ecosystem massively supported the remain vote on the 23rd of June for many reasons, including the fact that the international community is widely represented amongst the entrepreneurs and that the easy access to the Single Market is an important asset for the start-ups business development potential. Despite this position, the survey showed that the entrepreneur world stayed resolutely optimistic. The main concerns related to recruitment, skills and investment. On the one hand, 51% said they thought that it would be more difficult to attract and retain the very best talent, and 74% believed the business environment might get worse. However, on the other hand, only 22% expected to scale back their planned growth ambitions. Indeed, adapting to a fast changing environment and developing business cross-border is part of the tech entrepreneurs’ DNA.
In the beginning of July, several important fund raisings were announced: £50 million for Darktrace, a British cyber-security firm, $8.5 million for what3words and £7.75 million for the FinTech Revolut. One would believe it’s business as usual.