Blog Post

Brexit endangers London’s status as a financial hub

The UK’s competitive edge in financial services is substantial and would be difficult to dislodge. But Brexit could damage London’s attractiveness as the centre of European banking, as an entry point to the EU and as a global financial hub. FDI is also at risk.

By: and Date: March 10, 2016 Finance & Financial Regulation Tags & Topics

London’s strength as a global financial centre is impressive. The British capital has a share of nearly 50% in certain segments of global financial markets. Table 1 shows that the UK hosts  48.9% of the world’s interest rate over-the-counter (OTC) derivatives turnover and 40.9% of foreign exchange (FX) turnover. The UK is also one of the main players in the US equities trades, with 20% of the global market. By contrast, other European countries play only a comparatively small role in global markets: France hosts 7.3% of interest rate OTC derivatives, and 2.8% of FX turnovers. In terms of European markets, the UK and Germany each have a share of more than 20% in the issuance of securitisation. The share of investment fund assets in Europe is 24% for the UK, compared to 22% in France and 17% in Germany.

In general, the UK has been accumulating  substantial surpluses in trade of financial services over the last 15 years. Looking at the geographical distribution of UK financial service export in 2013, we see that 30% was with the European Union, while 70% was with the rest of the world. .

Recent research has found that the synchronisation of business cycles between the UK and the euro area has increased since the end of the 1990s. Campos and Macchiarelli have recently argued that this probably increases the costs of a potential UK exit from the EU. In a recent paper, we found that the UK credit cycle – measured here as the filtered growth of real bank credit to the private sector – has also become significantly more aligned with the credit cycle of the euro area, particularly since the end of the 1990s (figure 2). This suggests that EU-UK financial linkages have become tighter, although it does not tell us who would suffer the most from the financial consequences of Brexit. We should therefore look more in depth at specific aspects of UK-EU financial integration.

International integration of the banking sector

Turning to cross-border banking, table 2 shows that the banking sector of the euro area consists of 83% domestic banks, 14% banks from other EU countries, and only 3% from third countries. The rate of cross-border integration in the entire EU banking sector is even higher. 16 % of total bank assets are owned by banks based in other EU countries, and 9 % by banks from the rest of the world. By contrast, the UK seems to be a special case.  It is the only EU country with more claims from banks in the rest of the world (32 %) than from banks headquartered in the rest of the EU (17 %).

This can be explained through the role of major US and Swiss (investment) banks, which use their London offices as a springboard to conduct business across the EU. Indeed, when asked about the importance of EU membership for financial service businesses located in the UK, 49% of high-level professionals from “The City” cited access to EU customers and 46% cited the single regulatory framework for financial services as very important for their own business (see Ipsos Mori poll, 2013). The former is guaranteed through the role of UK authorities in ‘passporting’ banking and other financial services. Currently any firm headquartered in the UK can apply for a passport from the UK regulators to do business in the whole of the European Economic Area. The latter is granted through the European Court of Justice, which is in charge of enforcing single market rules.  84% of respondents said that the best option for the overall competitiveness of the UK as a financial center would be to remain a member of the EU.

Foreign direct investment in the UK

Beyond financial services, many European firms invest in the UK in a variety of sectors. When looking at the inward stock of Foreign Direct Investment (FDI), the EU is the biggest FDI investor in the UK, with nearly 500 bn GBP invested in 2014, as opposed to 253 bn GBP invested by the US (figure 3). The FDI investment of European firms is spread across different sectors (figure 4), in 2014 most notably retail and wholesale trade (83.2 bn), mining (67.5 bn), IT (48.7 bn) and financial services (47.5 bn).

In this context, 415 members of the Confederation of British Industry (CBI) in  a survey conducted by YouGov in 2013 also valued the financial aspects of EU membership: 52% of respondents said that the ability to invest in other EU states without restrictions had a positive or very positive impact on their business; 42% said that the ability of their company to attract inward investment from companies based in the EU would be negatively affected by the UK leaving the EU and 32% said that their company’s ability to attract investment from companies based in non-EU countries would be reduced. A sizable 75% of respondents expected that Brexit would have a negative impact on the level of FDI.

Brexit uncertainty

If Brexit happens, the advantages of EU membership that businesses appear to consider the most significant could be at risk. The UK’s passporting capacity in financial service might have to be re-negotiated. The UK’s adherence to a single rulebook would also be called into question, as exiting the EU would mean exiting the jurisdiction of the  European Court of Justice. However, much would depend on the exact form of EU-UK relationship that was built after Brexit. The UK could opt for a Norwegian-style agreement, and join the European Economic Area (EEA) with full access to the single market. It would then fall under the jurisdiction of the EFTA Court of Justice, which enforces European laws in countries which are part of the EEA, but outside the EU.This would mean adopting regulations and standards without much influence on their development, an awkward situation for the EEA’s preeminent financial centre. Another alternative would be free trade agreements or bilateral agreements, which could guarantee access to the single market in selected sectors while preserving independence in others.

However, the outcome of any negotiations for single market access or shared regulation is uncertain. This uncertainty alone could prove destabilising. Even if a new deal were eventually reached, the confusion surrounding the negotiations would have negative consequences for European firms operating in the UK and might endanger FDI flows to the UK. The attractiveness of London as a global financial hub and springboard to Europe might also suffer.

 


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article More on this topic More by this author

Opinion

IMG_1985

The G20 in a post-Brexit world

As Britain enters a period of political and economic instability, following a referendum vote that many now interpret as anti-globalisation, it is worth reflecting on what the consequences of Brexit will be for the world’s ‘economic steering committee’: the G20.

By: Alessio Terzi Topic: Global Economics & Governance Date: August 18, 2016
Read article More on this topic More by this author

Blog Post

IMG_1985

How to make the single market more inclusive after Brexit

The creation of the single market generated winners and losers. Yet redistribution remains first and foremost a competence of national governments. It is thus fair to state that a failure in national, more than European, policies and welfare systems can be partly blamed for current discontent with the EU and the single market.

By: Alessio Terzi Topic: European Macroeconomics & Governance Date: August 18, 2016
Read about event More on this topic

Upcoming Event

Oct
4
12:30

Barriers to long-term investment

Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article Download PDF

Policy Contribution

coverEuropean Parliament

Total assets versus risk weighted assets: does it matter for MREL?

As a consequence of the global financial crisis, various initiatives have been taken in different jurisdictions to ensure the future resolvability of banks without massive use of public funds. In Europe, the BRRD introduced the concept of MREL, which is in the process of being defined.

By: Bennet Berger, Pia Hüttl and Silvia Merler Topic: European Parliament, Finance & Financial Regulation Date: August 9, 2016
Read article More on this topic More by this author

Opinion

Dalia Marin

What’s the matter with Austria?

Austrian firms invested heavily in Central and Eastern Europe. They offshored the parts of the value chain that required specialized skills and produced valuable research. This resulted in lowered growth in Austria.

By: Dalia Marin Topic: European Macroeconomics & Governance Date: August 9, 2016
Read article More on this topic

Blog Post

Scott Marcus
IMG_20151119_103626

Brexit and its potential impact on international data transfers

If the UK exits the EU and the EEA, it will have to go to considerable lengths to enable continued data transfers from the EU. Without an agreement on data transfers and data protection, business in the UK and the EU will be disrupted.

By: J. Scott Marcus and Georgios Petropoulos Topic: Innovation & Competition Policy Date: August 4, 2016
Read article More on this topic More by this author

Blog Post

André Sapir

Should the UK pull out of the EU customs union?

The UK Government appears divided on whether the United Kingdom should seek to remain within the European Union’s customs union after Brexit. The United Kingdom is likely to want to leave the customs union, even it remains in the EU’s single market. But the UK should try and keep to the EU’s commitments at the WTO, at least at the start, in order to minimise the trade disruption that Brexit entails.

By: André Sapir Topic: European Macroeconomics & Governance Date: August 1, 2016
Read article More on this topic

Opinion

Grégory Claeys
Schoenmaker pic

Now is the time to open Strasbourg’s ‘Bronislaw Geremek’ European University

It is the right time to revive the proposal made 10 years ago by Bronislaw Geremek and Jean-Didier Vincent to create a truly European University in the European Parliament buildings in Strasbourg.

By: Grégory Claeys and Dirk Schoenmaker Topic: European Macroeconomics & Governance Date: August 1, 2016
Read article More on this topic More by this author

Blog Post

Nataraj_Geethanjali_Profile-Picture1

Will TTIP survive Brexit?

There are concerns that the UK’s decision to leave the EU may jeopardise future TTIP negotiations. Some fear Brexit could make the EU a less attractive trade partner for the US. However, it seems that the new US administration as well as upcoming elections in Germany and France could end up posing bigger threats to the trade agreement than Brexit.

By: Geethanjali Nataraj Topic: Global Economics & Governance Date: July 27, 2016
Read article More by this author

Opinion

Alicia García-Herrero

‘Old China’ bad, ‘New China’ good: Growing divergence in Chinese corporate health

Divergence in debt levels and corporate health in China is growing, with many state-owned companies still stuck in the past and new industries such as tourism and healthcare overtaking the old ones. While fiscal and monetary stimulus may temporarily cover up the problems of companies in the old industries, a restructuring of these sectors seems inevitable.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: July 26, 2016
Read article More by this author

Blog Post

Zsolt Darvas

Single market access from outside the EU: three key prerequisites

In relative terms, Norway’s current net financial contribution to the EU is similar to the UK’s. Switzerland and Liechtenstein pay surprisingly little, while Iceland is a net beneficiary. Relative to their population, Switzerland, Norway, Iceland and Liechtenstein received about twice as large an inflow of EU immigrants as the UK. These countries also have to adopt the vast majority of EU regulation to gain access to the single market.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: July 19, 2016
Read article More on this topic More by this author

Opinion

Guntram B. Wolff

The difficulties of defining EU-UK economic relations

Negotiations on the UK's exit from the EU have not yet begun, but the UK leadership needs to find a balance between single market access and free movement. There are also tensions between the demands of voters and what EU partners can plausibly agree. Guntram Wolff doubts the likelihood of a Norway- or Switzerland-style deals, and urges caution on all sides.

By: Guntram B. Wolff Topic: European Macroeconomics & Governance Date: July 19, 2016
Load more posts