Research commissioned by Woodford Investment Management, the independent asset manager set up by one of the UK’s best known portfolio managers Neil Woodford, suggests that UK exports of financial services to the EU could be halved by loss of passporting rights following a Brexit.
The report, produced by Capital Economics, estimates that “without passporting rights, it is conceivable that exports of financial services to the European Union could fall by half, or about £10bn (€12.8bn).”
This figures is derived from analysis of the most recent set of full year data, 2013, outlining exports of financial services to the EU of some £19.4bn. Imports that year were £3.3bn, resulting in a £16.1bn surplus, or 0.9% of UK GDP.
“Although there are no tariffs on financial services, leaving the European Union could lose Britain its ‘passporting rights’. These allow British-based institutions to sell into the rest of the European Union without having a branch there. Similarly, banks in, say, the United States can locate in the United Kingdom and sell to the European Union without setting up there.”
“There is major uncertainty over how important this issue is. Losing these rights could mean that banks would just have to set up a brass plate subsidiary in the European Union to process business essentially still done in London. But it is also possible that it would prompt the United Kingdom to lose large amounts of business to the European Union.”
The report notes that there is a way around the passporting rights issue, but it is one that would probably not be politically acceptable in the ongoing Brexit debate in the UK.
“United Kingdom could preserve its single market access and passporting rights if it remained in the European Economic Area. But this could still hurt the City, as Britain would have to adopt all European Union financial rules and many other regulations but would lose its ability to influence and / or block any damaging ones. The European Union could even deliberately undermine the City in order to win business for Frankfurt and Paris.”
Evidence from other models used by non-EU states who are also trying to sell into Europe do not bode well, the figures from Capital Economics suggest.
“If Britain did not want to stay in the European Economic Area, it could still negotiate bilateral trade agreements with the European Union, as Switzerland has done. But Swiss banks do not have passporting rights and so operate their European investment banking businesses through subsidiaries in London. This may help to explain why Swiss exports of financial services have performed worse than British exports over the last 15 years, despite the outperformance of the Swiss financial sector as a whole.”
However, Capital Economics warns that even if the UK wanted to use such a model, it would probably get a worse deal in its negotiations with the remaining EU states.
“It is unlikely that the United Kingdom would get a deal with the European Union as good as Switzerland’s. The Swiss negotiated their deal when they were planning to join the European Union; there would be less goodwill for a country leaving it. Although Britain could retaliate with its own barriers to trade in financial services, it has much more to lose given the disparity in trade. Indeed, financial services are the part of the economy where trade negotiations probably stand the smallest chance of success.”
“Meanwhile, non-European Economic Area institutions may soon face bigger barriers to providing financial services within the European Union when the Markets in Financial Instruments Directive II rules are introduced in January 2017. In essence, these rules force non-European Economic Area providers of financial services to have equivalent levels of regulation in their home country before doing business across the European Union.”
“So, Britain’s financial services exports to the European Union would probably be hit by Brexit. In addition, it would be wrong to assume that leaving the European Union would result in less regulation on the City. The British government has shown more zeal for regulation than its continental peers recently. Unlike those in other European Union countries, Britain’s banks will be required to ring fence their retail banks from their commercial banks from 2019. The Bank of England’s stress tests were tougher than the European Banking Authority’s last year.”
However, looking further ahead, Capital Economics suggests that the UK financial services sector could recover, as it builds more trade with other markets.
“Overall, financial services have more to lose immediately after a European Union exit than most other sectors of the economy. Even in the best case scenario, in which passporting rights were preserved, the United Kingdom would still lose influence over the single market’s rules. The City would probably be hurt in the short term, but it would not spell disaster. The City’s competitive advantage is founded on more than just unfettered access to the single market. A European Union exit would enable the United Kingdom to broker trade deals with emerging markets that could pay dividends for the financial services sector in the long run.”