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 Topic: Finance & Financial Regulation

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 by this author

Blog Post

The impact of Brexit on the Irish energy system – pragmatism vs. principles

Brexit promises pain for Ireland that could be cut off from the EU internal market and be left exposed to market instability in the UK. Georg Zachmann assesses the scale of the possible damage for Ireland, and how the UK and EU might use the special energy relations on the Irish island to commit to a pragmatic solution.

By: Georg Zachmann Topic: Energy & Climate, European Macroeconomics & Governance Date: November 21, 2017
Read about event

Upcoming Event

Dec
6
12:00

Zombie firms and weak productivity: what role for policy?

At this event, we will have the chance to discuss the final findings of OECD's project on Exit Policies and Productivity Growth, which started at the end of 2015.

Speakers: Carlo Altomonte, Dan Andrews, Giuseppe Nicoletti and Reinhilde Veugelers Topic: Finance & Financial Regulation, Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic

Upcoming Event

Dec
12
12:30

The impact of Brexit for Research & Innovation in Europe

This event will feature a new and interactive format, with a restricted and high-level on-site audience and in parallel, it will be livestreamed on our website to remain public and attract the widest participation

Speakers: Alastair Buchan, Matt Dann, David Earnshaw, Kurt Deketelaere, Maryline Fiaschi, Martin Muller, Christian Naczinsky and Reinhilde Veugelers Topic: Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article Download PDF

Policy Contribution

A ‘twin peaks’ vision for Europe

The organisation of the European Supervisory Authorities (ESAs) is based on a sectoral approach with one ESA for each sector, with separate authorities for banking, insurance and securities and markets. But is this sectoral approach still valid? This Policy Contribution outlines a long-term vision for the supervisory architecture in the European Union.

By: Dirk Schoenmaker and Nicolas Véron Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: November 13, 2017
Read article More on this topic More by this author

Blog Post

The Bank of England’s dovish hike

For the first time since 2007, the Bank of England raised interest rates, with a hike of 25 basis points. At the same time, it provided forward guidance that outlines a very gradual path for future increases. We review the economic blogosphere’s reaction to this decision.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: November 6, 2017
Read article More on this topic More by this author

Blog Post

Falling Pound might not bring UK trade balance boost

The Pound Sterling depreciated by 14% against a basket of world currencies in the four months after the referendum vote to leave the EU. A number of pundits claimed that this would improve the UK trade balance and boost the economy. But the data do not show any visible improvement in the trade balance to date. Could it be that currency depreciations have less impact on trade balances than before?

By: Nicholas Branigan Topic: European Macroeconomics & Governance Date: October 31, 2017
Read article More on this topic More by this author

Blog Post

EU borders: walking backwards from Northern Ireland to Cyprus

The Good Friday agreement put to rest age-old conflicts on Ireland. It also offered hope that the reunification of Cyprus might be possible within the European Union. Lately, however, the “Green Line” that divides the easternmost island of the EU, is viewed as a template for a soft border at the westernmost island of the Union after Brexit.

By: Stavros Zenios Topic: European Macroeconomics & Governance Date: October 25, 2017
Read article More by this author

Blog Post

Bailout, bail-in and incentives

Ever since the outbreak of the global financial crisis, more and more rules have been developed to reduce the public cost of banking crises and increase the private sector’s share of the cost. We review some of the recent academic literature on bailout, bail-in and incentives.

By: Silvia Merler Topic: Finance & Financial Regulation, Global Economics & Governance Date: October 23, 2017
Read article

Blog Post

India’s trade ties with the UK and EU

As EU and Indian leaders meet in Delhi, we look at the figures on trade. The UK’s place in the relationship warrants special attention. EU-India trade has more than tripled since 2000, but UK-India trade is largely static. The shift is especially noticeable for EU exports to India, where the UK share has dropped from 29% to 10%.

By: Maria Demertzis and Alexander Roth Topic: European Macroeconomics & Governance, Global Economics & Governance Date: October 6, 2017
Read article More on this topic More by this author

Blog Post

Catalonia and the Spanish banking system

As tensions rise around Catalonia's independence movement, there are worries about the impact on the Spanish banking sector. Banks based in Catalonia account for around 14% of total assets. Some major institutions are already moving their headquarters to other parts of Spain. However, most Spanish banks have significant exposure to the Catalan market, and all could be caught up in the turmoil.

By: Yana Myachenkova Topic: European Macroeconomics & Governance Date: October 6, 2017
Read article Download PDF More on this topic

Policy Contribution

A European perspective on overindebtedness

The sequence of crisis and policy responses after mid-2007 was a gradual recognition of the unsustainability of the euro-area policy framework. The bank-sovereign vicious circle was first observed in 2009 and became widely acknowledged in the course of 2011 and early 2012. The most impactful initiative has been the initiation of a banking union in mid-2012, but this remains incomplete and needs strengthening.

By: Nicolas Véron and Jeromin Zettelmeyer Topic: European Macroeconomics & Governance Date: September 28, 2017
Read article More on this topic More by this author

Blog Post

Chinese banks: An endless cat and mouse game benefitting large players

As deleveraging moves up in the scale of objectives of the Chinese leadership, banks now face more restrictions from regulators. As a result, banks have been very creative in playing the cat and mouse game in front of evolving regulations.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: September 26, 2017
Load more posts